As negative rates wreak havoc, it might be time to think more deeply about fixed income exposures
The act of “vandalism” can be a minor misdemeanour or a major violation, depending on context. If one thinks of it as covering walls with graffiti, as opposed to other unlawful acts like robbery, it might not sound so serious.
But when uttered by a financial expert describing the real-world impact of negative interest rates, the word takes on a whole new weight.
“The true madness is pension funds being forced to invest in assets which will be guaranteed to lose, such as in the case of long dated inflation-linked gilts at real yields of -3%,” Mark Dowding, chief investment officer at BlueBay Asset Management, recently told Bloomberg. “It is financial vandalism and the government and central banks need to wake up to this.”
He was airing concerns about a collapse in global bond yields, with negative yields being posted on over a quarter of investment-grade bonds, which has come amid a continuing decline in interest rates. This has prompted institutional investors around the world, including pension funds, to ratchet down their return expectations or find alternative — and riskier — assets.
The fallout isn’t confined to pensioners; savers also face a real threat. This is evident in Europe, where lawmakers and banking industry participants grapple with the problem of negative interest rates eroding the value of wealth held in deposit accounts.
Read more: The upside-down world of negative yields
The severity of the negative-yield problem varies across countries. As noted by Karen Schenone, CFA and fixed income product strategist at BlackRock, Germany’s entire yield curve has gone into negative territory; in Japan’s case, it’s mostly confined to the short end. The U.S. Treasury has indicated that it doesn’t wish to go there, though anemic yields on the US 10-Year Treasury have caused some soul-searching among fixed-income investors.
“Across regions and asset classes, bond yields are significantly lower than they were before the start of the global financial crisis,” Schenone said in a recent blog post.
Given the limited opportunities in the current environment, she encouraged bond ETF investors to be more selective in their exposures. The fact that U.S. government bonds are offering more yield than those from other developed markets, for example, makes ETF exposure to them a better choice to act as ballast to equities.
“In a low-interest-rate environment, yield will be a more important component of total return,” she continued. With that in mind, investors with a higher degree of risk tolerance might consider ETFs with more credit-risk exposure — high-yield bond ETFs or emerging-market bond ETFs, for example — which would potentially boost income.
The trend of falling yields, particularly outside the U.S., might also want to think about international bond ETF exposure as a source of gains from potential price appreciation. However, this strategy may be an ill fit for the risk-averse, particularly when one considers the possibility that bond-price moves are being motivated by excessive investor panic.