How do you hit your target returns in a negative yield environment with extremely low interest rates? Dial back your portfolio’s risk, according to Russell Investments.
Chief Research Strategist Bob Collie argued that padding on more risk in portfolios might not work for some investors as the return on low-risk investments falls.
“You earn nothing if you lock your cash in a safe deposit box, but even nothing is better than what you will earn from a debt instrument that offers a negative yield.” —Bob Collie“Some investors may respond to the decline in interest rates by increasing risk in their portfolios,” he said. “But increasing risk doesn’t make sense for everyone.”
And these “strange times” of negative yields are likely to continue, Collie said. Short-term debt issued by some nations in the euro zone had already been trading at negative yields in 2015 so far, he added, as well as some corporate debt. German five-year government bonds were trading at a yield of -0.1% this morning, according to Bloomberg.
“You earn nothing if you lock your cash in a safe deposit box, but even nothing is better than what you will earn from a debt instrument that offers a negative yield,” Collie said.
He acknowledged that, to make up the difference, investors could turn to other sources of return—including equity risk, credit, illiquidity premiums—adding more risk to the portfolio. Investors could also choose to lower their return expectations temporarily if they are not able to stretch their risk tolerance, he said.
However, Collie said it was likely there would be a dash to capture other sources of return as yield continues to drop, pushing down the reward for risk taken. Instead of crowding into risk premiums or even active management, investors could choose to lower their portfolio risk and take on more when the odds are better, he said.
PIMCO’s former CIO Bill Gross also emphasized in January that investors would eventually reach a point where there was too little return for too much risk, pointing to the death of the bull market.
“When the year is done, there will be minus signs in front of returns for many asset classes,” Gross wrote in his outlook for Janus Capital. “There comes a time when common sense must recognize that the king has no clothes, or at least that he is down to his Fruit of the Loom briefs, when it comes to future expectations for asset classes.”
Gross added that riskier asset categories are likely to become less and less desirable and suggested investors instead consider high-quality assets with stable cash flows.
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