
As German Bund Yields Head to Zero, They Still Beat U.S. Treasuries - paulpauper
https://www.bloomberg.com/opinion/articles/2019-02-08/as-german-bund-yields-head-to-zero-they-still-beat-treasuries
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sputknick
What I didn't get from the article is a "so what". Why does this matter? Or
maybe they did explain why it matters, and I just don't have enough knowledge
to understand.

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fauigerzigerk
What makes this article a bit confusing is that they give an answer without
making it clear what the question was.

Here's the missing question: Imagine you are a Eurozone pension fund or life
insurer. You have to invest billions of euros very safely and eek out a return
that is no less than inflation. How do you do that?

Inflation (HICP) was 1.73% in 2018. German Bunds, the safest euro denominated
investment with sufficient volume, yield close to 0%. Now you look across the
Atlantic and find that 10 year treasuries yield 2.63%.

The problem is that simply investing in treasuries wouldn't work because
currency fluctuations would likely dominate any interest income. So you would
need to hedge the currency.

The Bloomberg article is about why hedging the EUR/USD currency pair is
currently too expensive for this idea to work.

It matters for European savers, including everyone who is paying into a
defined contributions pension (e.g most workplace pensions). A significant
chunk of those savings currently yields negative returns. The alternative is
to take a lot more risk than you want to or are allowed to take.

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fbonetti
Why bother investing it at the point? What’s the advantage over holding cash?

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JumpCrisscross
> _What’s the advantage over holding cash?_

Where do you hold the cash? Physically? As deposits in a bank? “Cash” is short
hand. This article debates different forms of cash. (OTR sovereign bonds are
usually considered cash.)

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cynusx
It's deposits in a bank, yes. Many banks charge large deposit holders a
negative interest rate.

The alternative of holding it in actual cash, comes with security costs,
storage costs,... The negative interest rate is still cheaper then the 1%
annual cost of securing banknotes. It also puts an implicit floor on how low
the central bank can lower the interest.

~~~
JumpCrisscross
> _Many banks charge large deposit holders a negative interest rate_

Counterparty risk dominates, for most treasurers. You don’t want your billions
of corporate deposits in the bank that went bust. Treasuries—or their local
equivalent—are a safe way to hold cash.

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gok
Euro-hedged US treasuries

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klochner
Vs unhedged bund. Pretty lame.

~~~
mruts
Yeah I’m not sure they are really comparable. Most foreign governments buying
T-notes are not fully hedging their currency exposure. As the Bloomberg
article demonstrates, doing so heavily eats into your returns. You are paying
an expensive premium, it would probably just be a better idea to buy USD
denominated T-notes and deal with the currency exposure down the line.

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jonathanleane
Can someone with a finance background explain why this is happening?

Is the issue that there is loads of money in the system with not enough
productive and/or low risk opportunities to invest it, so people are basically
wiling to accept close to a zero return?

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ctas
I own German Bundesanleihe and I wonder what stops anyone buying units that
were released 20 years ago. Some of them yield around 4%. Of course they
expire within the next 4-8 years which is still enough time to profit. Maybe
I'm missing something...

~~~
mruts
What you’re talking about is the coupon, not the yield. Say you have Bunde
that was sold at 100 EUR. The coupon is 4 EUR. So the coupon is 4%. The yield
however depends on the current market price. To calculate the yield you take
the coupon and divide it by the current market price. Because bonds mature
into each other, that is a 5-year issued 4 years ago should be the same as a
1-year issued today, both bonds will have the exact same yield.

So effectively all the old bonds turn into new bonds, all linked to the same
yield. This is why yields can be negative, it’s not like a negative yield
bonds means you are paying someone. It just means that the price is so high
the effective return is negative (remember that you get the face value of bond
back after it matures)

One exception to this rule is newly issued bonds. Because of regulations and
rules, some institutional investors must buy bonds direct from the treasury.
This means that they often trade a premium (they have a lower yield) compared
to old bonds.

Bonds can be a little counterintuitive because when bond prices go up, yields
go down. So negative yields actually mean that market is very bullish.

You might then ask, why would anyone purchase a negative yield bond? Well,
there are a couple different reasons: a) they have to, due regulations or
internal rules. b) they are speculating on interest rates or currency. Or c)
they are speculating on the bond market (related to b).

Bonds can be complicated because they have exposure to a lot of factors:
rates, inflation, equities, debt, etc. But they are useful instruments because
they have intrinsic value: they simply pay a fixed coupon and then the
principal after N-years.

~~~
jorblumesea
Just to add on this... for most investors, they provide some backbone and
counterweight to market cycles. In terms of safety, they are a safer
investment choice because they represent debt, not equity.

