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Interest rates have reached new lows. This is not without consequence for savers; money market and bond investments offer much poorer earnings prospects and high-quality sovereign debt’s status as a safe haven largely seems to be a thing of the past.
A downward trend since the beginning of the 80s
The long-term downward trend in interest rates, which began in the early 80s, is largely the result of structural factors influencing savings and investments, such as less favourable productivity levels and demographics.
The deep recessions recorded following the 2008 financial crisis, and more recently during the COVID-19 pandemic, led central banks to adopt large-scale non-standard measures. The most prominent was the launch of vast bond-buying programmes, thus contributing to the upward pressure exerted on the prices of these assets and further pushing down rates. The aim of central banks is twofold: to promote a cyclical recovery in activity by easing financing conditions and to combat deflationary pressures. The monetary authorities are now determined to continue along this ultra-accommodative path in the coming years, deferring any possibility of policy normalisation.
This environment of persistently low interest rates – namely, key rates at rock-bottom levels for an indefinite period combined with heavy intervention by sovereign and corporate bond markets – is not without consequence for investors.
Earnings prospects for defensive investors
In recent years, very defensive investors have been forced to accept a structural loss in purchasing power for euro-denominated deposits. Inflation, although contained, cannot be offset by zero or indeed negative returns on money market products. These investors are therefore subject to a de facto taxation on their savings.
For private investors, exposing a portfolio to top-tier sovereign bonds has also lost its appeal. Indeed, German bonds with negative yields on maturities of up to 30 years have been issued. The risk of such an investment therefore seems entirely asymmetrical.
On the one hand, the yield to maturity is negative. Bond holders actually pay the German government to lend it cash. On the other hand, they are exposed to potentially significant capital losses in the event that yields rise while they still hold the bond. In addition, the protective role historically played by investment grade debt within a portfolio now seems to have basically run its course when we consider the limited upside potential of these bonds.
Alternatives for more dynamic investors
More dynamic investors, seeking exposure to investment grade corporate bonds, must make do with very low spreads and very limited returns. They could be tempted by the better performance of high yield bonds but this segment also offers meagre spreads. These investors are also exposed to definitive losses of significant capital in the case of default, which logically occurs more frequently in sluggish economic environments.
Provided that investors are able and willing to accept risk, they should opt for equity investments instead. Admittedly, they then take on exposure to equity market volatility, but the risk of a definitive capital loss is limited if they only focus on high-quality assets. Investing in these companies, which enjoy competitive long-term advantages and solid balance sheets and are able to set prices, will enable investors to increase their purchasing power in the long run by capitalising on regular dividend payments in particular. Furthermore, these companies still offer attractive relative valuations.
In conclusion, a context of persistently low interest rates heavily penalises defensive savers. The latter will need to accept diminished return expectations and, in all circumstances, maintain an investment strategy that is suited to their risk profile. In contrast, more dynamic savers should increase their purchasing power over time through exposure to high-quality equities purchased at a reasonable price.
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