Effect of Negative Bond Rates on Pension Fund

D

daymoh

Registered User
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Hello,

A significant portion of my pension is invested in a [broken link removed].
[broken link removed]
Its been performing well for the past year but I'm a little concerned with what may happen as interest rates start turning negative. Would the fund start losing money if it is investing in bonds with a negative interest rate? My understanding is that in a negative rate scenario investors are paying rather than receiving a fee for holding a bond.

Any thoughts would be helpful.
 
You actually have that the wrong way around - bond prices move inversely to yields so you should be worrying about yields rising, not falling. If bond yields start to rise the value of your bond fund will fall - at least in the short term - before the additional yield starts to exert an influence.

The performance of euro long bond funds has been pretty spectacular over the last 12 months as yields have confounded the expectations of many and continued to fall but if you are concerned about rising yields (ie if you want to take a more conservative position), you should move to an intermediate or even a short term bond fund, which are less sensitive to interest rate increases. As always, you will be trading risk for reward.
 
Thank you for responding Sarenco. I do understand that falling yields are good for the long bond fund however I was wondering what would happen if the fund was buying bonds that were yielding negative rates. Leaving aside bond prices going up/down wouldn't the fund be losing money by just holding negative rate bonds?? Please forgive my ignorance !
 
daymoh said:
Thank you for responding Sarenco. I do understand that falling yields are good for the long bond fund however I was wondering what would happen if the fund was buying bonds that were yielding negative rates. Leaving aside bond prices going up/down wouldn't the fund be losing money by just holding negative rate bonds?? Please forgive my ignorance !
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As an example of what I mean - if a fund bought the German 5 yr bond today, it's yield is -0.01%. Doesn't this mean that the fund would have to not only pay for the bond but also a -0.01% interest rate to hold that bond? I would see this as negative for a fund regardless of what way bond prices would go.
 
Yes, true, if the fund buys a bond with a very low yield, this means that the bond price is high.

Yes, that means the fund is buying at the top of the market.

Now, of course, the fund will also own lots of older bonds, on which it will have made large gains, as prices rose and yields fell.

But, yes, if you put 100k into a Bond Fund today, I wouldn't expect large gains over the next few years, as Govt and corporate bonds prices are high / yields are low
 
Also note that a Bond Fund would typically own dozens of bonds, maybe both Govt and Corporate.

So only very few would have zero or negative running yields.
 
Also note the specific fund you mention only invests in long-term European Govt bonds, over 15 years maturity.

It is up over 25% during the last year as yields have fallen.

I would not expect this performance to be repeated, as yields have been driven so low.

If yields rise, bond prices will fall, sharply.
 
Be very careful in having such a high proportion in Long Bonds. The compounding effect of a reduction in yield over such a long term will result in big losses. While there is a mix of bonds in that fund, they are all long dated, so you do not get the protection of short term bonds.

If you invested in long bonds to make a quick buck, ask yourself if the gains that you made are enough? When they do crash, the recovery time will be a lot longer than equities take.

Steven
www.bluewaterfp.ie
 
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