U.S. investors have looked with incredulity at the near $17 trillion of negative-yielding bonds across the world amid global economic concerns and easier monetary policy by central banks.
Textbook finance theory, itself, has struggled to explain why investors might want to tie their money in debt that if held through the entirety of its existence would give back less money than what had been invested, said Kathryn Kaminski, portfolio manager at AlphaSimplex.
Opinion: If the stock market is irrational, what do you call the bond market?
Nonetheless analysts say there are reasons for investors and traders to buy subzero-yielding bonds. Here are just a few of them:
Bagholders
Investors who scoop up negative-yielding bonds are betting on the value of the securities to keep rising, in effect, wagering that there are other “bagholders.”
With the European Central Bank widely expected to restart their asset purchasing program, European bond-buyers could be relying on the central bank to hoover up their portfolios of negative-yielding securities.
Although investors buying bonds with subzero interest rates are, in effect, paying for the privilege to hold on to an investment, that cost can be more than offset if the security’s price rises.
In July, an auction for €4 billion euros of 10-year German government bonds TMUBMUSD10Y, +2.23% sold at a negative yield of 0.26%, but at a premium price of 102.6 cents to the euro. The benchmark bund is now trading at a price of a 106.9 cents to the euro, meaning that investors who scooped up debt at last month’s auction would have reaped a gain of around 4% from the price increase alone.
“Everyone is buying this stuff like crazy, because there is too much money in the system from quantitative easing and too much money going to government bonds,” said Jim Bianco, founder of Bianco Research, in an interview with MarketWatch.
On the other hand, market participants say it is unclear if buying fixed-income securities in expectation of further price gains remains a sustainable trend.
Safe assets
Market participants say there are a few bolt-holes that are capable of weathering the deterioration of the U.S. economy and geopolitical tensions. When risk assets sell off, the issue of negative yields on government bonds may be overshadowed by their proven ability to rally during times of market distress.
“This realization that it is important to have high-quality income in fixed income portfolios has created a mini-panic in the market,” said Thanos Bardas, co-head of global investment grade at Neuberger Berman, underscoring that as of last week, all maturities of German bunds have been trading at negative yields.
Cross-currency hedging
Negative yields don’t mean negative income for some.
Unlike European and Japanese investors, U.S. investors are often paid to hedge against fluctuations of foreign currencies because U.S. interest rates are much higher than in other developed markets like Europe and Japan.
It is why American fund managers can still earn money from holding a negative-yielding European government bond. Currency hedging can provide an additional 3% annualized return for U.S. investors buying euro-denominated debt, according to Jens Vanbrabant, senior portfolio manager at Wells Fargo Asset Management.
Roll down
Another way investors can benefit from subzero interest rates is to take advantage of the yield curve’s slope, which still can be steep even for negative-yielding bond markets in Germany and Japan.
The yield curve represents the gap between shorter-term yields and longer-term yields, with a steep curve indicating a large difference.
For example, a trader might buy a negative-yielding 3-year bond and sell it after a year. Since debt prices move in the opposite direction of yields, the value of the 3-year bond should be higher than, say, a 2-year bond, all else being equal.
So long as the interest rates for shorter-term bonds are more negative than their longer-dated counterparts, the price for the long-term bond should generally rise as it moves closer to maturity, said Michael Chang, a rates strategist at Société Générale.
He cautioned that making money from “rolling down the yield curve” is only a short-term strategy, and that traders must sell the bond well before maturity, because the security will trade only at par when it expires.
Pimco says global debt investors often have employed this tactic to make money from Japan’s meager returning government bond market.