NEW YORK (TheStreet) -- Why in the world would anyone invest in something that claims it will lose them money?
It turns out there's a demand for negative-yield bonds; these very safe yet loss-producing assets have resulted in $1.7 trillion in European debt possessing a negative nominal yield. This means quite literally you are paying a government for the right to loan it money.
A five-year loan to Austria, Sweden, the Netherlands, and Finland all promise to give you less money than you originally started with. Denmark and German bonds offer negative yields on up to six-year notes. And in Switzerland you can find negative yields on bonds as long as 13 years in length.
Much of this ostensible irrationality is spurred on by deflationary fears and the sizeable central bank monetary easing policies of the European Central Bank. President Mario Draghi's pledge to complete a $1.2 trillion quantitative-easing-esque program of purchasing public and private debt has resulted in bond prices rising and yields, with their inverse relationship, plummeting.
So what are the rationales for investors and institutions owning this seemingly counterintuitive investment? Here is a breakdown of the reasoning and buyers of negative-yield debt:
- Currency speculation: An investor may make an investment into a negative-yield bond as a proxy for a currency investment if they think the currency they will be repaid in will appreciate in value in an amount that exceeds the negative yield of the bond. They then could swap the currency they receive in the open market for a profit. An approach such as this would have borne fruit for investors in the Swiss franc as of late: the Swiss National Bank recently eliminated the peg the franc carried to the euro resulting in the franc skyrocketing some 30 percent on the news.
- Those expecting deflation: An investment in a negative-yield bond could still result in a positive real yield. This means a yield that possesses increased buying power relative to your original investment. A way this could happen would be if deflation occurs at a rate greater than the negative yield on the bond. An example: if deflation in Germany is expected to be 3% for the year, and the yield on a German Bund is -1%, then the investor walks away with a real yield of 2%, representing his increased buying power from the investment.
- Those expecting bond prices to continue to rise: One of the more logical rationales for owning these negative-yield instruments is in anticipation of prices in the bond markets rising even further. Considering the ECB stimulus is in its nascent stage and hasn't really had a chance to make a material impact as of yet, bond prices may indeed have more room left to run. If this were to happen, investors could then trade their bonds purchased for a profit.
- Institutions, Bond funds, UITs, etc.: It's not much of a rationale, however many funds specializing in debt instruments have no choice but to hold these negative-yield assets to accomplish their investment objectives; so they continue to purchase and hold these bonds. Additionally, many institutions simply can't withdraw themselves from the market and be uninvested, resulting in ownership of these safe, yet loss accruing assets.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.