Market Insider

Why big investors including BlackRock are buying negative-yielding debt

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As the pool of negative yielding debt grows, big-name investors including BlackRock have jumped in.

Sluggish global growth has made many countries' central banks adopt a loose monetary policy — stepping up bond purchases and cutting interest rates, even into negative territory. With historically low yields limiting investors' returns, money managers are in a tough situation: There are few investment opportunities in a world where bond yields are low and U.S. stocks are near all-time highs.

In such an environment, "we do buy some negative rate corporate bonds," Rick Rieder, BlackRock's chief investment officer and co-head of global fixed income, said at a media roundtable the company held on Wednesday.

And he provided an explanation:

"The only reason you buy negative-rate bonds is if you think it's going to go more negative," he said.

Below-zero bond yields mean investors are essentially paying to put their money in those investments. But as bond yields fall further into negative territory, bond prices rise. (Bond yields and bond prices move inversely.) If investors buy a negative-yielding bond and the yield subsequently drops further, they can sell it at a profit. And for now, finding a buyer at those prices is almost guaranteed, given central bank policy.

Most notably among those buyers are central banks themselves. The European Central Bank, for one, began large-scale purchases of government bonds in March 2015 and expanded its quantitative easing program to include corporate bond purchases this June. Since April, the ECB has purchased the products at a rate of 80 billion euros ($90 billion) a month, and government bond holdings hit 1 trillion euros ($1.1 trillion) at the end of last week.

The bond purchase program is set to end in March. ECB President Mario Draghi said Thursday the central bank didn't discuss extending the program, but investors generally expect him to prolong purchases. The Bank of Japan, which also maintains a large asset purchase program, caused a surprise in January by cutting interest rates to negative.

People don't want to hold negative-yielding bonds. They just want to make a profit.
John Bredemus
vice president, Allianz Investment Management

All Japanese and German government bonds with a maturity of 10 years or less currently have negative yields or are very close to it. The U.S. 10-year Treasury yield has hovered just above all-time lows and was at 1.67 percent Friday afternoon amid increased expectations of a U.S. Federal Reserve rate hike.

John Bredemus, vice president at Allianz Investment Management, compared investing in negative-yielding debt to short-selling. That's when traders borrow shares and then sell them in a bet that the price will fall. When the share price drops, traders buy back the shares at a lower price and then return them to the lender, thereby netting a profit.

"People don't want to hold negative-yielding bonds. They just want to make a profit," Bredemus said. He said his team at Allianz doesn't think negative yielding bonds are a compelling investment.

Plenty of others do, however. More than $11 trillion is in negative-yielding government bonds worldwide, Fitch Ratings said in an early August report.

While shorter-term investors in negative-yielding bonds may turn a profit, the downward trajectory of yields limits returns for the longer-term investor, including pension plan holders.

"Should rates remain low for an extended period, it would likely erode earnings power for many large investment institutions and pension funds," Robert Grossman, head of macro credit at ratings agency Fitch, said in an Aug. 31 report.

The median 10-year yield for major investment-grade sovereign issuers stood at 1.17 percent at the time of the report, versus 3.87 percent in July 2011. That means that global investors have lost more than $500 billion in annual income on $38 trillion in currently outstanding bonds, Fitch said.

Yield of dreams: Stocks vs. bonds

To be sure, the negative yield bond investment strategy could backfire if central banks disappoint market expectations in some way. In late July and early August, the 10-year Japanese government bond yield went from negative 0.3 percent to almost zero after the Bank of Japan, contrary to expectations, did not increase government bond purchases.

In February, BlackRock's Rieder told CNBC that negative interest rates have diminishing benefits the longer they are in place and should be seen as a short-term effort during situations such as a financial crisis.

But "when you breach zero, you're taking money from savers, you're taking money from the banking system … and I don't see who you're handing it to," Rieder had said.

Regardless, investors still like the security of fixed income. U.S.-based taxable bond funds saw their fourth week in five of positive fund flows in the week ended Sept. 7, with gains of $3.4 billion in cash, Thomson Reuters Lipper data showed Thursday.

In contrast, U.S. stock funds posted their third-straight week of net withdrawals, with $271 million in outflows last week, according to the data.

Morgan Stanley's Chief U.S. Equity Strategist Adam Parker noted in a Thursday report that "it's a tough time to be an equity portfolio manager" as various investment strategies based on factors such as market cap did not significantly outpace markets in the last few months.

Meanwhile, investors remain concerned about market shocks from slowing global growth, a potential Fed rate hike, the U.S. presidential elections, political uncertainty in Europe and China's struggle to manage an economic slowdown.

"From a positioning standpoint, we don't think now is the time to take on a lot of risk," Michael Fredericks, portfolio manager of BlackRock's Multi-Asset Income Fund, said during Wednesday's roundtable. He said the level of risk exposure is one of the firm's lowest in years, and he's been cutting back on stocks and acquiring bonds such as emerging market debt.

"For the amount of risk and volatility you take in equities, you're going to do pretty well or just as well in fixed income," he said.

The negative yield phenomenon isn't just a development for the investing side. On Tuesday, two European companies — Germany's Henkel and France's Sanofi — became the first nonstate owned entities to sell negative-yielding nonfinancial corporate bonds in euros.

—CNBC's Patti Domm contributed to this report.