A once-unthinkable collapse in global bond yields is forcing pension funds to buy bonds that offer negative returns — putting the financial security of future retirees in jeopardy.
U.S. institutions managing trillions of dollars in retirement savings — including the $376.3 billion California Public Employees’ Retirement System, Sacramento — have been ratcheting down return expectations. Japan’s ¥159.2 trillion ($1.47 trillion) Government Pension Investment Fund, Tokyo, the world’s largest pension fund, has warned that money managers risk losses across asset classes. In Europe, pension funds might be forced to cut benefits in part thanks to the decline in rates.
Investors were already taking on more credit risk to make up for dwindling income elsewhere, with some chasing less liquid markets like private debt. Now, negative yields on more than a quarter of investment-grade bonds — with more monetary easing to come — are increasing the urgency for portfolio managers to find new sources of returns.
“The true madness is pension funds being forced to invest in assets (that) will be guaranteed to lose, such as in the case of long dated inflation-linked gilts at real yields of -3%,” said Mark Dowding, chief investment officer at BlueBay Asset Management, which has pension fund mandates. “It is financial vandalism and the government and central banks need to wake up to this.”
Pension funds invest in a variety of assets, but most, including defined benefit plans, use low-risk assets such as government bonds as the benchmark discount rate. While that means they have profited from the fixed-income rally, falling yields have also driven up future liabilities — in turn threatening their ability to meet oncoming obligations.
CalPERS Chief Investment Officer Yu Ben Meng said earlier this year that the expected annualized return over the next 10 years would be 6.1%, down from a previous target of 7%. Scott Minerd, CIO of Guggenheim Partners, warns that the Federal Reserve’s policy easing is contributing to a likely government-bond bubble and that very narrow credit spreads have greater potential to widen.
Ten-year yields are negative across higher-rated European government bond markets, while Germany’s entire curve fell below zero. Similar rates are also subzero in Japan, while they’ve recently hit record lows in Australia and New Zealand. In the U.S., 30-year Treasury rates hit an all-time low of 1.91% this month.