Last year we discussed “Negative Rates – For and Against”. We looked at the impact negative interest rates may have on the consumer and what measures governments have adopted which may be contributing to historic low interest rates- measures such as Quantitative Easing (QE)- and the ability to issue bonds on negative yields.
An area of the market where negative yielding debt is a reality is Europe and Japan. In both regions many investors are paying a premium for lending money to their governments.
Bonds with a negative yield are by no means a small corner of the market. They have a combined value of almost $17tn. Moreover, this figure is once again on an upward trajectory, heading towards the prior historic peak of just above $18tn reached in Q4 of 2020.
Chart 1: Global Negative Yielding Debt Market – $USD (trillions)
Source: Bloomberg 11/08/2021
Who Would Buy a Negative Yielding Bond?
With many options globally to invest in developed nations sovereign bonds with a positive yield, it begs the question who would ‘pay for’ rather than ‘be paid’ for the privilege of parking their money in these instruments and why?
To answer this question, we focus on Germany as an example. Currently all their term structure debt is negative yielding; the 2 year is -0.75%, the 10-year -0.51% and the 30-year -0.6%.
Bonds Also Act As Diversifiers…
Multi asset investors are keen to add diversification to reduce risk within a portfolio. Despite their unattractive yield profile negative yielding Bunds, under certain circumstances, are effective at doing just that.
Sticking with German Bunds we know they have a negative correlation with German Equities (DAX Index) observed for most of the time over the past 18 years – see chart below.
This means when German equities fall Bund prices rise, even in the current period when yields have been negative. The existence of negative correlation is what allows investors to considerably reduce volatility within a portfolio. Therefore, many investors are willing to accept a negative yield for this level of diversification.
Chart 2: Correlation – Dax vs Bunds – 2003 to Date
Source: Bloomberg 12/08/2021
Liability Oriented Firms Are Forced Buyers…
It may seem strange to admit that absolute returns are not the primary goal, but this is a reality for liability driven investors. Insurance firms and pension funds have known future liabilities and very stringent liquidity requirements to uphold. A key advantage of government bonds for these investors is they can be turned into cash at very short notice, making them ideal when large liabilities fall due. The premium paid for owning bonds with negative yields is a price these firms are willing to pay to hold assets that can be easily liquidated.
Security of Capital Is a Key Consideration…
On top of being a liquid asset, government Bunds are one of the lowest risk assets in the market. In volatile markets, such as what we have seen during unexpected and unwelcome events, investors are willing to park cash in government Bunds, knowing they will receive the face value of their bond at the end of its term.
Sovereigns offer the highest credit ratings available on debt and for this level of surety they command the highest of prices at times of uncertainty.
Concluding Thoughts
It seems counter intuitive to invest in an instrument whose current value today is higher than its face value when it matures.
However, currency hedging, diversification, liability matching and the desire for liquidity and capital protection are all important considerations for bond investors
With over $16tn invested in negative yielding government debt globally the market is huge and clearly justified in the eyes of many investors however incongruous this may seem.
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