Aug 21, 2019 was an historical day in fixed income with Germany issuing its first 30 years negative yielding bond. The bond is set up to mature in Aug 2050 and pays no coupon (zero-coupon bond), but instead of selling at a discount, it sold at a premium. In fact, investors have been willing to pay €103.66 only to receive €100.00 back in 30 years.
While it is still considered as unconventional it becomes a norm in the fixed income universe, especially with corporate debt. Negative-yielding corporate debt went from only $20 billion in January to $1 trillion recently, according to Jim Bianco, founder of Bianco Research.
So, why would investors still be increasingly willing to purchase bonds at a sure loss if held until maturity and what does that mean for investors?
First, negative interest rates, a monetary policy used to incentivize banks to lend money, has a direct impact on depositors as they must pay in order to keep their money with the bank, instead of receiving interest. Therefore, they will be interested to purchase bonds holding very little risk at a loss if they can’t keep it in banks for a cheaper cost.
Also, some financial institutions such as pension funds or banks have mandates to own risk free assets such as certain sovereign debt securities. This is why they are sometimes obliged to purchase these negative yielding bonds as part of their balance sheets.
One of the other reasons is bearish investors, some investors are scared to lose more money seeking risk; this is especially true in times when uncertainty and risk are rising as many investors expect an economic downturn. Conservative investors will therefore be willing to purchase negative yielding bonds if they believe that they would lose more money in the future by purchasing riskier bonds or assets.
While some investors are going into negative yielding bonds for safety concerns, others are joining the ride for profit. Several hedge funds made juicy profits of up to 36.1% (GAM Systematic’s Cantab Quantitative fund) by betting on falling bond yields. In fact, bond yield and price have a negative correlation: when the yield goes down, the price goes up and vice-versa. Therefore, these investors have been purchasing bonds (positive or negative yielding) and resold the securities on the secondary market for a profit as yields continued to decrease, thus appreciating the bond price.
Overall, it is one of the many factors of uncertainty that investors must face at the moment as downward risk is getting more apparent with the US-China trade war, Brexit uncertainty, unsustainable corporate debt levels and other signals (slowing of growth, manufacturing).
How hedge funds are thriving in a world of negative-yielding debt – Laurence Fletcher August 15 2019 – Financial Times
Surge in corporate debt with negative yields poses risk ‘unlike anything’ investors have ever seen – Jeff Cox WED, AUG 21 2019 – CNBC