Sub-Zero Bond Yields Push Investors From Safety Zones By Bloomberg

Sub-Zero Bond Yields Push Investors From Safety Zones

(Bloomberg) — Europe’s ever growing pile of negative-yielding sovereign debt is pushing investors to venture beyond their safety zones in search of returns.

Pacific Investment Management Co. favors emerging markets with relatively low valuations and better yields, while BNP Paribas (PA:) SA says investors may have to look at riskier corporate debt. Pimco is also seeking to cut duration in its fixed-income holdings on the view that global long-term debt rates no longer compensate buyers for the corresponding credit risk.

Banks and money managers are left struggling to eke out earnings from their investments with over $12.5 trillion of global debt — including benchmark bonds in Germany, France and Austria — slipping into the negative-yielding zone. Adding to investors’ dilemma is the fact that they also need suitably safe assets to guard against a global economic downturn.

“We’re looking pretty closely at emerging markets where we see valuations as less elevated, particularly in some local currencies where you get a decent source of yield and diversification,” said Gene Frieda, a global strategist at Pimco in an interview with Bloomberg Television. “But at the same time, we are trying to reduce the duration of our fixed-income holdings because you just don’t get compensated for taking long-term risk.”

The firm regularly stress-tests portfolios to see how they would perform in risk events similar to the 2008 global financial crisis or the Federal Reserve taper tantrum.

Benchmark yields in Germany and other major euro-area debt markets hit all-time lows this month as markets priced in the prospect of monetary easing by the European Central Bank in response to the region’s economic gloom. The rate on 10-year bunds plunged to a record of -0.41% on July 4, falling below the ECB’s deposit rate for the first time.

“What it means is, you need to be more diversified,” Pimco’s Frieda said. “You can still build a reasonable portfolio with some combination of safe fixed income, credit, some foreign currencies.”

While yields have slipped below zero in a fifth of European investment-grade credit as well, some of the riskier and more cyclically sensitive segments of the market offer better returns, according to Viktor Hjort, global head of credit strategy at BNP.

“The credit market is saying it’s all about central banks, we don’t believe in growth,” he said. “Obviously that’s very consistent with the market environment right now.”

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