No Risk Too Big as Traders Plot Escape From Negative Yields

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Allianz , Europe’s biggest insurer, is shifting from German bunds to bulk up on mortgages.

Allianz , Europe’s biggest insurer, is shifting from German bunds to bulk up on mortgages.

Photographer: Adam Berry/Getty Images

In the negative-yield vortex that is the European bond market, investors are discovering just what lengths they’re willing to go to generate returns.

Norway’s $870 billion sovereign wealth fund said this month that it added Nigeria and lifted its share of lower-rated company debt to the highest since at least 2006. Allianz SE, Europe’s biggest insurer, is shifting from German bunds to bulk up on mortgages. JPMorgan Asset Management is buying speculative-grade corporate debt to boost returns.

With the European Central Bank’s fight against deflation pushing yields on almost a third of the euro area’s $6.26 trillion of government bonds below zero, even the most risk-averse investors are taking chances on assets and regions that few would have considered just months ago. That’s exposing more clients to the inevitable trade-off that comes with the lure of higher returns: the likelihood of deeper losses.

“We are wandering into uncharted territory that’s subject to uncertainty and mistakes,” said Erik Weisman, a Boston-based money manager at MFS Investment Management, which oversees $430 billion globally. He’s buying debt with longer maturities and increasing his allocation of top-quality government holdings to Australia and New Zealand, which have some of the highest yields in the developed world.


The shift is a consequence of how topsy-turvy the bond market has become as falling consumer prices and stubbornly high unemployment prompted the ECB to step up its quantitative easing with government debt purchases.

About 1.44 trillion euros sovereign debt, valued at about $1.9 trillion as of their issue dates, from Germany to Finland and even Slovakia, carry negative yields.

That means the bonds guarantee losses for buyers who hold them to maturity. In effect, investors are betting the securities will appreciate in price before then, allowing them to sell at a profit before they come due.

On average, the 19 countries that use the common currency can effectively borrow euros for almost a decade and pay about 0.5 percent in interest, index data compiled by Bloomberg show.

The perils of going into riskier debt were demonstrated when Austria removed its support for state-owned Heta Asset Resolution AG, undermining confidence in the 1.3 trillion-euro market for state-guaranteed debt that was once deemed risk-free.

No Upside

Norges Bank Investment Management, the world’s largest sovereign wealth fund, increased corporate bonds rated BBB or lower to 8.3 percent of its debt assets at the end of last year from 7.5 percent in the prior quarter, the fund said March 13.

Among those assets are about $200 million of bonds issued by Petroleo Brasiliero SA. Brazil’s state-controlled oil company, the biggest corporate debt issuer in emerging markets, has seen its benchmark 2024 bonds tumble almost 10 percent since allegations of kickbacks and bribes emerged in November.

The fund also added developing countries such as Ghana and Mauritius and invested in Nigeria’s currency for the first time. It may invest “a lot” in Asian properties, said Karsten Kallevig, the head of real estate investments at the Oslo-based fund. Just 0.1 percent of the fund is invested in top-rated corporate bonds.

“We recognize that investments in frontier markets pose a higher risk to the fund,” spokeswoman Line Aaltvedt said in an e-mail. “We therefore attach importance to having sound risk management systems in place.”

Global Opportunities

Andreas Gruber, the chief investment officer of Allianz’s money-management unit, says his firm favors commercial-mortgage loans, infrastructure debt and emerging markets.

“Buying negative yield, on the long-term, you only have downside but you never have upside,” Gruber, who oversees 615 billion euros, said by telephone from Munich.

Before the credit crisis, bond investors could get yields closer to five percent from benchmark debt issued by Italy and Portugal, compared with yields of 1.3 percent, and 1.72 percent, respectively, as of 3:55 p.m. in London.

Now, monetary easing by more than two dozen central banks around the world, from those in Japan to Switzerland to China, means some investors are going further afield such as Indonesia to get the similar returns.

Iain Stealey, a fixed-income manager at JPMorgan Asset Management, which oversees $1.7 trillion, is doing just that. He says low borrowing costs and subdued inflation will support junk-rated corporate debt, which yields 3.6 percent in Europe.

Bond Support

“When you are paying some governments to own their bonds, 4 percent actually looks very decent,” Stealey, who declined to comment on specific fund holdings, said from London.

His Global Bond Opportunities Fund, which isn’t constrained by benchmarks, has about 75 percent its assets in speculative-grade or unrated debt securities, according to data compiled by Bloomberg. They include Kazakhstan’s KazMunayGas National Co., filing data compiled by Bloomberg show. The fund also owns Indonesia’s 9 percent local-currency bonds due in 2029 and Brazil’s 4.25 percent debt due in 2025, the data show.

European enthusiasm for higher-yielding assets has helped U.S. borrowers sell 3.28 billion euros of junk bonds in 2015, the busiest start to a year since the currency started in 1999.

In the month after the ECB announced that it would start buying government bonds, flows into the region’s high-yield corporate bond funds surged to the highest in a year, according to the Bank for International Settlements.

Capital Gains

Deutsche Asset & Wealth Management’s Stefan Kreuzkamp says that while ECB’s stimulus and negative deposit rate are sapping liquidity and making it more costly for money managers to hold cash, he’s not about to load up on emerging-market or junk bonds to enhance returns because the central bank’s bond buying will keep boosting prices.

Euro-area sovereign bonds have returned 4.4 percent in the first three months of the year and are poised for the biggest quarterly gain since 2008, according to index data compiled by Bank of America Corp.

The decline in yields isn’t “bad news for investors and it means further capital gains,” said Kreuzkamp, the Frankfurt-based firm’s chief investment officer for Europe.

The insatiable demand for higher-yielding assets from lower-rated issuers is leaving investors prone to sudden losses.

For MFS’s Weisman, the fact that yields for bonds of all types, from the most-creditworthy to the riskiest, are so historically low means that when the selloff finally does happen, it has the potential to be nasty.

‘Unpleasant Fashion’

Take Germany’s 16 billion euros of bonds due 2044, which the MFS Strategic Income Fund held at the end of last year, data compiled by Bloomberg show. If yields, currently at 0.59 percent, rose a half-percentage point in the coming year, buyers would suffer losses of almost 10 percent, the data show.

The bond market worldwide is more vulnerable to losses than at any time on record, based a metric known as duration, index data compiled by Bank of America show. The risk has ballooned as issuers worldwide took advantage of the decline in borrowing costs to sell more and more longer-term bonds.

“This probably means we end up seeing all these reverse in a very unpleasant fashion,” Weisman said.

(An earlier version was corrected to say that Austria removed support for Heta, rather than a guarantee on the bonds.)

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