We recently highlighted that now more than $10 trillion of government debt was trading at a negative yield. We mentioned it again in the Chalten Q2 Investment Review and have received a number of questions asking why anyone would ever hold a bond that would pay them back less than they invested. Why not just hold cash instead?
While it does seem bizarre at first there are both risk related / practical reasons why investors might hold negative yielding bonds instead of cash and some other reasons negative yielding bonds might still have value for investors.
Risk related / practical reasons for holding negative yielding bonds over cash
- Just to get this one off the table right away, it is simply not practical or safe to hold cash physically, in a safe, under the mattress or buried in the back yard in mason jars!
- Fortunately the above options aren’t necessary as we have banks however there are definitely times where the safety and security of specific banks or the banking system in general is called into question. We can’t really relate here in Canada but living in Hong Kong in 1997/1998 and in the UK in 2008/2009, the topic came up quite regularly and by the end of the most recent financial crisis a lot of the UK banking system was effectively nationalized (nobody lost any deposits). For large depositors, like institutional investors, keeping money in the form of bank deposits simply isn’t practical or prudent.
- Certain institutions, for example insurance companies, are required to hold specific asset classes. So some may not have a choice but to hold certain government bonds with negative yields.
Other reasons why negative yielding bonds might still have value for investors
- While certain governments’ bonds might currently be posting negative yields, an investor might still want bond exposure in that particular currency. For example, some global investors often think of the Swiss franc or Japanese yen as “safe haven” currencies. 10 year government bonds from those two countries currently have a negative yield. Perhaps the premium reflects current demand levels for safe haven currencies.
- If an investor feels yields are going to fall even further, they might be expecting to receive further gains from bonds, even if current yields are negative.
- In a deflationary environment, a bond with a negative nominal yield, could still give you a positive real (inflation adjusted) return. Ultimately investors care about real returns.
- Perhaps most importantly, bonds are not just return generators – their principal role in an investor’s portfolio should be to act as an uncorrelated shock-absorber when stock returns turn negative. According to Vanguard, current correlations between stocks and bonds are at records lows (see: By this metric, bonds have never been more valuable).
I’m sure there are more reasons. Yes, it still seems strange, however investors have gotten a little too used to thinking of bonds being return-generators or growth assets. Taken for what they really are, an investor’s safety net, bonds still hold a very valuable place in a diversified portfolio, even at negative yields. And of course there are still plenty of bonds, bond funds and ETFs offering yields well above those being offered for cash in the bank.