It has been a universal truth that borrowers need to incentivise lenders to provide loans, normally via the promise of the return of capital with additional compensation in the form of an interest rate.
The level of the rate should reflect the borrower’s ability to pay, the duration of the loan, whether there is asset backing and the lender’s required rate of return. This means that an individual seeking a payday loan – short term, no credit check and no asset backing – could pay an annual percentage rate of more than 1,500 per cent at Wonga.
The UK government, on the other hand, is able to borrow at a much lower rate, as it has a AA+ rating. The interest rate due to its one-month lenders is around 0.24 per cent.
But if an investor wished to lend to the Swiss government, the interest rate received for any period less than 50 years would be negative; in other words, the lender has to pay the borrower an interest rate.
There have been plenty of articles written on negative interest rate policy (NIRP), most pointing to the apparent absurdity of lenders having to pay to lend their savings. Many thought that negative interest rates would remain a financial experiment undertaken in economies away from the mainstream, but as legendary bond investor Bill Gross wrote recently, there is now in excess of $10trn (£7.6trn) of bonds with a negative yield.
There remain areas with positive interest rates, but more than 77 per cent of all sovereign bonds yield less than 1 per cent. Investors with a preference for yield are forced to take higher risks to generate a modest income, even straying away from bonds.
One of the areas that has benefited from the search for yield has been UK property, both residential and commercial. Shorter term this is an area that looks to be under pressure as international investors reappraise their desire to be exposed to UK fundamentals.
Domestic investors have reawoken to the problems associated with illiquid assets held in daily dealing open-ended funds, with seven high-profile retail property vehicles suspending redemptions.
Two property funds have reduced their quoted prices by double digits, wiping out roughly three years’ worth of income. The yields on these strategies were between 3 and 5 per cent, far greater than those on offer in the bond market due to NIRP.
This is a less extreme replay of the cycle that ended in 2008 when financial market conditions deteriorated, causing investors to remove assets in illiquid strategies, including property, only to find themselves unable to do so as funds suspended. Large capital losses were eventually sustained.
Having not owned any of these assets in 2008, we have again stayed away, fearing the potential suspensions and capital losses that could emerge, even with such beguiling yields on offer. This does not have all the hallmarks of 2008, but there are plenty of reasons why being cautious will pay off.
NIRP was designed to help generate economic growth and inflation, yet there is little evidence it has achieved this. The low interest rate environment it has perpetuated has caused savers to save more, reducing consumption and stifling economic growth. NIRP looks to have failed, so watch out for Ben Bernanke’s metaphorical ‘helicopters’ – particularly in Japan, where this new kind of monetary easing should provide a boost to risk appetite.
Marcus Brookes is head of multi-manager at Schroders