Investments Which Lose Money… On Purpose!
By Brad Thomason, CPA
2/1/2015
In the latest issue of Bloom berg Business week there’s an article about how bond managers are having to buy bonds which they know are going to lose money. The theme of the article is that the economic slowdown in Europe and Japan has created a situation where people are more concerned with investing in things for which they will get their capital back, than they are with actually earning a return. They are essentially paying for the privilege of making loans (bonds are debt instruments).
There’s a quote in the article from one of the managers they interviewed, which says, “We try to avoid buying or holding negative-yielding assets.” Gosh, who doesn’t? When I read that I literally laughed out loud. Later in the day I told a colleague that a statement like that seemed to belong in the same category as, “We consider the intake of air to be a positive, with respect to staying alive.” Both certainly seem like the kind of thing that it would never actually be necessary to say out loud.
But here’s the thing: the context of the article was that they were buying them anyway. Not sure how you square “try to avoid” with “we did it anyway.”
In case you’re wondering, bonds drop into negative yield territory when the price of the bond goes way up. With bonds, price and yield move in opposite directions. So if the demand for bonds is high enough the price can rise above the face value. That’s called a premium. If the premium gets high enough it can make the total price exceed both the amount which will be paid back when the bond matures, and the interest which will be paid along the way.
Professional managers often have well-developed allocation models which require that they always have x% of this and y% of that. So in the institutional management space, this is not quite as bizarre as it sounds. Close. But within context it makes at least a little sense. If your allocation mandate is that you have to have x% bonds, then you have to go out and get more bonds as the old ones mature, perhaps even if the pricing is screwy. That seems to be the situation here.
The good news for individuals though is that such strict allocation rules don’t have to be part of the picture. Although an overall sense of planning in portfolio construction – including attention to allocations – is a good thing, individuals have a lot more freedom to make changes when something clearly isn’t working. If the decision on the table is whether or not to invest in a guaranteed loss, that looks to me like a pretty good time to re-examine.
Institutional managers may be stuck in bonds. You aren’t. Even if you have been a bond investor in the past, this is an asset class which is having a tough time right now. That only becomes your problem if you chose to make it your problem. By redeploying into other asset classes, you can avoid the malaise and open up the possibility of meaningful yields, without ratcheting the risk exposure up into the high levels.
Given that, what possible reason could you have for buying a negative yielding bond?