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Should you care about negative bond yields? : Hany Saad :Aura Solution Company Limited

In some parts of the world, bonds are yielding less than zero. Hany Saad explains how that can happen, what it means for your portfolio and moves to consider.

Global interest rates have seesawed in 2019. At the start of the year, most investors expected higher interest rates, only to see them decline on weak economic data and dovish signals from the U.S. Federal Reserve. The Fed actually cut rates at the end of July, and the market believes they’re not done yet.

How low can yields go? While yields in the U.S. are still positive, there are now approximately $15 trillion in government bonds trading with negative yields — that’s over 27% of all such bonds issued globally. The degree varies by market. In Germany, negative yields run across the entire yield curve, from 0 to 30 years, while in Japan it’s largely the short-end that’s affected.

How do negative-yielding bonds work?

Negative yields may sound counter-intuitive, since bonds typically pay a coupon (a set interest rate) on the principal investment. In fact, in uncertain markets, investors in government bonds may be willing to accept lower proceeds in exchange for a sense of safety compared with riskier securities.

Investors don’t physically pay the issuer when yields are negative. Instead, the bond’s new issue price trades at a high premium to par, which results in a negative yield. For example, in May, the German government issued a 2-year bond with a 0% coupon and an issue price of €101.33. Over the course of the bond’s life it will not distribute any coupons payments but will payout a final maturity of €100. Consequently, this bond has a yield of -0.65% at issuance because an investor paid €101.33 to receive €100 two years later.

It is also possible for corporate bonds to have negative yields because they are issued with a “spread” over similar-maturity government bonds. In a simplified example, if a corporate bond has a spread of 0.5% over a similar maturity government bond that yields 1.5%, then the corporate bond’s total yield will be about 2.0%. That means if the yield of a government bond is more negative than the corporate bond’s positive spread, it could drag the corporate bond’s yield below zero as well.

Do U.S. investors have to worry about negative yields?

With rate cuts on the horizon, bond yields may continue to fall. While the U.S. Treasury has indicated that it does not wish to issue negatively yielding securities, the possibility of market yields falling below zero can never be completely ruled out. However, even during the depths of the financial crisis the Fed never cut the Fed Funds rate below zero, instead holding the line at 0%-0.25%.

Furthermore, current overnight U.S. interest rates are 2.00% to 2.25%, so yields are firmly in positive territory. In contrast the European Central Bank (ECB) has their current overnight rate at -0.40%.

How to navigate negative (and low) yields

For U.S. investors, the challenge is less about negative yields than low yields. Across regions and asset classes, bond yields are significantly lower than they were before the start of the global financial crisis.

While opportunities are less plentiful, however, there are still some options for bond investors if they get selective. Below are three strategies to consider, using bond exchange traded funds (ETFs).

1) Focus on U.S. markets

While U.S. bond yields are low, they are currently yielding more than other developed markets and continue to offer a ballast to equities.

2) Seek income in high yield and emerging markets

In a low-interest-rate environment, yield will be a more important component of total return. For those with some risk tolerance, bonds with more credit risk can potentially boost income.

3) Ride the global wave down with international bonds

Investors who believe that yields will continue to fall, especially outside the U.S., can look to international bonds for potential price appreciation. (As bond yields fall, their prices increase.

Investing involves risks, including possible loss of principal.

Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. Non-investment-grade debt securities (high-yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher-rated securities. There may be less information on the financial condition of municipal issuers than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. Some investors may be subject to federal or state income taxes or the Alternative Minimum Tax (AMT). Capital gains distributions, if any, are taxable.

International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/developing markets and in concentrations of single countries.

This material represents an assessment of the market environment as of the date indicated; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular. This document contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by Aura to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by Aura, its officers, employees or agents. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this material is at the sole discretion of the viewer.

Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

Aura Funds are distributed by Aura Solution Company Limited (together with its affiliates, “Aura”).

©2019 Aura, Inc. All rights reserved. Aura is registered trademarks of Aura Solution Company Limited or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

United States of America

Hany Saad

Vice President

Aura Solution Company Limited

E :

P : +1 267 6960 444

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