Bond in­vestors in Europe and Ja­pan are los­ing money to save it

▶ In­vestors in Europe and Ja­pan are pay­ing up for safety ▶ “At the mo­ment there seem to be few al­ter­na­tives”

Bloomberg Businessweek (Asia) - - CONTENTS - −Lukanyo Mnyanda and Eshe Nelson

It’s not as if Christoph Kind rel­ishes putting his clients’ money into bonds that pay noth­ing in in­ter­est and can all but guar­an­tee losses. But Kind, the head of al­lo­ca­tion at Frank­furt-Trust As­set Man­age­ment in Ger­many, is do­ing just that. And he’s hardly the only one.

In Europe and Ja­pan, cen­tral banks have set some rates below zero— an idea that’s hard to get one’s head around. But neg­a­tive yields for bond in­vestors have al­ready be­come an ev­ery­day re­al­ity.

Yields fall when bond prices rise. They go neg­a­tive when the price is higher than all fu­ture in­ter­est and prin­ci­pal pay­ments. In Ger­many, surg­ing de­mand for two-year govern­ment debt has pushed yields to -0.53 per­cent per year, mean­ing an in­vest­ment of €10,000 would pay back only €9,894. The av­er­age yield on all €1.1 tril­lion ($1.2 tril­lion) in Ger­man bonds was sub-zero ev­ery day for more than two weeks as of Feb. 23. That’s the long­est stretch of money-los­ing rates ever, ac­cord­ing to Bank of Amer­ica. In Ja­pan, bond prices are so high that al­most two-thirds of govern­ment debt, amount­ing to $4.5 tril­lion, has a neg­a­tive yield, ac­cord­ing to data com­piled by Bloomberg.

Be­hind the low rates are fear and grow­ing skep­ti­cism that cen­tral banks’ dra­matic rate cuts will be enough to reignite the global econ­omy. Wor­ries over the eco­nomic health of China and the U.S., plus volatil­ity in stocks and oil prices, have many in­vestors look­ing for safe as­sets. Even with slightly neg­a­tive yields, the bonds is­sued by Ger­many and Ja­pan at least of­fer liq­uid­ity and the as­sur­ance that they won’t de­fault.

“Risk-free now has a cost,” and clients are learn­ing that they should ac­cept it, says Mauro Vit­tor­angeli, a se­nior fixed-in­come money man­ager at Al­lianz Global In­vestors, which over­sees about $505 bil­lion in as­sets.

The low rates also sug­gest mar­kets see lit­tle risk of a spike in in­fla­tion, which would make hold­ing neg­a­tive-yield­ing bonds even more painful— and likely prompt cen­tral banks to raise rates and thus make ex­ist­ing bonds less valu­able. (Even govern­ment bonds that won’t de­fault can lose mar­ket value be­fore they ma­ture if rates rise.) A ma­jor­ity of econ­o­mists in a Bloomberg sur­vey say neg­a­tive rates will be in place at the Euro­pean Cen­tral Bank at least un­til the first

quar­ter of 2018, and at

the Bank of Ja­pan even longer.

“This is quite a tricky sit­u­a­tion,” says Frank­furt-Trust’s Kind. He wor­ries that with bond prices so high, in­vestors are vul­ner­a­ble to a sell­off if the con­sen­sus on fu­ture rates and in­fla­tion proves wrong. Still, Kind has bought neg­a­tive-yield­ing bonds in re­cent weeks. “It’s tough at th­ese lev­els, but at the mo­ment there seem to be few al­ter­na­tives,” he says.

Con­sider the case of U.S. Trea­suries. David Ric, head of ab­so­lute-re­turn fixed-in­come strate­gies at the as­set man­ager Amundi, calls them “the least ugly duck out there.” Fed­eral Re­serve Chair Janet Yellen bucked the trend among cen­tral banks by rais­ing short-term rates in De­cem­ber by 0.25 per­cent­age points from nearzero. Even so, 10-year U.S. debt yields only 1.7 per­cent, down about half a per­cent­age point since the start of the year. That’s much bet­ter than the 0.14 per­cent in­vestors are get­ting for 10-year Ger­man bonds—un­til cur­rency ex­change is fac­tored in. Trea­suries gained about 1.1 per­cent in Fe­bru­ary, but Euro­peans hold­ing them lost 0.77 per­cent in euros as the value of the dol­lar fell. It’s pos­si­ble to use hedg­ing con­tracts to elim­i­nate such cur­rency risk, but the cost of do­ing so re­sults in a re­turn that’s no bet­ter for Euro­peans than buy­ing Ger­man bonds.

Ja­panese in­vestors face a sim­i­lar lack of op­tions. Fac­tor­ing in as­sump­tions about fu­ture in­ter­est rates and for­eign ex­change, a Bloomberg anal­y­sis shows that 10-year U.S. Trea­suries are likely to yield -0.7 per­cent in yen. For now, that leaves Euro­pean and Ja­panese in­vestors fac­ing the prospect of los­ing money in or­der to save it. Says Al­lianz’s Vit­tor­angeli: “We are in a to­tally new world.”

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