Low yields + rising volatility = a toxic combination for bonds
Recent volatility in Japanese government bonds (JGB) highlights the fact that government bonds aren’t so ‘safe’ when yields are very low.
For example, over the month of July the 10 year JGB yield rose by 10 basis points (0.10%). That doesn’t sound like much but it translates to a capital loss of ~1% on an asset that was only yielding 0.03% to begin with.
To put that capital loss relative to income in context, it would be like a stock with a dividend yield of 5% dropping to zero in a month.
A less extreme version of that is evident in Australia, where the 10 year government bond has been experiencing 6 basis point daily moves, which translates to a capital loss of ~0.55% compared to an annual yield of 2.65%.
One way to look at that is you’re losing 20% of your annual income in a single day, another is that it’s an investment with a very poor information ratio because the yield cushion is providing very little protection against rising volatility.
A true hold to maturity investor may not bother about such short term volatility, but in reality few investors actually hold bonds to maturity and as more central banks shift away from abnormally loose monetary policy, we expect interest rate volatility to continue rising.
Government bonds are perceived as ‘safe’ investments but in reality, the combination of low yields and rising volatility makes conventional bond portfolios riskier than commonly assumed.