Owners of Negative-Yield Sovereign Debt Say They’re No Fools

Mike Amey never thought he’d buy bonds from countries like Germany and Switzerland when losses were all but guaranteed.

Then again, these are hardly normal times in the bond market. Europe faces a prolonged bout of deflation and signs abound that global growth is weakening as oil plummets. Some clients are more willing than ever to lose a little money in return for the security of government debt, said Amey, a London-based fund manager at Pacific Investment Management Co.

Bond prices are now so high that yields on more than $4 trillion of the developed world’s sovereign debt have turned negative. That means investors effectively pay a dozen countries from Germany to France and Japan to borrow.

“It’s not a good feeling,” said Amey, whose firm runs the world’s biggest bond fund and is one of the largest investors in nations with negative yields. Others include BlackRock Inc., Deutsche Asset & Wealth Management and Vanguard Group, data compiled by Bloomberg show.

The seemingly insatiable demand for only the safest assets underscores the challenge the European Central Bank faces in convincing bond investors it has the wherewithal to jump-start the euro region after consumer prices fell for the first time in five years. Last week, ECB President Mario Draghi pledged to pump 1.1 trillion euros ($1.2 trillion) into the region’s economies by buying public and private debt.

All In

Although the ECB’s move may push more investors into riskier assets, JPMorgan Asset Management’s David Tan says it’s possible to profit from holding negative-yielding debt.

The central bank’s full-scale quantitative easing, which starts in March, will lift prices of even the most-expensive bonds, while the potential for deflation to persist in the euro area means investors will see their purchasing power increase.

“It still makes sense to hold the bonds” when the alternative is the ECB’s deposit rate of minus 0.2 percent, said Tan, the London-based head of global rates at JPMorgan Asset, which oversees about $1.7 trillion.

Tan purchased German five-year notes when yields plunged to zero this month. The debt has since rallied, pushing yields to an all-time low of minus 0.06 percent last week. The rate ended at 0.017 percent on Jan. 26.

All around the world, bond yields have hit one low after another. Benchmark yields in all 25 developed nations tracked by Bloomberg have fallen this year. In Switzerland, investors are paying the government to borrow for longer than a decade.

‘Unique Situation’

For euro-area nations, average yields tumbled to a record 0.68 percent, data compiled by Bloomberg show.

“It’s a unique situation,” said Oliver Eichmann, the Frankfurt-based co-head of fixed income at Deutsche Asset, which oversees $1.1 trillion as Germany’s biggest fund manager. “We try to avoid buying or holding negative-yielding assets. This is something new and something we have to get used to.”

Part of it has to do with the deteriorating outlook for the global economy. This month, the International Monetary Fund slashed its growth forecast by the most in three years. Japan is mired in yet another recession and China is slowing.

The 58 percent plunge in oil since its high in June is also deepening concern a lack of inflationary pressure is becoming entrenched. Even in the U.S., the bright spot in the world economy, consumer-price increases have failed to reach the Federal Reserve’s 2 percent goal for 31 straight months.

Capital Preservation

For the 19 nations that share the euro, things are even more dire. The ECB is trying to avert a deflationary spiral in a region that’s been hobbled by a sovereign debt crisis and two recessions since 2008.

More than a dozen firms surveyed by Bloomberg, including JPMorgan Chase & Co., Goldman Sachs Group Inc. and Deutsche Bank AG, predict deflation in the euro area for 2015.

“We’re back to this return of capital and not return on capital time,” said Chris Ahrens, director at Charlotte, North Carolina-based hedge fund Round Table Investment Management.

With the ECB planning to buy government debt, Deutsche Asset’s Eichmann sees little reason negative yields can’t persist in Europe. Compounding the situation is the fact that many of the biggest money managers don’t have much of a choice when it comes to owning the debt because they run a substantial number of index-tracking funds.

BlackRock, the world’s largest asset manager, is the biggest bondholder in France and its positions are concentrated in exchanged-traded funds, data compiled by Bloomberg show.

‘Big Problem’

The New York-based firm’s top two holdings in the country, notes due 2016 and 2018, yield less than zero, the data show.

“The negative yield environment at the front end is a big problem for many of our clients,” Michael Krautzberger, London-based head of euro fixed income at BlackRock, said in an interview on Bloomberg Television’s “The Pulse” with Francine Lacqua. “You have to become slightly more active looking for opportunities, looking for yields, still finding solutions, but on the other hand as January shows there are still so many things happening in the market, so many opportunities.”

Vanguard’s $27.6 billion Total International Bond Index Fund, the largest of its kind, has more than 40 percent of its assets in Japan, Germany and France.

The three had the greatest amounts of negative-yielding bonds, which totaled about $4.6 trillion globally as of last week, data compiled by Bloomberg show. Vanguard didn’t have a fund manager available for comment, said Katie Henderson, a spokeswoman at the Valley Forge, Pennsylvania-based firm.

Opportunity Cost

When they aren’t constrained by fund mandates, some managers have already started moving into higher-yielding assets, which offer greater returns that don’t rely solely on price gains, Pimco’s Amey said.

Last week alone, 30-year bonds issued by Greece and Portugal, which yield 7.85 percent and 3.39 percent, rallied by the most among developed countries tracked by Bloomberg. Demand for U.S. Treasuries sent the 30-year yield to a record low of 2.33 percent on Monday.

“We are heavily underweight low- and negative-yielding bonds,” Jack Kelly, a director at Edinburgh-based Standard Life, which oversees about $303 billion, said on Jan. 21.

Not all money managers have that luxury. Owning a portion of assets in negative-yielding overseas bonds still provides higher returns for Japanese investors than those locally, said Hajime Nagata, who invests in non yen-denominated debt at Tokyo-based Diam Co., which oversees $119 billion.

About $2.9 trillion of bonds issued by Japan yield less than zero, and across all maturities, they average 0.3 percent. That’s less than half that for the euro area.

“We are not an absolute-return investor,” said Nagata, who tries to beat his benchmark index by 1 percentage point. With euro bonds, “the absolute yield level is very low. However, it’s better than Japanese government bonds.”

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