The Govvies Conundrum

Christian Armbruester, Blu Family Office

21 August 2020

Why it is time to move on from buying government bonds.

The yield on long term government debt in the US (and many other countries) used to be more than 15% in the eighties. Now it stands at just over 1.5%, and some are saying that the yield will go to zero like in Germany or Japan. If you had invested in these bonds at any time during the last forty years, you would have made handsome profits not only from the yield but also in capital appreciation.

Happy days, but things have changed. Not least of which, because with interest rates now very low, there is also the risk that they could go back up again. Whilst that looks highly unlikely at the moment, we also did not expect to be locked in our homes for months on end. The risk is there, and it could have a dramatic impact on the value of the bonds we hold. Say, we invest in 30 year US treasuries and interest rates were to go back to where they were in 2018, then our bonds would be worth 25% less than what we paid for them. Of course, we can always hold on to them for the next 25 years to make our money back, but that seems scant comfort for the huge losses we have to endure in the meantime.

The other argument for buying government bonds is to protect our investment portfolio. When equities go down, treasuries tend to go up, no matter how low the yield. Will that always be the case though? It is certainly possible that governments are struggling, having issued trillions and trillions in debt to pay for the great financial crisis, and now having to cough up even more money to deal with the Coronavirus. And let’s face it, we never really got over what happened in 2008, otherwise rates would not already have been so low prior to the current crisis.

So, if we don’t want to hold them because we get very little in yield and we don’t really trust them to be the lender of last resort anymore, and we are taking risk on inflation, it is quite clear that we have to move on. The whole concept of how we earn fixed yields and diversify our investment risk has been redefined. That’s neither good nor bad, it just is what it is. Investing is very much like putting together a structure with building blocks. You work with what you have, and there are plenty of other things we could be doing with our money instead of buying government bonds.