Jarod Dawson, Portfolio Manager of the Enhanced Yield Fund, comments on interest rate markets.
Original source: Nirmal Purja MBE/ Project Possible/ Facebook. Republished in the Sydney Morning Herald.
Like many, I noticed this photo on The Sydney Morning Herald website, part of a broader article, on the 27th May. It is a recent photo of climbers at the top of a very congested Mt Everest, waiting for their turn to stand on the summit. A climb which for some had sadly already turned to tragedy.
As each minute passes, the waiting climbers - who are already exhausted - consume more oxygen, crave more water, and leave themselves more exposed to an unexpected change in weather conditions – not to mention the unpredictable behaviour of their equally fatigued and in some cases delirious fellow climbers - all for the prized trophy of being able to say that they reached the absolute top.
It reminded me a little of interest rate markets.
With yields on 10 year government bonds around the world at anaemic levels in many cases (including some major European countries such as Germany where yields are actually negative), I find myself reflecting on just how much those who are holding material interest rate duration in their portfolio’s are risking for little to no after-tax return? And how rational will the behaviour of their fellow investors be if the weather does turn and everyone tries to make it back down the mountain at the same time?
In countries like Australia, where you currently get more or less the same yield on a 3 month bank bill as you get from a 10 year bond (~1.5% currently - which in my mind is really not that far from 0%), the air is more than a little too thin for us. I wonder just how long it will be before those investors with significant interest rate exposures, all crammed together hoping to stand on the summit, find themselves trying to scramble back down the mountain with not enough oxygen to go around.
In the knowledge that every 1% move in the yield of a 10 year bond results in a ~10% move in the price of many of these bonds (eg an increase in yield from 1.5% to 2.5% would result in around a 10% drop in capital value), we will happily sit at home in front of a warm fire with little to no interest rate exposure, looking for safer risk/ reward opportunities.
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This article reflects opinions as at the time of writing and may change. PM Capital may now or in the future deal in any security mentioned. It is not investment advice.
