In 1999, Japan experienced an unusual and unprecedented event, becoming the first country to experience zero interest rates on the back of deflationary issues within its economy. Initially viewed by many as an isolated event for a country struggling with an ageing population and declining corporate profitability on the back of falling prices, zero rates were considered unthinkable in other developed nations. As we would later learn, an era of interest rates at zero percent became the reality.
As the Global Financial Crisis sent stock markets plunging, central banks raced to slash interest rates in a bid to stabilise the economy. The Bank of England would cut its base rate eight consecutive times until, by March of 2009, it was sitting at 0.50% where it would stay for the coming decade. It occasionally moved higher, but ultimately declined again at the hands of COVID-19. 2022 saw the start of a repeated hiking of the base rate in response to inflation, currently at 4.25% after ten consecutive increases. The 13 years of interest rates of near-zero would impact every asset class and income investors would have to get creative in the hunt for yield.
By August 2019, low yields across the quality spectrum of corporate bonds had become an everyday fact of life. So compressed had the yield become that a quarter of the global bond market traded at a negative inflation adjusted yield. If held to maturity, investors were guaranteed to make a loss in real, or inflation adjusted, terms. According to Intercontinental Exchange, bonds with yields of more than 10% made up just 0.4% of global bond markets. Fixed income investors began searching for yield in riskier areas of markets, heading into lower quality bonds of companies and governments. Two individual bond issues potentially highlight investor appetite for risk in the zero-rate world. In early 2019, Uzbekistan issued its first bond, aiming to raise US$1bn, and investor demand exceeded the US$6bn mark in their efforts to chase a 4.75% yield. The second, Austria’s 100-year 2017 bond issue, offered a coupon of 2.1% with significant interest rate risk that saw the price rise from €100 to €220 in the first three years as interest rates fell. But with rates higher, the price currently sits around the €70 mark.
To generate yield for income portfolios, adjustments were required. The period saw a growth in the popularity of bond-proxies – relatively stable income producing assets but with limited or no growth in the yield distribution. Infrastructure funds such as HICL and Greencoat UK Wind offered attractive yields with a degree of security, as cashflows are often government backed. REITs (real estate investment trusts) became a useful income-generating asset for portfolios with some of the higher yielding options attracting significant retail investor attention.
Record-low annuity rates created another challenge for pension income. Annuity rates are closely linked to 15-year government gilt yields. An increase or decrease in the yields of these gilts significantly affects the yields available on standard annuities. Example illustrations suggest that a level annuity for a 65-year-old bought for £100,000 pre-financial crisis in March 2008 would offer a yearly income of c.£7,740. By August 2016, the same sum would yield only £4,696 – an all-time low. The return of higher interest rates and yields on gilts has seen the income on the hypothetical annuity recover to almost pre-financial crisis levels, with £6,852 quoted.
With little-to-no yield to be had from fixed interest or bank deposits and so much cheap borrowing available, assets ranging from equities to property reached historic valuations. Property assets within the supply constrained industrials sector experienced significant capital gains as yields declined and high growth companies were the popular place to be. Financial professionals banded the phrase ‘There Is No Alternative’ (TINA), implying equities were the only game in town but, after recent interest rate increases, TINA looks to be no-longer.
As interest rates have begun to rise again, a ‘normalisation’ of yields could be said to have emerged. Income-seeking investors no longer have to pile into more speculative debt in their search for returns.
As the pendulum of monetary policy in developed economies swings the other way after more than a decade, trends that have become entrenched are unwinding. Yields on investment grade government and corporate bonds are looking much more attractive, along with other areas of the market. Many investors will now be considering how to re-adjust their portfolios in the new environment. While the question remains as to where inflation will go and how central banks will wrestle with it, new opportunities have emerged in the hunt for attractive income streams.
This article was taken from the
Spring 2023 issue of
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Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance.