What is Investing?
Eran Peleg, CIO December 4, 2017
Investing is the act of committing money or capital to an endeavor (a business project, real estate, etc.) with the expectation of obtaining an additional income or profit.
In the Eurozone, low-risk investments, like cash and short-dated bonds, are in negative interest-rate/yield territory. German government bond yields are negative out to seven year maturities.
The truth is that nominal yields don’t really matter – it is real, inflation-adjusted, returns that investors should care about.
REAL YIELD = NOMINAL YIELD – (EXPECTED) INFLATION
In a truly deflationary environment (i.e. the inflation rate is negative), a zero or even negative nominal yield could actually translate into a positive real yield -- making such an investment perhaps worthwhile. The math could go, for example, as follows:
NOMINAL YIELD = 0%
INFLATION = (-2%)
REAL YIELD = 0% - (-2%) = +2%
Very recently, for the first time ever, a BBB-rated company issued a negatively-yielding bond. Veolia Environment, a French utilities company, issued a Euro 500m 3-year bond yielding -0.03%. The bond does not pay a coupon and was issued at a price slightly above par (100.078). In three years’ time, bondholders will get their capital back.
Investors who were fighting to participate in the bond issue – it was 4-times oversubscribed -- are providing Veolia with capital for 3 years and are not expecting to be paid for this service. Furthermore, they are taking on the credit risk of the company over this period – hoping that it will be around at payback time.
Perhaps some investors in the bond are taking the view that inflation will be negative during the life of the bond and that they will earn an adequate positive real yield. However, they should take into account that at 1.4%, inflation in the Eurozone is currently positive (albeit not high) and that recent improvement in economic activity reduces the chances of deflation going forward.
In any case, it is clear that the lack of attractive short-duration fixed-income investment alternatives has a major impact on investor decision-making today. The 3-year German government bond, with a comparable maturity to the Veolia bond, for example, is yielding (-0.63%)….
A new record has been set by the ‘Easy Money’ market environment. Given these changes, perhaps we should re-consider the definition of ‘Investing’…!