Negative yields force benchmark rethink

IFR 2299 7 September to 13 September 2019
6 min read
Christopher Whittall

The rapid growth in negative-yielding debt is prompting investors to overhaul how they measure the performance of bond funds.

The worldwide pool of such debt has roughly doubled to more than US$16trn in recent months, raising questions around the traditional practice of benchmarking fund performance against standardised bond indices.

Some funds are in discussions with index providers to help craft benchmarks free of negative-yielding bonds. That would potentially exclude a substantial chunk of the market. Around 30% of the global tradeable bond universe yields less than zero, according to a recent report from JP Morgan. Moving towards so-called absolute return targets is another option, where investors set an annual performance objective of several percentage points over inflation or cash.

Such changes could encourage investors to buy riskier types of debt that offer juicier returns, as well as channel yet more money into higher-yielding currencies such as US dollars.

But many fund managers believe a shift is inevitable given the clouded outlook for global growth and the trajectory of central bank policy, which both signal the mountain of negative-yielding debt is unlikely to disappear any time soon.

“We’ve got to protect the capital and grow the capital of clients,” said Paul Griffiths, chief investment officer for fixed income and multi-asset solutions at First State Investments.

“We could choose to invest in those [negative-yielding] markets, but we don’t want to be forced to invest in these markets.”

Investment funds across equities and bonds have traditionally compared their performance against broad-based indices to help demonstrate the value of their services to clients.

That practice has drawn criticism from some quarters over the years and it has become more common for new funds to opt for an absolute return target. But it is the steep increase in negative-yielding debt this year that has provided the strongest impetus yet for bond fund managers to reconsider how they operate.

Some clients of asset managers, such as pension funds and insurance companies, need to own bonds to match their long-dated liabilities. The problem is a growing proportion of those securities yield below zero, particularly in Europe. That comes amid concerns over growth and signs the European Central Bank is gearing up for another round of monetary stimulus.

“Lots of people/prospects are asking for absolute return [strategies] … in order to get positive returns in this deflationary world,” said Philippe Berthelot, co-chief investment officer for fixed income at Ostrum Asset Management.


Finding a positive yield has never been harder. One go-to strategy – buying long-dated debt – is less effective now that German government bond yields are negative across the curve – out to 2050 – and French bonds out to 2035 yield less than zero.

Another obvious strategy – buying riskier corporate debt – has also lost its potency. The amount of euro corporate bonds trading at a negative yield has more than tripled in recent months to €1.1trn, according to a recent Bank of America Merrill Lynch report.

“The lines between investment-grade credit [funds] and everything else has been blurring for some time. The explosion of negative-yielding debt this year has been accelerating that process,” said Hans Lorenzen, head of European investment-grade credit strategy at Citigroup.

Griffiths at First State Investments said he had been talking to clients about what is their investment goal, which may mean stepping away from the traditional “benchmark plus performance” target. That could involve moving to an absolute return target such as inflation plus a percentage, or building a tailored benchmark free of negative-yielding debt.

“It’s something that we’re looking at,” said Griffiths. “Fixed-income investors and benchmarks are not natural bedfellows. The low level of yields only reinforces that.”

But developing indices that exclude negative-yielding debt could produce other issues. The US share of global investment-grade yields climbed to 95% in August, according to BAML, while non-US sovereign yields were on average negative for the first time ever. Removing negative yields could force investors to pile into US bonds, as well as corporate credit and emerging-market debt, to find positive returns.

The two largest bond index providers, Bloomberg (which owns the Barclays bond indexes) and IntercontinentalExchange (which owns the Bank of America Merrill Lynch indexes) did not respond to requests for comment.


It is early days in these types of conversations, not least because the rise in negative-yielding debt has been so quick, with much of it happening over the summer holiday period.

More conservative investors, such as European insurance companies, may be reluctant to abandon benchmarks. Regulation constrains their investment strategies, and bond indices help define and limit the risks they are taking.

Other investors may be appeased for the time being by the strong performance of bond funds this year, buying asset managers some time in the benchmark debate. The Bloomberg Barclays Global Aggregate Index, for instance, has produced a total return of 7.5% so far this year.

Citigroup’s Lorenzen said the problem really comes when fund managers have to argue how they are going to deliver returns next year, given that yields are already so low. Charging management fees of a quarter percentage point when euro investment-grade credit yields roughly the same amount could be a tough pitch.

“That’s where invariably they’re trying to offer new and more ‘interesting’ funds to end investors,” said Lorenzen.

Nolwenn Le Roux, a senior portfolio manager at Ostrum, suggested active managers may have to stray from standard benchmarks in order to stave off the competition from exchange-traded funds, whose assets have climbed steeply in recent years.

“This should be the future of asset management. If we want to sell an active management [fund] in the coming years, we will have to … differentiate [ourselves] from ETFs and give a positive return to our clients,” she said.