The invisible rise in risk

The global central bank interest-rate cycle points downwards. This impacts on the yields on government bonds, which are falling worldwide. In Germany, Bunds are in negative territory, even at the long end. This only serves to make the global bottleneck in investment opportunities all the tighter. As a result, the “Bloomberg Barclays Global Aggregate Negative Yielding Debt Market Value Index”, which covers all bond types offering a negative yield, is now back close to the highs last seen in 2016.

Irrespective of whether yield decreases arise owing to a rise in risk aversion among market players or owing to the expectation that central banks will ease their monetary policy, this boosts the relative appeal of bonds offering an appropriate positive yield. Since it is now virtually impossible to achieve positive yields with government bonds, with the exception of those at the very long end, investors will presumably increasingly focus on corporate bonds that boast an investment-grade rating.

Amongst the 1,515 corporate bonds listed in the iBoxx Euro Non-Financials Senior, the benchmark index for corporate bonds that are rated as investment grade, 93.1% offer a positive yield. While the vast majority of the bonds are rated “BBB”, i.e. in the lowest rating category in the index, even amongst those in the A segment there are no less than 464 bonds offering a positive yield. The air gets thinner when it comes to achieving a target yield of 1.0%. That said, no less than 26.5% of all the corporate bonds listed in the index top the target yield stated. However, more than three quarters of all the bonds offering a yield north of the target yield stated come with a BBB rating.

One should not be deceived by the current high scale of the yields, but factor in other aspects when taking an investment decision. The countless geopolitical risks and their potentially negative impacts both on the economic cycle and on corporate business prospects could in the medium term unfavourably influence companies’ ratings. In particular those corporations that are classified at the bottom edge of the investment grade at “BBB” and are thus still just on investors’ radars run the risk of dropping out of that segment as a result of the economy cooling. If that happens, investors would be forced for regulatory reasons to jettison such bonds. In such phases, liquidity will likewise not be overly opulent and high supply would go hand in hand with very meagre demand; the prices of such bonds would probably then fall swiftly and significantly. The same would also apply to other bonds offering higher yields, for example from the emerging markets.

The low yields on relatively safe government bonds compel investors sooner or later to accept greater risk in their portfolios in order to get anywhere near meeting their yield expectations. These risks were justifiable in past years as the global economy was relatively stable and central banks could, if necessary, support the bond markets. However, the picture has since dimmed, the economy is cooling and the scope for central banks to act is limited. This means that there has been a rise in the implied risk that investors shoulder with corporate bonds or similar instruments. This cannot yet be seen in market prices as the risk function of prices no longer fully applies. Thus, in a corresponding setting a systemic crisis could swiftly arise, as it would no longer be possible to balance the supply/demand relationship. In other words, for investors the opportunity/risk ratio has appreciably deteriorated.

In the final instance, an investment in such bonds given the current level of yields also entails the hope that the central banks will, if necessary, support the market with bond purchase programmes. Investors should be aware of this trend, even if, in the light of the given target yields, there is often no alternative to such investments.

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