What challenges do negative yields create?

Lower chance of meeting return targets

Central banks engaging in NIRP are punishing cash investors by cutting short-term rates below zero. This is dragging longer-term rates down too – exacerbated further by asset purchase programmes. At its simplest, this means that the universe of bonds with positive yields is declining. For investors with fixed return targets, it means a lower probability of meeting those goals.

Positive Yield Negative Yield
Source: Bloomberg, Barclays. Data as of 31 March 2016. Includes all government bonds in the Barclays Global Aggregate Index.

Nowhere left to hide

Many assets previously considered risk-free, such as German and Japanese government bonds, are now yielding below zero. If you buy a bond with a negative yield and hold it to maturity, you are guaranteed a loss. As such, conservative investors looking for capital preservation have nowhere left to hide. Essentially, they can either lose money on negative yielding bonds or invest in riskier assets, by moving to longer maturity bonds or into different sectors of the bond market.

Source: Bloomberg as of 31 March 2016

What can you do?

Holding bonds with a negative yield may still be rational. Bonds provide diversification, and a negative yielding bond can generate a positive return if interest rates fall further. However, with rates where they are, negative yields likely represent negative future returns. To combat this, investors can move out on the risk spectrum, into global and corporate bonds. But as these sectors become more crowded, managing risk will be essential. Active approaches that can identify the most attractive opportunities without stretching for yield are more critical than ever.

Enhance your cash

Investors seeking higher yield but still low-risk alternatives to money market funds can look to enhanced cash solutions. Unlike money market funds, these vehicles have a floating NAV. This means they incorporate a small amount of mark-to-market volatility but may offer greater scope to achieve a higher yield.

Diversify the core

Investors seeking higher yields while maintaining core bond attributes, such as capital preservation, can look to global or credit-focused strategies. Negative yielding bonds are largely concentrated in European sovereign debt, so moving beyond that opportunity set provides access to a wider universe of positive yields.

Maintain a higher return driver

Investors seeking to boost overall yields – and who are willing to assume more risk – can explore high yield and bank capital. A small allocation to these sectors may be an attractive substitute for equities, offering an attractive balance of risk and reward as part of a diversified portfolio.

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RISK: Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Commodities contain heightened risk, including market, political, regulatory and natural conditions, and may not be suitable for all investors. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio. Derivatives may involve certain costs and risks, such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Sovereign securities are generally backed by the issuing government. Obligations of U.S. government agencies and authorities are supported by varying degrees, but are generally not backed by the full faith of the U.S. government. Portfolios that invest in such securities are not guaranteed and will fluctuate in value. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. Income from municipal bonds may be subject to state and local taxes and at times the alternative minimum tax. Swaps are a type of derivative; swaps are increasingly subject to central clearing and exchange-trading. Swaps that are not centrally cleared and exchange-traded may be less liquid than exchange-traded instruments. Inflation-linked bonds (ILBs) issued by a government are fixed income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Treasury Inflation-Protected Securities (TIPS) are ILBs issued by the U.S. government. Certain U.S. government securities are backed by the full faith of the government. Obligations of U.S. government agencies and authorities are supported by varying degrees but are generally not backed by the full faith of the U.S. government. Portfolios that invest in such securities are not guaranteed and will fluctuate in value.

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