4 ms·

In a nutshell: 1. interest rates on government bonds, perceived as the safest asset class, have fallen to historic lows, even below zero in many countries 2.

by aazaa 7y ago

In a nutshell: 1. interest rates on government bonds, perceived as the safest asset class, have fallen to historic lows, even below zero in many countries 2. pension funds' expected rate of returns have barely budged since the 1970s (7-8%) despite the fact that interest rates have dropped from double digits to below zero in many cases 3. to make up the loss of yield, pension funds have turned to riskier assets such as stocks 4. fueling the fire, state regulations have been relaxed to allow these public pension funds to invest in risky assets 5. since the 2008 crisis pension funds have been underfunded - they take in too little money to be self-sustaining 6. it's becoming increasingly clear that pensions can't "grow out of" their underfunded positions 7. having loaded up on risky assets, pensions will face large declines in the next recession as stock markets deflate The joker in the deck is how the pension funds will react to a declining stock market. Their only viable option would appear to be government bonds. A collective flight into bonds would further depress interest rates. Falling interest rates produces capital gains on bonds, which attracts still more investors, driving rates further down. And so on. Flight to bonds on a large scale driven by pensions would also accelerate stock market declines, making bonds that much more attractive. Having broken the zero interest barrier, there appears to be no bottom to interest rates anymore. The lack of a bottom opens up some very bizarre scenarios.

davedx 7y ago
How will negative interest rates work in practice? Will they always be confined to bonds, or will they spill over into interbank lending or even retail debt?
- throw0101a 7y ago
  Generally speaking, we don't know. The financial sector has never had been in this situation before. > While the ECB wants to spur people to invest, there’s concern that the banks will face mass withdrawals if they introduce negative interest rates for retail clients. * https://www.bloomberg.com/news/articles/2019-08-25/germany-in-uproar-as-negative-rates-threaten-saving-obsession https://www.bloomberg.com/news/articles/2019-08-25/germany-i... > Jyske Bank A/S this week said it will charge Danish depositors with 7.5 million kroner ($1.1 million) or more in their accounts; earlier this month, UBS Group AG halved the level at which its annual 0.6% fee kicks in to 500,000 euros ($560,000). * https://ca.finance.yahoo.com/news/negative-rates-coming-savings-050005475.html https://ca.finance.yahoo.com/news/negative-rates-coming-savi...
throw0101a 7y ago
Smaller pension funds should be doing the same thing us 'retail' investors are doing: using passive index funds. Perhaps a 60/40 equities-bond balance. * https://en.wikipedia.org/wiki/Index_fund#Pension_investment_in_index_funds https://en.wikipedia.org/wiki/Index_fund#Pension_investment_... A part of the fixed-income ("bond") component should be in money market account or term deposits to meet short-term needs. During/after the Great Recession it took markets about five years to claw back to the same level they were at their peak, but that is an extreme case. Most recessions and bear markets last less than two years before they're back to the same level. Trying 'advanced' techniques generally does not work out well: * https://awealthofcommonsense.com/2019/02/how-to-wreck-a-pension-plan-in-3-easy-steps/ https://awealthofcommonsense.com/2019/02/how-to-wreck-a-pens... Unless you're a fairly large pension, and are able to throw a decent about of money around to buy "real" assets (pipelines, utilities, airports, marine ports, toll highways), then it's best to stick with passive indexing AFAICT: * https://en.wikipedia.org/wiki/Ontario_Teachers%27_Pension_Plan#Investments https://en.wikipedia.org/wiki/Ontario_Teachers%27_Pension_Pl... * https://en.wikipedia.org/wiki/CPP_Investment_Board#Investments https://en.wikipedia.org/wiki/CPP_Investment_Board#Investmen...
- nzealand 7y ago
  I presume by 60/40 you mean the pension funds should lower risk. If they lower risk, they are not going to get close to their presumed 7-8% growth. Expected stock market growth rates is around 5%(https://www.cnbc.com/2019/02/11/vanguard-cuts-expected-return-for-stock-market-over-the-next-decade.html https://www.cnbc.com/2019/02/11/vanguard-cuts-expected-retur...) Rate of return on bonds is even worse. Assuming this is correct, the choice is either increase contributions, or decrease payouts.
- notfromhere 7y ago
  getting to 5-6% returns isn't super difficult for a pension, getting that extra 1-2% is bloody hard and requires some risk given that you can't just put cash in treasuries and get a 8% payout like you could in the 70s and 80s. You really can't have the whole market go into passive investments - it'll just cause a large amount of volatility given that market movements will be based on a shrinking number of fund managers.
DebtDeflation 7y ago
>Having broken the zero interest barrier, there appears to be no bottom to interest rates anymore. The lack of a bottom opens up some very bizarre scenarios. The flaw in that argument is that it seems to assume individual bonds are perpetuities (actual perpetual bonds are extremely rare). At some point, the bonds you have purchased will actually mature, and you will be paid face value. If it is less than the price at which you purchased the bond, this means you take a capital loss at that point. This decrements your overall rate of return. Therefore, you cannot just drive the price of bonds up forever by ignoring the yield becoming increasingly negative and just focusing on market price appreciation.
sweeneyrod 7y ago
> A collective flight into bonds would further depress interest rates. Falling interest rates produces capital gains on bonds, which attracts still more investors, driving rates further down. What do you mean by this? That increased demand causes higher prices causes increased demand under the expectation of the trend continuing?
- thefj 7y ago
  Not OP, but it makes sense. A lot of investors hear about an asset going up and they want to join the party. A lot of the other investors try to predict where the emotional investors will go and buy the asset in anticipation.
  - sweeneyrod 7y ago
    Yes, that certainly can happen. But when that kind of speculation has a significant effect it's called a bubble, and is an exception to the usual rule that increased demand causes prices to increase up to a new equilibrium point and no further. Is there any reason to think that a bubble would occur in this particular situation?

