Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

It’s bad enough investors are earning nothing to own trillions of dollars of government debt. What’s worse is that in some cases they’re paying higher bond-fund management fees than the yield generated by the underlying notes.

Consider the iShares 1-3 Year International Treasury Bond ETF, a $117 million exchange-traded fund: The assets it owns are currently yielding negative 0.07 percent, while its expense ratio is 0.35 percent.

Even when the yields remain positive, the fees are causing serious erosion. For example, the iShares International Treasury Bond ETF, a $513 million exchange-traded fund that focuses on non-U.S. government debt, has a 0.35 percent expense ratio while its 12-month dividend yield is only 0.1 percent after subtracting fees, according to data compiled by Bloomberg.

Dangerous Downside
The lower yields go on developed-market sovereign debt, the less cushion there is against losses.
Source: Bloomberg

The fund lost 3.5 percent over the past year even as bonds of developed economies gained pretty much across the board. What does it own? Mostly European sovereign debt, with a smaller, 22 percent slice in Japanese notes, Bloomberg data show.

This isn’t short-term debt. About 30 percent of the ETF's holdings matures in more than 10 years and almost 18 percent of the assets come due in seven to 10 years. These bonds are becoming increasingly expensive at a time when central banks from Europe to Japan are adopting negative-rate policies. Yields on five-year bonds of Germany, Japan, Switzerland, France and several others have all turned negative.

That's a lot of duration risk for minuscule income. The potential upside is uninspiring, but the possible downside is breathtaking. It won't take much to cause some pretty big losses for these bondholders, who can no longer count on receiving regular interest payments, because there are none.

The only way for investors to profit on a swelling volume of debt is simply to pray that yields continue to slide (more negative! why not?) and prices continue to climb. Perhaps central bankers can make that happen with even more stimulus, although a growing number of signs indicates that policy makers are running out of ammunition.

Meanwhile, investors are facing the problem of where to park their money in the face of growing global uncertainty and fears of slow growth. They're apparently willing to pay managers to find those spots in sovereign debt markets, even as many bonds hold little promise for income.

Plummeting Potential
Investors are giving up on any interest payments at all on a growing volume of government debt.
Source: Bloomberg

The iShares ETF isn't alone. Pimco’s Euro Short Maturity Source UCITS ETF, a $2.5 billion fund that seeks to generate bigger returns than money market funds, has an expense ratio of 0.35 percent, while its one-year yield is just 0.19 percent after subtracting fees, Bloomberg data show.

The trouble isn't the fees, which are fairly average compared with similar funds, according to one of my colleagues, Bloomberg Intelligence analyst Eric Balchunas. As he put it, some funds are just in “the wrong place at the wrong time.”

It’s not just the funds that are in a bad spot, it’s any investor who’s hoping to find safety outside of U.S. government bonds. It comes with a risk that threatens to keep rising.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

(Corrects descriptions of yields on iShares International Treasury Bond ETF and Pimco Euro Short Maturity Source UCITS ETF to clarify that they reflect fees.)

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net