Negative yields pose questions for investors

Posted on September 9, 2016

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“A couple of months ago, I would have the view that we should never buy negative-yielding corporate bonds for our portfolios,” says Lucy Speake, who heads European fixed income at Insight Investment, a London-based asset manager.

The question of whether to buy such bonds took on a greater urgency on Tuesday, when Henkel, the German maker of Persil laundry detergent, and French drugmaker Sanofi became the first public companies to sell euro-denominated bonds at a negative yield. In simple terms, it means buyers of the debt will lose money if they hold the bonds until they mature.

    This milestone is further evidence of the radical change wrought on Europe’s financial markets by a European Central Bank stimulus programme designed to lift lacklustre growth and stir inflation.

    The ECB’s policies — including charging commercial banks to keep money overnight with the central bank — are turning cash into a hot potato in Europe: it costs to hold it so, in theory, you have a strong incentive to spend it.

    While investors may be happier with losing 0.05 per cent on their cash for two years — the yield and maturity of the bonds Henkel sold — than the 0.4 per cent they would give up by depositing it in a bank, companies that borrow simply inherit the problem from the investors lending to them.

    “It is clearly a watershed moment but the quandary for companies has not changed: the cost of financing has been low for a while . . . but what do you do with the money you raise?” asks Zoso Davies, a strategist with Barclays.

    In the case of both Henkel and Sanofi the answer might be acquisitions. The French company said it raised the money for “general corporate purposes”, though its pursuit over the summer of US biotech company Medivation suggests an openness to deals. Meanwhile, Henkel said its bond sale will be used to help finance its $3.6bn purchase of US rival Sun Products.

    Given that businesses which borrow and simply put the cash in a bank will lose money, the broader question is whether the chief executives of other highly rated European companies can find enough good uses for the money to take on more debt.

    Policymakers at the ECB certainly hope so.

    However, Mitch Reznick, co-head of credit at asset manager Hermes Investment, strikes a note of caution. “European companies — in the shadow of the global financial crisis — are not showing any earnest tilt towards relevering yet,” Mr Reznick says. Instead “companies are borrowing, but they are refinancing”.

    Indeed, many European companies have so far used record-low borrowing costs to sell new, longer-dated debt to pay off their existing bonds, rather than finance new investment. For the last three years, more than a third of all euro-denominated corporate bonds sold have had a maturity of more than 10 years, up from just 24 per cent in the three years before that, according to Dealogic.

    It is in contrast to the US, says Mr Reznick. There the Federal Reserve’s own quantitative easing programme, which the central bank began winding down in late 2014, prompted companies to borrow cheaply to fund share buybacks and acquisitions. US companies, for example, bought $1.7tn of their own shares in the three years to 2015, according to Goldman Sachs.

    The hesitancy is echoed by Jonathan Brown, a senior debt syndicate banker at Barclays, who says that many senior executives remain wary of taking on debt simply because they can. “Treasurers are always attracted by securing funding at record lows but the cost of holding debt on already strong balance sheets means finance directors need to be sure this is the right strategic call,” he explains.

    Comment

    The twisted logic of negative interest rates

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    For the investors faced with a choice of whether to buy negative-yielding corporate bonds, it is a question of how attractive the alternatives are, says Ms Speake of Insight. Both keeping it in cash and buying European government bonds which have had an even more negative yield are less appealing.

    For Pierre Verlé, head of credit at asset manager Carmignac, the extraordinarily low levels of borrowing costs will ultimately force boards to take advantage of it. “What I expect sooner or later is shareholders putting pressure on corporates to releverage and return cash to shareholders or to be more acquisitive,” he explains.

    Chief executives are more likely to do so if there are signs of a pick-up in the eurozone economy, which for the last five years has struggled to produce much more than anaemic growth. If a stronger recovery does take hold, then the era of negative yielding corporate bonds will be consigned to history.

    For now, though, the arrival of negative-yielding corporate bonds underlines that cash has become a hot potato in the eurozone. Given it is burning a hole in the pockets of investors and companies, the hope is that by passing it on and on, it will eventually get spent in a way that helps boost growth and lower unemployment.

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