Market Watch: Why do investors buy bonds with negative returns?

Why are investors flocking to bonds markets to buy assets with negative interest rates?

About one quarter of global bonds (US$17 trillion worth) now provide negative returns.

"In an uncertain environment people don't want to lose money so they go to bonds as a safe-haven, that's what's driven the demand," says Pie Funds chief executive Mike Taylor.

Bond markets can seem complex and difficult to understand. There's a counter intuitive aspect to the way they trade.

"The easiest way to look at it is that when the yield of the bond goes down, the price of a bond goes up," Taylor says. "It's opposite of what you might expect with shares.

It is important to remember that when you see media stories about US$17tn of negative-yielding bonds, they are not all being issued that way, he says.

"So not necessarily that many government bonds have been issued with a negative yield. They might be issued at, say, 1.5 per cent, but demand for those bonds is so strong that the price is pushed up and that means you're buying something that over a 10-year period will give you a negative return."

Investors are prepared to pay for certainty and because the demand for certainty is so high in the current market there are good returns being made even for low-yielding assets, Taylor says.

A good example is two 100-year bonds issued in recent years by Austria and Argentina.

If you bought the Austrian bond you would have doubled your money, even though the yield was just mid 2 per cent, because of the demand for that safer haven, Taylor says.

If you had bought an Argentinian bond you would have lost half your money - even though the yield was close to 8 per cent - because people think they won't be able to repay that.

"So there are risks with bonds, they are not always safer havens and people who are buying bonds with long-term maturity need to be a bit careful at the moment," he says.

"What happens if things don't turn out as badly as investors are expecting?"

The positive side is simply that the cost of borrowing is extremely low.

"For Kiwis it's good if you've got a mortgage," Taylor says.

Mortgages are at historic lows and that's good for consumers.

"In these Western economies that rely on the consumer, things just keep moving along. If you've still got a job, you've still got money, everything's hopefully ok," Taylor says.

What's less clear is how sustainable this will be.

"A decade ago we had a race to the bottom on equity markets, now we've got a race to the bottom in terms of interest rates and bond investors are doing very well out of that."

"It is concerning because when you get to this point you reach what in the industry we call TINA - there is no alternative."

Unless there is a major shift in the global economy - such as a resolution to the trade war - it looks like we would be in the same environment for some time yet, Taylor says.

"Economies will keep slowing and there will be pressure on rates to go lower."

- Market Watch is produced in association with Pie Funds