June 30th, 2016 5:32 am
This WSJ article notes the outsized returns this quarter of the government bonds if many developed country. The article also points out the inverse relationship between price and yields if you happen to be reading about bonds for the first time.
By Mike Bird and
June 29, 2016 7:33 p.m. ET
A corner of the market once sought after for steady returns has been this year’s jackpot investment: the government debt of advanced economies.
Sovereign debt rallied in the market turmoil that followed Britain’s vote to exit the European Union on Thursday, amid a rush for havens and expectations that central banks will ramp up stimulus measures.
Prices of Japanese, German, U.K. and other sovereign bonds have been surging for most of the year as interest rates turned negative and global economic uncertainty pushed investors to buy haven assets.
Then came Brexit, which roiled markets and added roughly an extra $1 trillion to the global total of negative-yielding debt, taking the total to nearly $11 trillion, according to strategists at Bank of America Merrill Lynch.
As yields fall, prices move higher, boosting returns.
For an investor in sterling, Japanese 40-year government bonds soared in price by 24.7% in the three trading days after Britain’s referendum vote, giving these securities a gain of 95.8% since the beginning of this year. In dollar terms, the price of these bonds has increased 77% this year. After the U.K vote, the yen soared against the pound and moved higher against the dollar, increasing the return in those currencies.
In the same period, the S&P 500 is up 1.3% and Europe’s Stoxx 600 is down 10.75%. Gold, one of the other main haven assets, is up a less impressive 25%.
Last December, Jim Leaviss bought long-dated Japanese government debt in what became a very lucrative investment.
Mr. Leaviss, head of retail fixed income at U.K. fund manager M&G Investments, said he should have invested “the whole fund in 30-year JGBs, with the benefit of hindsight—I didn’t have enough of them.”
In December, the 30-year securities offered a yield of about 1.25%. But that had fallen to roughly 0.3% by the time Mr. Leaviss sold the bonds last month.
The average yield on global 10-year government debt has nearly halved this year to 0.58%, pushing returns higher, according to the Barclays Global Treasury bond index.
Over the last two weeks, those returns have accelerated, with government bonds breaking records across the world’s advanced economies. For the first time ever, yields on the U.K.’s 10-year gilts fell below 1%, Germany’s 10-year bund yields dropped into negative territory and the yields on Swiss government bonds are negative all the way out to 30 years. Typically, the longer the maturity, the more an issuer must pay an investor for taking a bigger risk.
Meanwhile, U.S. 10-year Treasury yields fell to 1.461% Monday, the lowest level since July 2012. Yields have moved up in recent days but are still down 0.796 percentage point this year.
Long government bond funds have had stellar performance so far this year, according to data from Morningstar, with returns of 14.37%. In comparison, U.S. midcap value equity funds—the best-performing category of U.S. stock funds in 2016—have booked returns of 1.24%.
Much of the recent fall in yields came after the U.K. referendum. Investors fear that Britain’s departure from the EU not only removes Europe’s second-largest economy from the bloc, but that the precedent could lead to further fragmentation and a period of investment-sapping uncertainty around the world.
So investors are moving into these securities for safety and as they anticipate further central-bank action, in the form of interest-rate cuts and asset purchases, or quantitative easing. Interest-rate cuts will typically boost the price of outstanding securities because it means future issuance will likely offer a lower yield.
“The economy is likely to go through a slowdown,” said Mitul Patel, head of rates at Henderson Global Investors. “The potential for rate cuts and QE is likely to keep government bonds well supported,” Mr. Patel bought gilts on Friday after being wrong-footed by the Brexit vote.
With yields now so low, some investors are looking beyond the most popular haven government bonds like Japan’s to the debt of other countries.
“In most of our portfolios we were overweight Japan, for a long time, we liked Japanese 20-year,” said Bob Michele, head of global fixed income at J.P. Morgan Asset Management. Like their 40-year peers, yields on 20-year bonds have fallen to practically nothing, moving from 1% at the end of 2015 to as low as 0.04% this week.
Now, J.P. Morgan Asset Management has rotated into higher-yielding sovereigns, like Australia’s 10-year notes.
But some investors believe that not only has the rally in government bonds run its course, there are reasons to be cautious about holding them.
Today, with global interest rates so low and borrowers issuing ultralong debt, duration risk is shooting up. This means investors must wait longer until they get back the money they initially invested, and a small rise in interest rates could easily wipe out years of returns.
“The potential returns against the mark-to-market risk are not favorable,” said Andrew Bosomworth, managing director at Pacific Investment Management Co., one of the world’s biggest bond-fund managers.
Still, last week’s Brexit vote has other investors betting that yields in this market may continue to fall.
Potential fallout from Britain’s exit from the EU adds to a long list of concerns that had already hobbled returns in other markets, from corporate profitability to worries over Chinese economic growth.
“Lower bond yields are a logical response to the structural imbalances in the global economy,” including demographics, the distribution of wealth and heavy debt loads, said Steven Major, global head of fixed-income research at HSBC Holdings PLC. “In a way, the Brexit vote is a symptom of all of the above.”
Write to Mike Bird at Mike.Bird@wsj.com and Christopher Whittall at email@example.com