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:
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.
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:
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% 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.