Bond madness: the yield is not enough

Unless you are a parent (or maybe a sibling), you’d probably expect to get back any money you loan to someone – and maybe even a bit extra as a thank you.

That’s certainly the expectation of bond investors when they loan money to governments and companies. Or is it?

As Chris Garsten, manager of Waverton European Capital Growth, pointed out to us in May, 51% of all Euro area government bond paper now has negative yields. This figure rises to 80% in Germany.

The problem extends far beyond Europe and indeed governments: according to Goldman Sachs Asset Management, $13 trillion in global debt now trades at sub-zero yields and a fifth of European investment-grade debt (loans to companies) is trading at negative yields.

And – even more extraordinarily – according to Rathbones, several European high yield bonds are now trading at negative yields. Surely that’s an investment oxymoron?! High yield bonds are supposed to have a high yield to compensate investors for the extra risk they are taking…

The result is that investors are actually paying for the privilege of lending their money to institutions.

When I spoke to Chris Higham, manager of Aviva High Yield Bond fund, last week, I asked him why an investor would do this: he said the most likely explanation is a strong belief that yields will only get more negative (and prices will go higher).

This makes sense: as M&G’s Jim Leaviss also pointed out recently: “In the wake of Mario Draghi’s European Central Bank speech last week, one investment bank speculated that the 10 year yield on German government bonds could fall from -0.31% to -2%! Madness?”

Where to find positive yields

One area of the world that doesn’t have a problem with negative yields is emerging markets. In terms of the 10 year government bond yields of major markets, Mexico comes top, with an average of 7.61%*, followed by Brazil at 7.28%*. India is third with a yield of 6.33%*.

A fund that can take advantage of these higher rates is M&G Emerging Markets Bond. Managed by Claudia Calich, its top end holdings** include a Brazilian bond yielding 10%, an Indonesian bond yielding 8.25%, a Peruvian bond yielding 8.2%, an Indian bond yielding 7.3% and a Rwandan bond yielding 6.625%.

Of course, the risks are higher in emerging markets, but Claudia has an excellent track record. She uses her vast skill set in this asset class to analyse the macroeconomic environment, and individual companies, to pick what she believes to be the best mix of bonds for this portfolio. The fund currently has a yield of 5.62%***.

If emerging markets are not your cup of tea, Aviva High Yield Bond fund is an option. While developed market bond yields are lower, Chris has been taking advantage of a ‘Brexit anomaly’ to invest in higher yielding bonds. Debt issued by European and US companies in the much-unloved British pound has much higher yields than the same debt in euros or dollars – simply because no one wants to own sterling assets at the moment. So you can own the same company’s debt, but get better income returns. The fund currently yields 4.6%***.

GAM Star Credit Opportunities fund takes a different approach: the managers invest mainly in the ‘junior debt’ of investment grade companies. A company can issue a number of different bonds, and they will be ‘ranked’ as to which will get paid back first should a company fail. Junior bonds are at the lower end of that list, so are deemed more risky – if the bankrupt company only has a small amount of money left these bond holders may not get their capital returned. So the strategy used by the managers of this fund basically means that the companies they invest in are unlikely to default on their loans, but they can get a better yield by investing in the more risky bonds they issue. The fund has a yield of 4.4%***.

If you want the best of all worlds, TwentyFour Dynamic Bond can invest in any type of fixed income and currently has 30%^ in government bonds, 25.6%^ in bank bonds, 13.5%^ in European and US high yield bonds, 11.1%^ in asset-backed securities and 6.8%^ in emerging market bonds.

This fund has a 4.4%*** yield and is managed with an emphasis on credit risk to ensure protection of investors’ capital and income wherever possible. It differs from most other strategic bond funds due to a consistent weighting to subordinated financial debt and asset-backed securities – areas in which the team specialises.

For investors worried about the long-term impact of negative yields, AXA Sterling Credit Short Duration Bond fund is worth a look. We spoke to manager Nicolas Trindade this week, and he feels there is too much dislocation in the market at the moment and is very conservatively positioned. He is also of the view that, while sterling bonds issued by European or US companies are indeed better value as Chris Higham said, UK companies themselves are not cheap enough to compensate for Brexit risk. He therefore has a much lower weighting to UK companies than usual. This fund has a yield of 1.6%^^.


**Source: FE Analytics, holdings as at 31 May 2019
***Source: FE Analytics, 16 July 2019
^Source: Fund fact sheet, 28 June 2019

^^Source: AXA IM, 30 June 2019

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