Why Would You Settle For –0.0081% a Year?

I’ve learned a few things in more than a decade of investing.
I know my way around a company’s balance sheet.
I’m familiar with all the main valuation methods.
I know the difference between a P/E ratio and my old P/E kit, and I know why a high dividend yield can sometimes be bad, and why a company with lots of debt can sometimes be good.
And I’ve learned Warren Buffett’s most important rule by heart…
Rule No 1: Never lose money.
Oh, I’ve learned Buffett’s second rule, too…
Don’t forget rule No. 1!

Professional losers

Of course, I’m but a humble investment analyst and scribbler. Not for me the managing of billions of pounds of pensioners’ savings!
Those guys must really know their onions, right?

Well, perhaps.
What I do know is some of them seem to have forgotten both of Buffett’s maxims.
I haven’t been snooping in on their calls – and I’m not about to reveal the terrible long-term returns of some pension fund or another.
Nevertheless, I know some seem are probably doomed to lose money because the yield on certain Nestlé corporate bonds tells me so!

Low blow

Let’s get one thing straight – investing in bonds is not like investing in shares.
With a bond, you know in advance roughly what return you’ll get if you hold a bond until it matures – assuming the bond does not default. (Oops! There goes rule No. 1).
This is because all standard government and corporate bonds pay a fixed income, together with a promise to buy back the bond at face value when it reaches maturity.
True, there are some fancier bonds that do slightly different things.
And to be very precise you can’t know your exact return in advance – the so-called yield-to-maturity – because it will depend on the bond’s price on the day when you’d theoretically reinvest the interest paid.
But let’s not get too het up on all that – this isn’t an article about investing in bonds.
No, it’s an article expressing amazement that the yield-to-maturity on some Nestlé bonds recently went negative.
Investors look set to lose money if they bought and held these bonds to that bitter end.

Heads you lose, tails you lose

Now I don’t know for sure that any of Nestlé’s bonds will be sporting a negative yield when you read this – just in case you were itching to rush into a once-in-a-lifetime opportunity to get poorer.
When I researched them, the negative yield on one of Nestlé’s two-year bonds was -0.0081%.
But perhaps it is worse now, or perhaps you’ll get a bargain and hit breakeven!

Who knows? These bonds aren’t for trading by the likes of us, they are institutional instruments owned by pension funds and the like.

But what I do want to emphasise is that this is just how crazy the bond market has become after six years of near-zero interest rates and multiple rounds of global quantitative easing.
Paying for the pleasure of owning a bond. Whatever next?
Remember too that even though it’s one of the world’s most solid companies, it’s not impossible that Nestlé could somehow get into massive difficulties, which could mean the bond defaulting.

That’s a risk you’re definitely not getting paid to take with a negative yield of 0.0081%.

(Admittedly it would probably take a nuclear bomb to stop Nestlé’s honouring its commitments here, but still…)

I’ve was expecting more, Mr Bond

Of course, there may be good reasons why some of Nestlé’s bonds are sporting a negative yield.
As I said, interest rates have been pulled towards zero, and government bond yields have been dragged down as well.

That’s seen the price of corporate bonds rise – and their yields lowered – in tandem.
Then there’s the Eurozone QE as announced by ECB president Mario Draghi.
Some onlookers think this will make the madness in the bond market even worse, by taking more government bonds out of circulation and forcing banks and others who need bonds to buy more corporate ones, even at crazy prices.
In fact, that’s kind of the point of QE…
Also, Mr Draghi has turned to QE because the Eurozone seems to be on the cusp of deflation (aka negative inflation).
In a deflationary world, the value of paper money assets like bonds can go up in real terms as retail prices fall – so even a bond with a negative yield could be worth owning if it’ll be worth more in the future in real terms.
Finally, many blame the myriad regulations that compel pensions and the like to buy bonds even at seemingly dumb prices.

So perhaps their managers know these bonds are a lousy deal, but they have to buy them anyway.

Expensive bonds, cheaper equities?

What can we learn from all this, other than it’s probably not a great time to buy Nestlé’s bonds?
Well, for one thing it might confound those – such as famed investor Neil Woodford – who suggest that the share prices of consumer giants like Nestlé, Unilever and Reckitt Benckiser are over-priced right now.
I understand where Woodford is coming from, looking at their valuations.
But at least these companies boast dividend yields around the 3% mark.

That’s not amazing – but it’s a lot more than a negative return.
However, we do have to remember that share prices can and will decline from time to time, and that such a move can easily wipe out a 3% yield – at least temporarily.
Indeed, that’s the other thing to think about when pondering the ultra-low yields in the corporate bond sector.
Bond investors seem to see little prospect of inflation, nor of the economic growth that might fan it.
And that matters, because if they’re right then we could be much nearer to the end of this stock market bull-run than the beginning…

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Both Owain and The Motley Fool own shares in Unilever.