Text on screen: PIMCO

Text on screen: PIMCO provides services only to qualified institutions and investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized.

Text on screen: Jerry Tsai, Vice President, Quantitative Research Analyst

Tsai: Even though low yield is new for many countries, including the U.S., it is not a completely new phenomenon for some other developed economies. So what we can do here is that we can actually take a look at some of these other countries and see how their bonds have performed in these low yield environments and learn from their experiences.

So the most familiar case here is probably Japan. Yield in Japan has been low for over two decades. More specifically, for example, if you look at ten-year Japanese government bond yield, it has been below 2% since the late 1990s and fell below 1% in 2010.

Chevron split screen – Text on screen (left): Despite low yields, 10-year Japanese government bonds returned nearly 2.2% annually from 1999-2020; Image on right: Japan, Japanese Stock Exchange

And however, despite this low yield, during the period between 1999 and 2020,10-year JGB actually delivered a positive return, around 2.2% per year.

So some might think this is quite impressive given that the average 10-year bond yield during this period is only around 1%. So in addition, the return has also been quite consistent, and it was only negative for three out of the past 22 years.

Overall, 10-year JGB has delivered a Sharpe ratio of around 0.9. In comparison, during the same period, Japanese equities has a Sharpe ratio only around 0.3.

Why is this the case? How are the returns on bonds higher than their initial yields?

FULL PAGE GRAPHIC – Title: Roll down: How bond returns can be higher than their yields; text: Yields remain low + upward sloping yield curve + buying longer dated bonds with higher yields = positive returns by “rolling down the yield curve” (selling at a premium before maturity)

The secret here lies in rolldown. It is true that lower yields and rising rates could lead to lower bond returns.

However, the reality is that as long as yields remain low and the yield curve is in its normal upward-sloping shape, investors can actually collect a positive return by buying longer dated bonds with higher yields and let them roll down the yield curve.

So let’s consider an example here. Let’s consider the case where the yield curve is upward-sloping, and let’s assume that it doesn’t move across time. So in this case, think of an investor that buys a 10-year bond and holds it for one year.

So in this case, the investor will get a return that is higher than the initial 10-year bond yield. And why is that? That is because in addition to the 10-year bond yield, the 10-year bond is going to become a 9-year bond during this one year, and in the process, the yield is going to decrease. Therefore, it’s rewarding the investor for additional rolldown return.

Now, going back to the Japan example, in this case, the carry plus rolldown for the 10-year JGB over the last 22 years is on average around 1.9% per year, which contributes to the majority of the return in this case. And Japan is not alone here. Although bonds in Europe have been trading at a lower yield for a much shorter period of time, it nonetheless provides us with another example.

So here we’re going to take a look in Germany. In Germany, the 10-year German bund yield has fell below 1% in 2014 and the average 10-year yields in the last six years or so was around 20 basis points.          

Chevron Split Screen – Text on left: Despite low yields, 10-year German government bonds returned nearly 3.6% over the past six years; Image on right: Japan, Japanese Stock Exchange

However, similar to Japan, despite the yield being so low, 10-year German bund has delivered a positive return, and it’s on average around 3.6% per year for the last six years.

So while the conditions for each of these cases are unique and different, these two case studies could provide some leading indicators for where the rest of us may be headed.

Text on screen: For more insights and information, visit Pimco.com

Text on screen: PIMCO

Disclosure

Past performance is not a guarantee or a reliable indicator of future results.

All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Sovereign securities are generally backed by the issuing government. Obligations of U.S. government agencies and authorities are supported by varying degrees, but are generally not backed by the full faith of the U.S. government. Portfolios that invest in such securities are not guaranteed and will fluctuate in value. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Equities may decline in value due to both real and perceived general market, economic and industry conditions.

Japanese Government Bond (JGB)

The Sharpe Ratio measures the risk-adjusted performance. The risk-free rate is subtracted from the rate of return for a portfolio and the result is divided by the standard deviation of the portfolio returns.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision. Outlook and strategies are subject to change without notice.

This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. | Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission. | PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. | PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E) and PIMCO Europe GmbH Irish Branch  (Company No. 909462) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Italian Branch, Irish Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; and (3) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and  203  to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2) . The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser. | PIMCO Asia Pte Ltd (Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Asia Limited is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. PIMCO Asia Limited is registered as a cross-border discretionary investment manager with the Financial Supervisory Commission of Korea (Registration No. 08-02-307). The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Investment Management (Shanghai) Limited Unit 3638-39, Phase II Shanghai IFC, 8 Century Avenue, Pilot Free Trade Zone, Shanghai, 200120, China (Unified social credit code: 91310115MA1K41MU72) is registered with Asset Management Association of China as Private Fund Manager (Registration No. P1071502, Type: Other) | PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246862. This publication has been prepared without taking into account the objectives, financial situation or needs of investors. Before making an investment decision, investors should obtain professional advice and consider whether the information contained herein is appropriate having regard to their objectives, financial situation and needs. | PIMCO Japan Ltd, Financial Instruments Business Registration Number is Director of Kanto Local Finance Bureau (Financial Instruments Firm) No. 382. PIMCO Japan Ltd is a member of Japan Investment Advisers Association and The Investment Trusts Association, Japan. All investments contain risk. There is no guarantee that the principal amount of the investment will be preserved, or that a certain return will be realized; the investment could suffer a loss. All profits and losses incur to the investor. The amounts, maximum amounts and calculation methodologies of each type of fee and expense and their total amounts will vary depending on the investment strategy, the status of investment performance, period of management and outstanding balance of assets and thus such fees and expenses cannot be set forth herein. | PIMCO Taiwan Limited is managed and operated independently. The reference number of business license of the company approved by the competent authority is (109) Jin Guan Tou Gu Xin Zi No. 027. 40F., No.68, Sec. 5, Zhongxiao E. Rd., Xinyi Dist., Taipei City 110, Taiwan (R.O.C.). Tel: +886 2 8729-5500. | PIMCO Canada Corp. (199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, ON, M5L 1G2) services and products may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. | PIMCO Latin America Av. Brigadeiro Faria Lima 3477, Torre A, 5° andar São Paulo, Brazil 04538-133. | No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2021, PIMCO

CMR2021-0505-1636516