Article by Robert Currie for the Times & Transcript published September 12, 2019

As interest rates around the world have fallen lower and lower and the amount of negative yielding debt crossed the US$17 trillion mark in August, it’s worth asking yourself what this means for investments

etienne martin 2 K82gx9Uk8 unsplashWhat is a
negative yielding bond? For simplicity, imagine paying $101to get $100 back in 10 years. Said differently, some companies and governments are being paid to borrow money. To put that in perspective, look at the 10-year yield on government debt for the G7 countries. Canada: +1.34%, United States: +1.61%, France: -0.28%, Germany: -0.59%, Italy: +0.94%Japan: -0.25%, and the UK: +0.59%. 3/7 are negative. 5/7 are yielding below 1%. 

On another end of the risk spectrum we have Venture Capital(VC). One of the common things founders and venture capitalist alike are saying lately is that its a great time to be a founder. That usually means it’s not a great time to be a venture capitalist. When you hear it’s a great time to sell your home, it’s usually because you are likely to get a very good price, which comes at the detriment of the buyer. In 2018, there was over US$250 billion invested in VC, a new record for this decade.2 This comes as Softbank, the Japanese tech conglomerate, raised its second Vision Fund of over US$100 billion which it plans to start investing later this year.3

What do government bond yields and VC investing have in common? They show a telling story of capital around the world seeking a home. There are significant differences between how bubbles and business cycles impact investments – business cycles are to be expected and bubbles are to be avoided. It’s not obvious the market in general is in a bubble, however, that doesn’t mean you can’t find bubbles in the market at all. 

There was a headline a few days ago that read Capital is a Commodity – a statement worth reflecting on. A commodity, from a conceptual standpoint, is something that is not distinguishable by its origin; wheat from one farmer is indistinguishable from another. In that sense, you can’t go to the German government and make a case that your cash is much nicer than what they can find elsewhere so they should give you a higher yield to compensate. Cash is cash. And because cash is cash, when you are selling cash, you take the market price. You are guaranteed to lose money if you buy a 10-year German government bond and hold it to maturity, so instead more investors than would have otherwise give a few-billion to Softbank. 

There is a pretty large gap between the stock of US17 trillion invested in negative yielding debt and the flow of US$250 billion+ in VC – people are not selling bonds to buy startups en masse – but negative yields are certainly pushing money into unconventional areas in hopes of earning higher returns. 

Few people are likely to hold these negative yielding bonds until maturity. One way a bubble can occur is when people buy an investment not because of fundamental value, but because they believe they will be able to sell it to someone else at a higher price later. When those buyers are no longer there, it can be very painful for any investor left holding the hot potato.