Editor’s Note: that this blog post is in relation to the current macro economic outlook of the Eurozone (in February 2019). When that macro economic outlook changes this post may not be relevant.
The problem with Eurozone government bonds is that yields are abnormally low. Yield can be understood as the annualized expected income (i.e. only interests/dividends not capital gains).
A yield curve compares the yield of bonds of different maturities. The maturity is the termination date of a bond. At current interest rates, one would have to hold a 10-year German bond in order to register a yield of 0.109%. One would have to hold a 6-year French bond in order to register a yield of 0.048%. German and French short term bonds have negative yields. The image below also shows that you can get higher yields by getting exposed to more risk. Italian bonds have higher yields due to recent political uncertainty – event risk. Greece’s bonds are not considered investment grade – default risk – therefore they also have high yields.
Bond funds won’t have the same yields as shown above because the yields shown above are for a single bond while a bond fund has a combination of multiple bonds with different maturities (short term, long term), different credit ratings and from different countries.
The FTSE EMU Government Bond Index tracks investment-grade sovereign bonds in the Economic and Monetary Union of the European Union. Its weighted average yield to maturity is 0.75% for a weighted average maturity of 8.87 years. These yields are in line with the examples I gave earlier for single country bonds.
Eurozone government yields are low because the European Central Bank (ECB) has been relying on Quantitive Easing to mitigate the impact of the Great Financial Crisis of 2018 on the European Economy. Under Quantitative Easing the ECB is buying Eurozone government bonds in large quantities, therefore leading to unusually high demand for these assets which increases prices and reduces bond yields.
What can you do about it?
Asset allocation – your split between equities and fixed income – is one of the most important investment decisions you can make since it will be the main driver of your returns. Bonds are a type of fixed income but they aren’t the only one.
You should consider savings accounts and certificates of deposit because their yields are currently comparable (sometimes better) to the yields of the Eurozone government bonds. Additionally, savings accounts and certificates of deposit are covered by Deposit Insurance Schemes in the EU which insure at least 100,000 EUR in the event of a bank bankruptcy. This means that savings accounts/certificates of deposit may provide similar or better returns with less risks than Eurozone government bonds given that bonds are exposed to interest rate risk and political risk.
Alternatively you can consider investment grade foreign bonds. Foreign bonds may have better yields since they are not being affected by the ECB’s Quantitative Easing. Just make sure that you only buy foreign bond funds when hedged into your currency and that you check if their yields are reasonable.