This is a good example, graphed:
[https://www.google.com/search?tbm=fin&q=MUTF:+VBMFX&stick=H4...](https://www.google.com/search?tbm=fin&q=MUTF:+VBMFX&stick=H4sIAAAAAAAAAONgecRozi3w8sc9YSm9SWtOXmPU4OIKzsgvd80rySypFJLiYoOyBKT4uHj00_UNK8uTCsvzilN4FrFy-4aGuFkphDn5ukUAAJdCiW1KAAAA&biw=1440&bih=711#scso=_SBtfXJqwEOm0ggeplaqoCg2:0,_eBtfXJfiK-
Gm_QbPo6HQBg2:0&smids=/g/1ywbr166m&wptab=COMPARE)

Bonds Summarized:

a) are less volatile compared to equities

b) provide consistent and guaranteed returns, albeit at a lower rate compared
to equities

c) often work counter to market cycles: when interest rates rise, bonds fall
in value, and when interest rates are cut, bonds rise. Depending on the depth
of the fund, you may not see any changes at all.

Generally speaking, stocks almost always perform significantly better than
bonds over long periods. If you can handle the risk, in theory 100% stocks is
a better investment. Bonds provide the "don't freak out and sell" part of your
portfolio.

~~~
mruts
A couple on interesting points:

a) Bonds, as you said, were traditional seem as counter cyclical, when
equities or rates went up, bonds went down, and vice-versa. Nowadays, it seems
like this might not be true anymore. So much money is pouring into the US
securities market that both often now move in tandem. In the past, in risk-off
environments (when you want to lower your risk), investors would move out of
equities and into bonds. But now, since so much money is foreign, you see
outflows from both bonds and stocks is a risk-off environment. This makes
bonds a worse hedge today against equities than in the past.

b) It's true that 100% stocks almost always outperforms 100% bonds. But things
get really interesting when you consider a mix of equities and bonds. Take an
100% equities portfolio of say 10 stocks: do a simulation in which you vary
the weights of each position (the percentage of each stock that makes up your
portfolio). Now graph the historical returns on Y axis and the historical
volatility of all these simulated portfolios. What you'll see is called the
"Markowitz Bullet"[1] The efficient frontier (EF), is all the portfolios that
have the best risk adjusted returns (also known as the Sharpe ratio).
Basically what that means is that those portfolios on the EF (the top "edge"
of the bullet) have better risk/reward characteristics than any of the
portfolios below them. so with a 100% equities portfolio, the best you can do
to maximize your Sharpe ratio will be on the top edge of the curve.

Now consider mixing in some bonds which are at the risk-free rate. 3 month US
T-notes are traditionally considered to be _the_ risk-free rate. That is, they
have no volatility and a fixed return (say 2%).

By adjusting your allocation of risk-free bonds and equities you can achieve a
better Sharpe ratio than anything you could do with just equities alone. So
now, with adding bonds, you can now _beat_ the EF. The EF is now the line
drawn between the risk-free point (0 variance, 2% returns) and tangent
portfolio (the highest point on the curve). Check out the picture below for an
illustration.

But it gets even better! If you can _borrow_ at the risk free rate, you can
now your leverage returns (but also volatility) into outer space!

Modern portfolio theory is based on this concept that adding the risk-free
rate to your portfolio can actually make you achieve better risk-adjusted
returns than you otherwise could with just equities alone. Seems pretty
magical when you think about it (though it's predicated on the original sin of
finance: that the risk-free rate actually exists)

[https://en.wikipedia.org/wiki/Modern_portfolio_theory#/media...](https://en.wikipedia.org/wiki/Modern_portfolio_theory#/media/File:Markowitz_frontier.jpg)

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xchaotic
Basically everyone is desperate to invest money somewhere.

Bonds are one of the safest instruments and often pension funds are legally
obligated to invest at least a proportion of funds in safe, not risky
instruments.

This will not end well IMO.

~~~
cmurf
TIPS bonds are one of the safest instruments. A regular bond can be as risky
as stocks, whether traded short term or held to maturity. What people get with
bonds, depending on the rating, is something short of a guarantee they'll get
principle back with the agreed upon interest - but can you really accurately
assess risk over 10 years? 30 years? There's widespread agreement that
corporate bonds aren't paying enough compared to the risk, and yet people
continue to invest in it.

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ng12
I would argue that a "regular" bond refers to government-backed securities,
basically AA at a minimum. When people want to talk about corporate bonds
they're careful to refer to them as junk bonds.

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cmurf
Literally none of this is correct. Bonds do not inherently or even typically
refer to government securities. And not all government issued debt is AA, for
example Mexico bonds are currently rated BBB+. Junk bonds are speculative
rather than investment grade, quite a lot of corporate bonds are investment
grade.

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KorematsuFred
German Bund is clearly something totally different than German Bonds.

