What next for planet sub–zero bond yields?
Global bond markets have continued their rally this year despite record low yields. Most prominently German bunds are leading the way in Europe with record low yields. German 10-year bunds (generously) offer minus 60 basis points (bps). French and other core European bonds have also entered the sub-zero world, raising the questions of the added value of fixed income investments and the question why would someone consider buying a bond in order to capitalise a loss with certainty (when held to maturity)?
The idea of a safe-haven investment in the above context seems debatable. But there seems to be value in negative yielding investments and yes there is life under the surface of 0%. Institutional buyers keep the market alive: for example, mandated institutional investors who must provide positive returns overcome re-investment risk by investing in long duration bonds. Active managers, on the other hand, take advantage of relative opportunities rather absolute yield while providing positive returns for their investors.
Profiting from negative yielding bonds
Who would have thought in January that one of the best performing asset classes this year would be German bunds yielding 25bps? Buying ultra-long bonds at record low yields just seems counterintuitive. Investors who were brave enough to buy the 100-year Austrian sovereign bond at a price of 120 in January and a yield of 1.6% would have made over 60% so far. So for the doubters, there should be enough evidence that there is money to be made even in a negative or low yielding world of bonds.
Trend to lower yields set to persist
Investing in long-dated bonds is not the solution per se in a low-yielding environment. So it is advisable to look at the likely scenarios from here.
For now, investor concerns about the implications of the late cycle as well as risks arising from trade tensions and Brexit dominate. We believe that it would require a substantial change in the current landscape for yields to trend higher again. There are simply too many factors that weigh on bond yields: political uncertainties which lead to a deterioration in growth, lower trending inflation and central banks starting to lower yields around the globe.
The market, as ever, seems biased and tends to overshoot. A more positive outcome from US-China trade negotiations or US gross domestic product growth resisting significant falls could lead to some repricing. In the longer run, however, it will be the US and European central banks’ main aim of tackling lower trending inflation that takes precedence. Leaving rates unchanged or hiking is the least likely scenario and rates will continue to anticipate this.
Diversification is key
Where should investors invest in a world of negative yields? It primarily depends on each investor’s return target, risk profile, investment restrictions and preferences as well as other factors. In the long run we believe in diversified multi-asset portfolios that can withstand short-term volatility, sharp pricing actions or even negative yields. Our parents and grandparents always had the answer and we never liked it: too much of anything can be bad for you. This could be even true for low yielding even negative yielding money market investments.
We think that investors must take measured risk to achieve their investment goals in the long term. From a market perspective we see value in investment grade bonds, selected emerging market bonds and quality stocks as diversifying options to achieve positive returns in the long run.
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