Pandemic has caused a surge in gold and green bonds

Governments and corporates around the world have issued debt to help fund health services, alleviate the economic shock of national lockdowns, or adapt business models, to suit today’s ‘new normal’.

For example, issuance of new bonds from US corporates has already set new records in 2020 surpassing $1.919 trillion in new funding.

Companies in sectors hit hardest by the pandemic, like the airline industry, have pledged assets such as planes and flight routes as collateral to secure funding deals.

Governments have expanded debt issuance substantially, as they finance furlough and job support schemes by increased borrowing.

Government debt has also been supported by central bank purchases, both to stabilise financial markets, and ease monetary policy by lowering the cost of capital.

Central banks also responded by lowering interest rates to record lows to stimulate growth.

Despite historically low yields, sharp falls in interest rates and bond yields in 2020 have meant long dated Government bonds delivered strong total returns, of 16 per cent in the first nine months, on the FTSE World Government bond index (WGBI).

Thus, some UK Gilts entered negative yield territory in August for the first time, joining several other European countries. (Negative yields mean that if bonds are held to maturity, bondholders make a small overall loss, and effectively pay the UK Government to continue to hold these securities, rather than receive a positive overall return).

The search for higher yield has led some investors towards riskier bonds.

Thus the FTSE European High-Yield Market Index measures the performance of high-yield corporate debt in Euro, Swiss Franc, and UK Sterling and has a redemption yield of 3.88 per cent.

These yields are notably higher than Government bond yields, but may be a value trap, because default risks are higher on these bonds, and central banks are selective about the high yield credits they buy.

Indeed, the BoE is not buying high yield, or sub-investment grade bonds in its QE.

Apart from high yield corporates, FTSE Russell’s Emerging Market Government Bond Index, measures the performance of local currency government bonds from 16 countries, and offered a yield of 4.5 per cent to redemption on September 30, 2020.

This contrasts to its developed market counterpart, the WGBI, which offers only 1.96 per cent, consisting of government debt from over 20 countries including negative yielders like Switzerland, France and Germany.

Interest rates near zero on cash, and near-cash, have also driven investors to other assets like gold, which almost reached $2,000 a troy ounce over the summer, as well as alternative asset classes like private equity 1.

A key reason for gold’s surge is that with interest rates this low, or negative, the fact that gold pays no interest or coupon matters far less for investors.

Another area of rapid recent growth has been green bonds, where the proceeds of a bond are used by companies to deliver certain environmental benefits.

Yorkshire Water, for example, issued a £350m sustainability bond with a tenure of 22 years in 2019, a move that marked the 100th sustainability bond available to trade on London Stock Exchange.

Although very low interest rates make bond investing more challenging, 2020 has shown Government bonds can still deliver strong total returns, in a very uncertain world, without the risks in high yield corporate bonds, and as a complement to equities.

The difficulty for income investors in 2020/21 is finding acceptable income levels without unacceptable risks.