Fixed income

How to negate negative yields

Scott Thiel |12-Aug-2016

Negative bond yields are becoming more common, but that does not mean investors have to accept them.


On June 14th, the yield on 10-year German government bonds turned negative for the first time in history1.

In one sense that was startling, but in another it was simply an inevitable next step in a longer-term trend. For while negative 10-year yields were a first for Germany (and have since returned to positive territory), that milestone had already been passed in Japanese and Swiss government bonds2.

And while such negative yields may seem to run counter to good investment sense, their origins are fairly easily traced. During a period of macroeconomic and political uncertainty, these mainstream government bonds are viewed as safe havens; this increased demand for them pushes up their prices and so depresses their yield.

Central bank intervention

A less traditional source of demand has been the European Central Bank, which in March announced that it would raise the volume of its monthly asset purchases by €20 billion to €80 billion. It is now buying at a pace that could outstrip supply, further raising bond prices and lowering their yields. The European Central Bank’s March cut in its deposit rate, from -0.3% to -0.4%, also served to reduce one floor for bond yields3.

Unconstrained active managers can always choose not to own unattractive bonds

Those conditions help explain how yields came to be so low or even negative, but why would anyone want to hold these bonds? There are four possible answers.

First, if investors expect that deflation will become entrenched, modestly negative yields could still generate a positive inflation-adjusted return. Second, if yields continue to fall, holders could make money from current levels by selling their bonds. Third, yields on these government bonds may be above the deposit rate. And finally, passive investors have to own the negative-yielding bonds if they form part of the index tracked.

Of course, those are closer to rationalisations for holding negative-yielding debt than compelling arguments in favour of buying the assets. Fortunately, unconstrained active investors do not need to succumb to negative yields.

Searching for the positives

Flexible bond managers can look for opportunities beyond European or Japanese government bonds and find areas of the fixed-income market where yields are not only positive but attractive in their own right. These could include emerging-market bonds, mortgage-backed securities, corporate bonds or peripheral European debt.

Investors with a global mandate are furthermore not stuck in Europe’s negative-yield rut and can take advantage of divergences between different markets.

The US Federal Reserve, for example, may have been forced to delay the normalisation of its interest-rate policies this year – first by ‘tightening’ international economic and financial conditions in March, and then by disappointingly weak employment numbers in May – but it should still begin to increase rates long before the European Central Bank.

Investors, therefore, need not accept negative yields. Unconstrained active managers can always choose not to own unattractive bonds and can instead focus their portfolios on parts of the market where the risk/reward dynamics are far more appealing.

Scott Thiel
Managing Director, BlackRock’s Deputy Chief Investment Officer of Fixed Income and Portfolio Manager, BlackRock Fixed Income Global Opportunities Fund
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This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of 1st August 2016 and may change as subsequent conditions vary.

1Source: Bloomberg, 14 June 2016.
2Source: Bloomberg, April 2016.
3Source: European Central Bank, March 2016.