While it is easy to focus on recent new highs in the US equity market, one of the big stories this year has been the scale of the move in the government bond market, particularly recently. The shift in central bank policy from gradual normalisation back to full on easing, or at least the market’s expectation of easing, has led to a huge fall in bond yields across the board, meaning positive capital returns for investors but leading to lower yields in the future.
The degree to which yields have fallen recently is evidenced by the fact that $12.5 trillion of bonds now have negative yields. While it might seem absurd to think that you might buy a bond knowing that you will receive less back in capital and interest than you paid for the bond, it reflects the fact that deposit interest rates in Europe are negative. This forces investors who are seeking low risk investments to either pay for the privilege or move on to higher risk investments. This continues right along the risk spectrum. Negative deposit rates lead to negative government bond yields, which lead to negative or very low investment grade corporate bond yields and so on. The same goes for the yield curve – negative short-term yields cause investors to drive down yields for longer dated investments.
The intention of the policy was ostensibly to encourage individuals and companies not to hoard cash but to invest it in new productive assets, but this simply has not happened to any meaningful degree. Instead, asset prices have risen, and companies have taken advantage of cheap money to buy back shares or make leveraged acquisitions. The fact that it doesn’t work hasn’t stopped central banks from again proposing a further round of QE now that economic growth is slowing, which is what has caused the recent dip in yields worldwide.
All of this creates a significant problem for investors in the long run. While it is pleasant in the short-term to reap the rewards of higher capital values from falling bond yields, this comes at the expense of future returns. The scarcity of income has led investors and businesses to seek ever riskier strategies and ever greater levels of leverage.
Many investors are constrained to follow a highly defined mandate focussed on a single asset class. For bond investors, as more and more of their market falls into negative yield, and central banks buy ever more of the less risky bonds, they are forced to crowd ever more tightly onto a shrinking island of quality bonds or swim with the sharks in the riskier assets such as high yield. Thankfully, we are not so constrained in our running the Miton Multi Asset fund range and can look globally for opportunities and across asset class boundaries to find ways to construct our portfolios to meet their risk and reward objectives.
Despite recent falls in yields, US dollar bond markets seem less distorted than Euro markets, reflecting the fact that the US federal reserve managed to avoid the highly distorting purchases of corporate bonds that the ECB has been conducting. For this reason, credit risk seems more fairly priced in Dollars than Euros. The same can be said for the relatively small Sterling bond market. At least in these markets yields may be low but they are not negative.
Finally, we can look outside of bond markets for our ‘risk off’ exposures, in areas such as property and gold which are considered low risk, and therefore do better in weaker or less certain economic environments. These are also real assets, offering inflation protection, and these now form a larger portion of our portfolios than at some times in the past.
The value of stock market investments will fluctuate and investors may not get back the original amount invested.
The performance information presented on this page relate to the past. Past performance is not a reliable indicator of future returns.
Forecasts are not reliable indicators of future returns.
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Source for information: Miton as at 10/07/2019 unless otherwise stated.
The views expressed are those of the fund manager at the time of writing and are subject to change without notice. They are not necessarily the views of Miton and do not constitute investment advice.
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