May 16, 2016
Let’s talk interest rates this week. With global growth slowing in so much of the world, low interest rates are becoming the norm more and more. A global search for yield on sovereign debt estimates that over 80 percent of the world’s government bond debt is yielding less than 3 percent. In fact, in certain parts of the world interest rates have gone negative. Let’s look at various countries and what their average government debt is yielding:
Country Effective Yield
Not much yield on the sovereign side but what about the debt of companies, is there any yield there?
US Corporate Bonds 3.03%
US High Yield Bonds 7.75%
Emerging Market Corporate Bonds 5.56%
European Corporate Bonds 0.81%
The demand and need for income is usually high in an investor’s portfolio. It is a fact that today’s buyers of bonds are enthusiastic about investing in bonds at virtually any price for any period of time. The WSJ this week noted that the demand for debt (income) in Europe is so great that companies and nations are issuing very long term debt that doesn’t mature for 50 and 100 years! The Spanish government issued a 50-year bond that rewards the investors a yield of only 3.45%. Last month the French government sold a 50-year at a return of only 1.75%. Six years ago the same 50-year debt carried a rate of 4%. Have investors lost their minds locking in a 1.75% for 50 years?
It’s not just bond investors that are impacted in this new low interest rate environment. We had a discussion this week with a long time real estate professional on the state of his market. He pointed out how the demand for yield and the acceptance of low rates has spread to real estate investors. Report after report shows that the metric used in calculating the value of income-producing real estate called the capitalization rate (cap rates) continues to drop for all property types. Long-term players in the real estate market are beginning to question some of the valuations due to these historically low cap rates. The problem is buyers continue to look for yield.
If you are the manager of a pension fund, you must invest your capital to produce income in order to pay your pensioners. You must find investments that generate the yield you need. In the past you might get that yield from government bonds, but not today. That might cause you as the portfolio manager to turn to riskier options in corporate or high yield bonds. But what if that rate is too low? The next option is to invest in longer and longer term bonds. Both of these options are very risky to the bond investor, but the reality is they are doing it and there is no end in sight to their demand and to their problems. If you need to borrow money globally there has never been a better time – the buyers for your debt await with open arms and low rates.