What the Canadian sale of negative-yield bonds means for investors
August 4, 2016
A major Canadian bank sold an investment that guarantees investors will lose money.
That might seem absurd but hold on for a second, it gets more interesting. The bank had investors lining up and could not meet the demand.
The Canadian Imperial Bank of Commerce raised almost $1.8 billion by selling bonds that yield minus 0.009 per cent. They are the first Canadian bank to offer negative-yield bonds. Meaning those who bought the bond when it was first offered, and hold it to maturity (six years), will have less money than they started with.
The bond issue was oversubscribed and CIBC could have sold twice as many bonds as were offered.
The obvious question is why would investors buy an investment that loses money?
The answer: Capital preservation. The bonds are safe and during times of uncertainty investors are looking for additional security.
A slightly negative yield is more attractive than other options, some with the potential of big losses.
This is the new normal and has serious implications for investors.
Many investors, particularly during retirement, rely on interest-rate returns to pay the bills.
Decreasing interest rates over the last many years has made it difficult for retirees and others who relied on interest income.
The prospect of negative returns for holding fixed income investments makes it even more difficult to generate interest income.
The lack of fair interest-rate return on bonds, and other fixed income investments, may lead some investors to look for fixed income investments that have high returns without first asking the important question: Why are they higher?
The higher the interest rate, the riskier the investment.
Interest rates are high if the quality of the fixed income investments is low.
In the new world order of low and negative-yield fixed income investments, if it looks too good to be true, it likely is.
I anticipate a lot of promotion towards purchasing fixed income investments that have apparently high investment returns.
Please do not be fooled by stronger than expected investment returns. Taking excessive risk with fixed income products just to chase returns that might not be there, can be dangerous.
Buyer beware because high returns equal high risk.
Investing is like life, there are choices. I recommend determining the amount of investment income you need.
Then determine the best ways to earn that income that are consistent with your investment objectives and the amount of a risk you are willing to accept.
We are in a period of low or negative interest rates and it is important to ensure this is accounted for with your investment planning.