by aazaa 7y ago

davedx 7y ago

How will negative interest rates work in practice? Will they always be confined to bonds, or will they spill over into interbank lending or even retail debt?

throw0101a 7y ago
Generally speaking, we don't know. The financial sector has never had been in this situation before. > While the ECB wants to spur people to invest, there’s concern that the banks will face mass withdrawals if they introduce negative interest rates for retail clients. * https://www.bloomberg.com/news/articles/2019-08-25/germany-in-uproar-as-negative-rates-threaten-saving-obsession https://www.bloomberg.com/news/articles/2019-08-25/germany-i... > Jyske Bank A/S this week said it will charge Danish depositors with 7.5 million kroner ($1.1 million) or more in their accounts; earlier this month, UBS Group AG halved the level at which its annual 0.6% fee kicks in to 500,000 euros ($560,000). * https://ca.finance.yahoo.com/news/negative-rates-coming-savings-050005475.html https://ca.finance.yahoo.com/news/negative-rates-coming-savi...

throw0101a 7y ago

Smaller pension funds should be doing the same thing us 'retail' investors are doing: using passive index funds. Perhaps a 60/40 equities-bond balance. * https://en.wikipedia.org/wiki/Index_fund#Pension_investment_in_index_funds https://en.wikipedia.org/wiki/Index_fund#Pension_investment_... A part of the fixed-income ("bond") component should be in money market account or term deposits to meet short-term needs. During/after the Great Recession it took markets about five years to claw back to the same level they were at their peak, but that is an extreme case. Most recessions and bear markets last less than two years before they're back to the same level. Trying 'advanced' techniques generally does not work out well: * https://awealthofcommonsense.com/2019/02/how-to-wreck-a-pension-plan-in-3-easy-steps/ https://awealthofcommonsense.com/2019/02/how-to-wreck-a-pens... Unless you're a fairly large pension, and are able to throw a decent about of money around to buy "real" assets (pipelines, utilities, airports, marine ports, toll highways), then it's best to stick with passive indexing AFAICT: * https://en.wikipedia.org/wiki/Ontario_Teachers%27_Pension_Plan#Investments https://en.wikipedia.org/wiki/Ontario_Teachers%27_Pension_Pl... * https://en.wikipedia.org/wiki/CPP_Investment_Board#Investments https://en.wikipedia.org/wiki/CPP_Investment_Board#Investmen...

nzealand 7y ago
I presume by 60/40 you mean the pension funds should lower risk. If they lower risk, they are not going to get close to their presumed 7-8% growth. Expected stock market growth rates is around 5%(https://www.cnbc.com/2019/02/11/vanguard-cuts-expected-return-for-stock-market-over-the-next-decade.html https://www.cnbc.com/2019/02/11/vanguard-cuts-expected-retur...) Rate of return on bonds is even worse. Assuming this is correct, the choice is either increase contributions, or decrease payouts.
notfromhere 7y ago
getting to 5-6% returns isn't super difficult for a pension, getting that extra 1-2% is bloody hard and requires some risk given that you can't just put cash in treasuries and get a 8% payout like you could in the 70s and 80s. You really can't have the whole market go into passive investments - it'll just cause a large amount of volatility given that market movements will be based on a shrinking number of fund managers.

DebtDeflation 7y ago

>Having broken the zero interest barrier, there appears to be no bottom to interest rates anymore. The lack of a bottom opens up some very bizarre scenarios. The flaw in that argument is that it seems to assume individual bonds are perpetuities (actual perpetual bonds are extremely rare). At some point, the bonds you have purchased will actually mature, and you will be paid face value. If it is less than the price at which you purchased the bond, this means you take a capital loss at that point. This decrements your overall rate of return. Therefore, you cannot just drive the price of bonds up forever by ignoring the yield becoming increasingly negative and just focusing on market price appreciation.

sweeneyrod 7y ago

> A collective flight into bonds would further depress interest rates. Falling interest rates produces capital gains on bonds, which attracts still more investors, driving rates further down. What do you mean by this? That increased demand causes higher prices causes increased demand under the expectation of the trend continuing?

thefj 7y ago
Not OP, but it makes sense. A lot of investors hear about an asset going up and they want to join the party. A lot of the other investors try to predict where the emotional investors will go and buy the asset in anticipation.
- sweeneyrod 7y ago
  Yes, that certainly can happen. But when that kind of speculation has a significant effect it's called a bubble, and is an exception to the usual rule that increased demand causes prices to increase up to a new equilibrium point and no further. Is there any reason to think that a bubble would occur in this particular situation?