Watching formerly risk-averse investors adapt to a negative interest rate
world is almost as much fun as watching Europe try to keep Greece and Germany
in the same financial family. In each case, success depends on all the parties
becoming something they really don't want to be.
On the negative interest rate front, consider this from yesterday's Bloomberg:
No
Risk Too Big as Traders Plot Escape From Negative Yields
Norway's $870 billion sovereign wealth fund said this month that it added Nigeria
and lifted its share of lower-rated company debt to the highest since at least
2006. Allianz SE, Europe's biggest insurer, is shifting from German bunds to
bulk up on mortgages. JPMorgan Asset Management is buying speculative-grade
corporate debt to boost returns.
Norges Bank Investment Management, the world's largest sovereign wealth
fund, increased corporate bonds rated BBB or lower to 8.3 percent of its
debt assets at the end of last year from 7.5 percent in the prior quarter,
the fund said March 13.
Among those assets are about $200 million of bonds issued by Petroleo Brasiliero
SA. Brazil's state-controlled oil company, the biggest corporate debt issuer
in emerging markets, has seen its benchmark 2024 bonds tumble almost 10 percent
since allegations of kickbacks and bribes emerged in November.
The fund also added developing countries such as Ghana and Mauritius and
invested in Nigeria's currency for the first time. It may invest "a lot" in
Asian properties, said Karsten Kallevig, the head of real estate investments
at the Oslo-based fund. Just 0.1 percent of the fund is invested in top-rated
corporate bonds.
With the European Central Bank's fight against deflation pushing yields
on almost a third of the euro area's $6.26 trillion of government bonds below
zero, even the most risk-averse investors are taking chances on assets and
regions that few would have considered just months ago. That's exposing more
clients to the inevitable trade-off that comes with the lure of higher returns:
the likelihood of deeper losses.
"We are wandering into uncharted territory that's subject to uncertainty
and mistakes," said Erik Weisman, a Boston-based money manager at MFS Investment
Management, which oversees $430 billion globally. He's buying debt with longer
maturities and increasing his allocation of top-quality government holdings
to Australia and New Zealand, which have some of the highest yields in the
developed world.
Sub-Zero
The shift is a consequence of how topsy-turvy the bond market has become
as falling consumer prices and stubbornly high unemployment prompted the
ECB to step up its quantitative easing with government debt purchases.
About 1.44 trillion euros sovereign debt, valued at about $1.9 trillion
as of their issue dates, from Germany to Finland and even Slovakia, carry
negative yields.
That means the bonds guarantee losses for buyers who hold them to maturity.
In effect, investors are betting the securities will appreciate in price
before then, allowing them to sell at a profit before they come due.
"We recognize that investments in frontier markets pose a higher risk to
the fund," spokeswoman Line Aaltvedt said in an e-mail. "We therefore attach
importance to having sound risk management systems in place."
Here in the US, those Nigerian bonds look tame compared to what's in the accounts
of unsuspecting retirees. From yesterday's New York Times:
Americans'
Retirement Funds Increasingly Contain Tech Start-Up Stocks
The retirement accounts of millions of Americans have long contained shares
of stalwart companies like General Electric, Ford and Coca-Cola. Today, they
are likely to include riskier private stocks from Silicon Valley start-ups
like Uber, Airbnb and Pinterest.
Big money managers including Fidelity Investments, T. Rowe Price and BlackRockhave
all struck deals worth billions of dollars to acquire shares of these private
companies that are then pooled into mutual funds that go into the 401(k)'s
and individual retirement accounts of many Americans. With private tech companies
growing faster than companies on the stock market, the money managers are
aiming to get a piece of the action.
Fidelity's Contrafund includes $204 million in Pinterest shares, $162 million
in Uber shares, and $24 million in Airbnb shares. Over all, there were 29
deals last year in which a mutual fund bought into a private company, and
they were worth a collective $4.7 billion, according to CB Insights. That
was up from six such deals, worth a combined $296 million, in 2012. T. Rowe
Price was the most active big investor, making 17 investments in private
tech companies.
Because these tech companies are not required to issue financial reports
and are not traded on traditional exchanges, they are the sort of speculative
investments not normally found in retirement accounts. Increasingly, however,
investors are betting that these companies will be bought or go public at
prices that exceed their latest funding rounds, a prospect that is anything
but guaranteed.
"I think it goes beyond what mutual funds were set up to do," said Leonard
Rosenthal, a professor of finance at Bentley University in Waltham, Mass. "It's
great for the portfolio manager, but it's not necessarily in the interest
of the shareholders of the fund. If investors are looking for a portfolio
of risky securities, there are plenty of stocks to trade in the public market."
The dilemma for big fund managers is that fast-growing technology companies
are so reluctant to sell private stock to the public that there is now a
term -- "unicorns," reflecting just how wonderful and magical they are considered
to be -- for the dozens of private firms worth $1 billion or more. Several,
including the ride-hailing company Uber, the room rental site Airbnb and
the digital scrapbook Pinterest are worth more than $10 billion.
Those lofty valuations, combined with the eagerness investors show in bidding
them up, have created a shadowy market for private stock issued to tech companies'
early investors and employees. For the last few years, mutual funds have
sat on the sidelines.
Now, they are racing to get in. "More and more, the big lopsided growth
is happening away from the public markets," said Andrew Boyd, head of global
capital equity markets at Fidelity.
This is, believe it or not, exactly what the world's governments hope will
happen: Formerly risk-averse investors, unable to earn a living wage traditional
fixed income, are rolling the dice by moving waaaayyy out on the risk spectrum.
The hope is that these exotic emerging market bonds and pre-IPO tech companies
will yield big returns, make their investors rich and lead them to leverage
their gains by borrowing and spending lots of new money. In this way the global
economy will grow out of its excessive debts.
Well, good luck. A quick glance at financial history reveals that this kind
of behavior marks the terminal stage of a financial bubble, the victims of
which are the people who get in last.
A cynic might view negative interest rates as a ploy to help the 1% to hand
its most egregious paper off to the rest of us, just before valuations return
to historical norms. The same cynic might point out that today's markets look
just like the final year of the tech and housing bubbles, when previously-conservative
investors finally gave in and went for the easy money, only to be impoverished
when the bubbles burst. The only real difference is that this time the Money
Bubble is global, with a whole world of sheep lining up to be sheared.
