Last week, investors yet again favoured bonds over any other asset class, despite central banks cooing dovish everywhere.
The Fed is cutting rates? No worries, buy bonds. The European Central Bank prepares to push rates even further into negative territory? Bonds are the ticket. The Bank of England gets the printing press ready again? Oh yes, some bonds would be great.
And who can blame investors for taking this stance? After all, bonds — and real estate in big cities — have been some of the best forms of investment over the past decade.
At first glance, it’s hard to understand why. Bonds with negative yields – where investors pay the issuers for the privilege of lending them money – are worth around $13.2 billion in total. With yields so low or negative, how do investors make money?
Easy: they treat the bonds almost like equities. If once upon a time a bond was a safe investment to be held to maturity (or at least for a relatively long term) today bonds are used, a lot of times, as securities to be sold on and make a quick profit on the price appreciation.
As bond yields move inversely to bond prices, every time a central banker makes a dovish noise or move, bond yields go through the floor and prices through the roof. Rinse, repeat, and pocket the profit.
Last week was the 31st week of inflows for fixed income funds, according to data analysed by Bank of America Merrill Lynch.
In these turbulent times, the need for quality is obvious, with investment grade funds receiving a weekly average of $4 billion since May.
The speculative nature of the bond trade is evidenced by the maturities of the instruments bought. The chart below shows cumulative capital flows into the various maturities of investment grade bonds as a percentage of assets under management.
Source: Bank of America Merrill Lynch
The data, from fund flow and asset allocation data provider EPFR Global, defines short-term as up to four years, mid-term between four and six years, and long-term anything above six years.
Clearly, long term instruments are not among investors’ favourites. Even high quality longer-term bonds are avoided.
Perhaps the most important message of the bond market is that in the long term, investor confidence looks very much like bond yields: negative.