Thursday, 24 November 2016

Investors are challenged by the idea of negative interest rates. So what are they, why do they occur and how has QSuper responded?

Negative interest rates refer to when investors pay to invest their money, rather than receive a return on their investment. Imagine investing your savings at a bank, but rather than earning interest, you actually pay as your balance falls over time. This is the reality for government bonds worth trillions across the globe, particularly in Europe and Japan.

Negative interest rates on cash investments and bonds are unprecedented but have occurred recently due to the combination of loose monetary policy and the mechanics of how a bond is valued.

Central banks in Europe and Japan have loose monetary policy with their official rates set at or below zero. For example, the Bank of Japan charges financial institutions 10 basis points to keep some excess reserves overnight. In comparison, the Reserve Bank of Australia currently pays 1.5% to keep money overnight. This feeds through into low or negative deposit and lending rates via financial institutions.

Bonds have various periods to maturity with their value determined by the yield to that date. If investors expect central banks to reduce cash rates (possibly to negative), the bond yield will fall accordingly, perhaps even to below zero. Additionally, Central Bank buying of government bonds (a form of quantitative easing) increases demand for these bonds and therefore reduces the yield. For example, the Bank of Japan, European Central Bank and Bank of England are currently purchasing government bonds. The magnitude of this demand has been sufficient to lower the yield on some bonds to below zero.

The objective of negative interest rates is to stimulate economic growth by encouraging banks to lend rather than leave money with the central bank and suffer a loss. In the case of Japan, the Central Bank is seeking to increase inflation to avoid the potential damaging consequences of deflation.

So, how does this affect QSuper’s portfolio1? We have sought to avoid investing in markets that offer negative yields in favour of markets with positive yields. Currently, this preference has resulted in no exposure to Japanese and German bonds. We tend to favour the positive (albeit historically low) yields offered on domestic and United States bonds. But we continually adjust exposures in response to risks and opportunities.

1. The term ‘QSuper portfolio’ is used to refer collectively to the underlying portfolios of assets which in combination make up the individual asset allocations of  QSuper Lifetime and the Balanced, Moderate and Aggressive investment options.

The views of the author and those who provide the responses to the comments posted on this blog are not necessarily the views of the QSuper Board. We’ve put this information together as general information only and as such it doesn’t take into account your personal financial objectives, situation or needs.  You should get professional advice before relying on this information.

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