German 10-year bunds are currently yielding -0.62%. The yield on 30-year Swiss government bonds is 0.34%.
For Michael Power, global investment strategist at Ninety One, these sorts of numbers don’t make sense for investors.
‘It is becoming increasingly difficult to make the case for Western government bonds, because you are not going to be getting any return, especially in real terms,’ said Power. ‘In the UK and US bonds carry negative real yields, and in most of Europe and Japan nominal yields are negative.’
Around the world, 70% of sovereign debt has a negative real yield.
Subsidised cost of capital
‘The reason for this is that in democracies where there is now a huge clamour to support consumption, the only way that this can be done is by financing it through what is essentially free government borrowing costs,’ said Power. ‘The result is we’ve seen state debt underwritten by zero for longer interest rates, and capital investment, such as companies are doing it, subsidised by negligible costs of capital.’
This is not just a problem for investors, in Power’s view. It has negative long-term consequences for the ‘industrial landscape’ of the West.
‘It leads to intense zombification,’ said Power. ‘We are seeing weak companies survive on life support because they can get this artificially negative yield debt
‘This essentially breaks the capitalist dynamic which Schumpeter captured called “creative destruction”. There is no destruction taking place, so there is no release of capital that can then be redeployed.’
Bonds are therefore no longer serving their traditional purpose.
‘If Modern Monetary Theory means that government debt issuances are quickly monetised, the axiomatic role of government bonds is being undermined,’ said Power.
This is all leading to ‘profound questions’ being asked about traditional models of asset allocation.
‘The 60/40 split between equities and bonds is being jettisoned because it is simply not yielding enough,’ said Power.
Anyone investing in bonds with negative yield is simply detracting from their overall portfolio performance.
This is also raising questions about what investors should be using as the risk-free rate.
‘The standard answer is tending to be high-quality corporate debt,’ said Power. ‘However, for many international investors, I think it is becoming cash in a strengthening currency, with the annual capital appreciation result being a substitute for yield.’
One possibility in this regard is the Singapore dollar.
‘It is the best stepping stone into Asia,’ said Power. ‘You are going to get a small yield and the possibility of capital appreciation over time.’
Outside of that, finding assets for investors looking to preserve capital is difficult.
‘Bonds are no longer playing the critical anchoring role in a portfolio that they once did,’ said Power. ‘Property can offer some downside protection, but beware: post-Covid, some US real estate valuations are down 25%. There is a famous Dutch global property investor whose share price is down 70% over the course of this year.’
Other options are Asian real estate and bonds. These offer positive, if marginal, yields but also potential protection against a weakening US dollar.
‘Gold is also an option and can offer protection against the US dollar, especially when there is no yield from US bonds,’ said Power. ‘It was always said that the reason you shouldn’t invest in gold is because it doesn’t give you any yield. Well, neither do US bonds any longer.’