However, you will be surprised to know that globally nearly 27% of all investment grade bonds are giving negative yields. We are not talking in terms of real returns or post tax returns. We are talking about nominal pre-tax yields. Take a look at this chart below.
This is the period from 2015 till December 2020. Back in early 2015, the total volume of negative yield bonds in the global market was about $3 trillion. Forget about 2015, even in March 2020, the volume of negative yield bonds was at about $7 trillion. Between March 2020 and December 2020, the volume of negative yield bonds globally has shot up from $7 trillion to $18 trillion. What caused this surge in negative yield bonds;why do investors buy such bonds and what could be the implications?
What led to this surge in negative yield bonds?
One reason is that investors are looking for safe havens. They even don’t mind paying a small price as long as the principal is safe. That explains why the stockpile of negative-yielding debt has swelled to record highs. Bonds issued by a stable European central bank or the Bank of Japan is a safe haven even if the yields are negative. According to Barclays, the volume of outstanding high-grade bonds in the market is $67 trillion of which nearly 27% or $18.04 trillion are negative yield bonds. In Dec-20 alone, another $1 trillion of bonds have turned negative yield.
Another reason for the increase in negative yield bonds is the sustained monetary support from the central banks. Most investors don’t see this ending any time soon and the recent Fed policy only affirms that. As long as the liquidity remains abundant, the likelihood of any spike in yields is ruled out. The latest boost to negative yield bonds came from the ECB (European Central Bank) boosting its asset purchase program by another $500 billion to keep liquidity abundant. It is not just the Japanese, German, Swiss and Scandinavian bonds giving negative yields. Of late, even Spanish and Australian bonds are giving negative yields.
Why investors want to buy negative yield bonds?
That is the million dollar question. Would investors not be safer keeping their money under the pillow rather than buying bonds with negative yields? There are various reasons why negative yield bonds still find buyers.
• Negative yields offered by sovereign bonds are acceptable for two reasons. Firstly, in a desperate search for safe havens even negative-yield sovereign bonds look attractive. Secondly, if yields are likely to go deeper negative then the bond becomes a price play.
• Most pension funds and insurance companies are required to statutorily hold some part of their portfolios in sovereign debt for the sake of stability and safety. In the current scenario, they don’t have a choice but to buy negative yield bonds.
• For most foreign portfolio investors or FPIs, bond investments are a play on yields and also on currencies. For example, if Japanese bonds give negative yields but the Yen is strong, then in dollar terms, investors can still make positive returns.
• Lastly, negative yield bonds still make sense ahead of deflation, when the purchasing power of money increases substantially. That compensates for the negative yields.
Are there side effects of negative yield bonds?
Clearly, negative yields are not a sustainable scenario in the long run and we are already seeing some of the ramifications in global markets. Here are a few risks.
• Negative bond yields can push a lot of investors into equities and even high risk bonds in search of higher yields. We have seen this shift even in the case of very large investors like the Norwegian Pension Fund and ADIA. This comes with its own set of risks.
• Whenyields are negative, pension funds and provident funds may have a serious problem earning enough to ensure a decent retirement corpus for the ageing investors. That could mean unfunded liabilities in many cases.
• At a macro level, investments and capital formation only happen through savings. When yields are negative, there is no incentive to save.
One trend visible in India in the last few months is the rush to open demat accounts and trade equities. While the equity cult is good, it is not always a good idea to have people chasing returns in equities to compensate for low yields on bonds. That could be a bigger risk.