Finding Yield In A Low Yield World – New White Paper! by Meb Faber
I’m writing this post from snowy Japan. After a day of skiing, an onsen, and some sushi and sake it is easy to reflect on the state of the world. This is a picture I took on top of a mountain in the Honshu region today:
Japan has long had low bond yields (their 10-year is currently around zero), but I never thought I would see this in my lifetime but lots of government bonds have negative yields. At a recent shareholder meeting of the Daily Journal Corporation, Charlie Munger commented – ” [Negative rates]…surprised everyone, including economists who pretend that they knew it all along. I was flabbergasted when they became low, but when they get negative I became really flabbergasted.”
Think about that for a second, paying governments to hold your cash! (Below is a chart courtesy of Pension Partners detailing some of the yields around the world. )
So, what is an investor to do? Can we build a better strategy for investing in global bonds? I believe you can. Much like value investing in stocks, one can apply a value methodology to global bonds.
You can go here to download for free my short new white paper that tackles the subject.
Let me know what you think!
Finding Yield In A Low Yield World
Cambria Investment Management
Do you know what the largest asset class in the world is?
Many investors are surprised to learn that the answer to this question is foreign debt. The below chart is from a Vanguard article on bonds.
How much of your global allocation do you invest in foreign bonds? Likely very little.
Following the global market capitalization weighted portfolio, investors should have about 30% of their portfolio in foreign government bonds, but very few do. (Likewise US investors should have about half of their global stock allocation in foreign stocks but most only have about 30%.) Why does this matter right now?
As of January 2016, US 10-year government bonds yield 2.25%, and 30-year bonds yield 3.00%. Many investors that rely on income, particularly retirees, struggle with such paltry yields.
Thankfully, US investors are not limited to investing within our borders. Would adding foreign bonds help diversify a US-centric portfolio?
Global bonds have seen similar real returns as US bonds all the way back to 1900. The Dimson, Marsh, and Staunton team examined investing in 16 countries stock and bond markets in their outstanding book The Triumph of the Optimists. They demonstrated that US bonds had real returns of 2.0% from 1900-2014, and the median country had returns of 1.7%. (Note: real returns are returns after inflation.)
The best performing sovereign bond market experienced real returns of about 3.3% (Denmark), and the worst, well, there are some unfortunate examples of hyperinflation that destroyed investor’s capital. But in general a diversified portfolio of sovereign government bonds did an admirable job of protecting purchasing power overtime. Businesslnsider.com has a good article on the causes of the nine worst episodes of hyperinflation in the past 100 years.
However, even in global developed and emerging markets there is wide disparity between yields. On one hand you have many European countries that are yielding less than 0.5% (and in some cases negative yields!), and on the other, many countries, particularly in the emerging markets, have yields above 5%. The median and average yields for the combined developed and emerging country universe are 2.2% and 3.7%, respectively. So, even in the global bond space you’re not getting much more yield than in the US.
However, most bond indexes are market capitalization weighted, which means you invest more in the countries that have the most debt outstanding. Does that make much sense? Would you lend more to your neighbors or family members based only on how much debt outstanding they have?
Global bond indexes are dominated by the five biggest issuers: the United States, Japan, Germany, France, and the United Kingdom. Those five countries alone account for about 70% of total debt outstanding, but less than half of global GDP and about 10% of global population. (For a wonderful overview of the sovereign bond space, with discussion of index construction you can view the Research Affiliates piece, ”Debt be not Proud) Is there a better way to invest in global bonds? We know that moving away from market cap weighting in stocks is a smart move, and in particular a value approach has performed well over time. Does applying the same logic to global bonds lead to higher returns?
See full white paper below.