The value of global bonds with negative yields stood at US$13.4 trillion at the end of October, having risen as high as US$17 trillion a few months earlier. That means investors around the world have been willing to pay a premium to corporations or countries for the privilege of lending them money.
This strange turn of events is part of a trend in which government bonds across much of the developed world yield less than 2%.
Although prospects for bond returns have dimmed as yields have fallen, it’s important to remember the role that bonds play in a portfolio, Vanguard experts Paul Jakubowski and Alexis Gray note.
Government bond yields’ steady downward trend
A quick look at how we got here
Since the global financial crisis, central banks have cut their targets for short-term interest rates, seeking to make borrowing cheap in hopes that consumers and businesses would boost economic growth by buying cars, taking trips, hiring more workers, or investing in equipment. These short-term rate cuts can weigh on longer-term yields as well when investors interpret them as a sign that policymakers are worried about the economy’s health.
Investors buying bonds in anticipation of even lower yields have also played a role. After all, bonds’ prices rise when yields fall. So even bonds with negative yields can generate positive returns. “To realize a positive return, an investor must opportunistically sell the bonds prior to maturity, which may not be desirable or feasible for some investors,” said Mr. Jakubowski, Vanguard’s head of global fixed income indexing.
Fear has also driven yields lower, said Ms. Gray, a Vanguard senior economist. Some risk-averse investors—worried about the prospects of an economic slowdown or lofty stock valuations, for example—have chosen bonds’ near-zero returns over the risk of a significant stock market downturn of 10%, 20%, or even more.
Where yields might go, and what investors should consider
Yields are already low, but uncertainty over global growth and trade tensions in particular could well result in further easing by central banks. So it’s a difficult call. Yields could rise and normalize—or continue to go lower.
Because yields are a good proxy for bonds’ potential annualized rate of income, the bond environment is likely to remain challenging. Mr. Jakubowski and Ms. Gray offer some tips on how to navigate it:
- Diversify globally. Negative yields in some markets shouldn’t deter investors from holding a global bond allocation. “If the exposure is hedged, the income return along with the resulting hedge return tends to produce total returns in line with those of local bonds but still offer the benefits of diversification,” Mr. Jakubowski said.
- Resist the urge to reach for yield. Tilting your portfolio away from high-quality bonds for investments with potentially higher yields might be tempting in this environment, through either lower-quality bonds or high-dividend-yield stocks. More yield and more risk are a package deal, however. “Keep in mind why high-quality bonds are in your portfolio in the first place,” Ms. Gray said. “Their primary role is not to boost your portfolio’s return, but to act as a cushion for the higher volatility and downside of the riskier assets you hold in your portfolio such as stocks.”
- Be realistic. Base your financial goals—such as sending your children to college or providing for your retirement—on realistic return expectations, Mr. Jakubowski cautioned. Starting to save if you haven’t already, saving slightly more of your pay every month, or extending your time horizon by, for example, planning to work a little longer are all more reliable ways of meeting those goals than counting on a hoped for level of market returns.
- Keep an eye on costs. All else being equal, well-designed, low-cost investments provide more of an asset’s return to investors. By simply keeping costs low, you can boost income without an increase in portfolio risk.
Originally Posted on November 27, 2019 – Navigating a World Awash in Negative-Yielding Bonds
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