Investors who own bonds with a negative yield are “certain to lose money” in the coming years, according to a range of fund managers.
Despite US interest rates rising four times and a change in Japanese central bank policy in October 2016 both having the effect of pushing yields upward, there remains in the market $9trn (£6.99 trillion) of bonds that trade with a negative yield.
The Bank of Japan announced in October that it would target its ten-year bond to yield zero, rather than a negative number.
In order to achieve that, the Bank of Japan’s action in the market would be to buy less of its own bonds. That pushes the yield on Japanese government bonds steadily upwards, and had the effect in the final quarter of last year of causing bond yields to rise around the world.
It was this, more than the election of Donald Trump, that caused investors to buy stocks such as banks, which do better when bonds yields are higher and investors start to feel more optimistic about the global economy.
Bond yields have since fallen as inflation expectations have moderated in the US and UK.
Bonds trading at negative yields come to the market with a positive yield, and then are bought in such quantity by investors that the prices of the bonds rise and the yields are compressed to such an extent that the yield becomes a negative number.
But David Jane, who runs £750m across three multi-asset funds at Miton, told FTAdviser that despite negative yields, financial regulations mean many banks are required to hold some of the bonds.
This is because banks are required to hold certain assets for liquidity reasons, and developed market government bonds are among the most liquid asset class from a regulatory point of view.
Central banks have also been buying bonds as part of their quantitative easing programmes, creating a buyer in the market who will pay any price for the assets.
This requirement to hold bonds trading regardless of the yield for regulatory reasons also extends to many insurance companies.
Mr Jane added that some bond fund and multi-asset fund managers must also own bonds even as they have a negative yield, because they are confined to investing in line with a benchmark, so have no choice but to buy certain assets.
He said that investors who own bonds with a negative yield are “guaranteed to lose money”.
But he said rising interest rates are unlikely to mean a sharp drop in bond prices.
Mr Jane said: “Bond yields have been pushed downwards due to quantitative easing, but central bankers know what they have done, and so they will raise interest rates very very slowly. So investors owning bonds with a negative yield will lose money, but slowly.”
He believes the slow pace of interest rate rises means that the current strong performance of equity markets will continue, as equities will look attractive relative to bonds.
Bryn Jones, who runs the £810m Rathbone Ethical Bond fund said he has not invested in any bond trading at a negative yield.
“Those assets will see price falls and investors will have made a loss on their positions,” he said.
Angela Murfitt, a chartered financial planner at Fairstone, said: “The inverse relationship bonds have with interest rates is a challenge since a rise in interest rates will almost certainly lead to significant capital loss for some bond holders.
"Every day we are one day closer to the point where this issue will materialise.
"However markets tend to anticipate and therefore even though there is no material change in these factors, fear of the outcome moves in and can cause prices to shift purely on sentiment.
“We would be looking for shorter average duration funds to gain some measured return whilst insulating our clients’ portfolios with the lower risk of capital loss this investment brings.”
David.Thorpe@ft.com
