Risk reward of German bond investing poor

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With inflation in Germany currently running at -0.3%, investors might consider that they are still well served with a negative yield of -0.22% on Germany sovereign bonds. In particular if you consider Germany’s status as one of the fixed income safe haven on the planet.

Still the risk reward of investing in German sovereign bonds seems quite poor. First, because of the asymmetry between the upside and the downside potential of such a trade: indeed, should Mario Draghi successfully combat the deflationary pressures afflicting the Eurozone, such an investment could deliver a significantly negative inflation adjusted return. Second because there are many more attractive alternatives.

That’s the case of European peripheral countries such as Spain and Italy which offer sovereign bonds yielding in excess of 1.5% for 10 year maturities. That’s also the case of the US and UK for investors looking for sovereign bonds backed by stronger credit rating.

A compelling feature of both the US and the UK is indeed their superior nominal growth which is key to judge the long term fiscal sustainability of their public debt. Both UK and US 10 year bonds offer yields in excess of 1.5% versus less than 0.5% for Germany.

While the desperate search for yields and safety of fixed income investors might explain that the German rate curve remains in negative territory up to 5 years, investors should evaluate the asymmetric risk of such a position and consider alternatives to find good yields at the right risk.

Jean Medecin is member of the investment committee at Carmignac Gestion.

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