The Dutch asset manager said that pension funds and insurers should not readily abandon bonds with a guaranteed negative return.
Yields on nearly a third of government bonds in developed markets, mainly in Europe and Japan, have entered negative territory, it said.
The journey of negative rates
Most recently, bond yields fell because of the US-China trade war, but the journey to negative rates has been largely driven by the difficulty to sufficiently raise economic productivity.
A big factor has been the eurozone’s inadequate policy response to the global financial crisis, NN IP said.
“The combination of secular plus cyclical forces is likely to result in relatively low policy rates for the foreseeable future. In this environment, a sizeable part of the euro government bond market will have a negative yield,” it says.
A de-escalating trade conflict or intervention by the Fed or the European Central Bank could boost higher rates. However, NN IP believes that the only impactful (but unlikely) policy by the US is significant fiscal stimulus to move to another rates regime.
Rather than higher rates in developed markets, NN IP expects them to drop again in the near term and remain at extremely low levels in the medium term.
Further rate decline may create broader problems, which can turn negative interest rates into a real threat to economic growth.
Finding value in negative return bonds
Yet, NN IP argues that buying negative return bonds could still be valuable for long-term investors.
Fixed income investors can profit from a positive carry or if the “roll-down” is positive, when yield curves are sloping upwards.
“Assuming unchanged yields, the price of an eight-year bond, for example, will rise when it becomes a seven-year bond.
“Investors might even expect the yield to move down even further, in which case they can book a capital gain by selling the bond before it matures,” it writes.
And, in comparison, a negative yield of a one-year bond held to maturity may still return more favourably than other asset classes.
“For instance, a stock with a 40% probability of a 10% decline and a 60% probability of a 5% increase has an expected return of -1.0%,” it said.
Risk and illiquidity
NN IP also points to a number of risks that could result from low rates to long-term investors, such as regulatory risks.
If interest rates remain at the current levels for some time, we could expect further decreases of the ultimate forward rate over the coming years, which would have a material impact on the Solvency II balance sheets and capital positions of some insurers.
NN IP warns long-term investors against moving into riskier assets.
“A move of funds into riskier and illiquid assets at a time of depressed risk premia is a decision [to be] taken with a healthy reluctance,” it says.