Bill Gross, the legendary bond investor who runs a fund at Janus Capital Group, has a word or two for his fellow bond investors, the gist of which is: you suck at math.
In his latest investment outlook, he points out that many professional investors do not understand enough math and economics when it comes to investing in bonds with negative yields and that lack of knowledge could have serious consequences.
He reckons that to be a successful bond investor one should be one-third mathematician, one-third economist and one-third horse trader. But he laments that “many professional investors are still thinking and managing assets at the grade-school level.”
That’s mainly because many, in his opinion, do not understand the absurdity and consequences of negative bond yields — when an investor pays money for the privilege of lending it to governments.
To explain his thesis, Gross draws on Zeno’s paradox.
In the ancient Greek’s paradox, if a walker reduces the distance between his start and finish line by half with every step, even after an infinite number of step he would never get to the finish line. Gross notes, that’s “mathematically correct but the real world resolution was that Zeno’s walker and everything else that we experience moves forward in full step integers as opposed to fractions. It was a mathematical twist only.”
Gross warns that investing in negative-yields bonds with a hope to sell them before maturity and making a profit on the difference between even lower-yielding bonds is a bit like “convincing themselves that they will never reach the loss-certain finish line at maturity.”
He points out that some investors will have to hold negative-yielding bonds to maturity and with the 30%-40% developed bonds with negative rates and 75% of Japanese bonds with negative yields, that’s a lot of investors.
He argues that if a bond investor loses money on his or her negative-yields bonds, a stock investor will earn much less return than what was historically assumed, or even lose money.
Central banks purposefully have kept rates low or negative with the hope that investors will invest in assets with a positive yield and that it would reflate their economies. Read:Negative interest rates put the global economy on a razor’s edgeGross points out that the seemingly logical strategy is not working in the real world and that central banks are running out of time to achieve the desired growth rate before investors start losing money.
He concludes his note with a warning:
“The real market and the real economy await a different conclusion as losses from negative rates result in capital losses, not capital gains. Investors cannot make money when money yields nothing. Unless real growth/inflation commonly known as nominal GDP can be raised to levels that allow central banks to normalize short-term interest rates, then south instead of north is the logical direction for markets.”