Negative yields: are we about to see a structural re-pricing?

20 February 2015

We have recently seen the Governments of Finland, Germany, Switzerland, Austria and the Netherlands, to name but a few, following Japans lead in issuing bonds that have a negative yield.

Just to be clear, this means that in absolute terms investors get back less than they paid even after the receipt of dividends. What’s more there is a reasonable chance that a number of corporate bonds could also trade on the basis of a negative yield; the bonds of companies such as Roche and Nestle already trade at barely positive levels and seem to be headed even lower.

To add to this, a recent report from Mckinsey surprisingly highlighted the fact that global debt has increased by $57 Trn. to nearly $200Trn. One of the consequences of this is likely to be that central bankers will be even more reluctant to raise interest rates very aggressively for fear of destabilising the economic system.

Potentially this may also lead to a lower demand for debt in the short to medium term. Both of these are factors are likely to maintain low interest rates.

I’m reeling! One of our Middle East clients often comments that “Ian has seen at least five market cycles” and, whilst I am not quite that old, this is still completely outside of my experience; which would equally apply to the vast majority of investors.

If this situation persists it could potentially force a recalibration of what is an acceptable yield across all asset classes, including investment property. It also begs the question as to whether it is time to accept that we have seen a structural shift to a very low inflation and interest rate/ bond rate environment; and that, importantly, things may remain like this well into the future.

If correct, this would change the pricing of all asset classes which could mean that a 4.25% yield on a prime City office may actually look a good deal, particularly with rental growth running at over 10% p.a.

If we are about to experience a prolonged period of deflation/very low inflation (and the jury is still out on this) then once yields have adjusted, investors face significantly lower returns than they have been used to.

Are we about to see a complete reassessment of the average investors return aspirations? Only time will tell, but definitely food for thought!!

Ian Whittock

CIO, Knight Frank Investment Management

20th February 2015

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