(Bloomberg) -- Plummeting European bond yields have sunk so low they’ve created a distortion with potentially far-reaching effects across the banking and investment industries.
The average yield on European investment-grade corporate bonds -- currently around 0.3% -- is lower than bid-ask spreads which analysts use as a proxy for transaction costs and now stand at 0.44 cents on the euro, according to data compiled by Bloomberg.
That has potentially deep implications for bond traders and could lead to long-lasting shifts in the investment industry if they persist for too long. The development discourages active trading by making it harder to turn a profit. It could also help drive investors toward new instruments, such as exchange-traded funds because it makes less economic sense to buy and sell individual bonds.
Transaction costs that exceed yields mean investors will have to devote “more thought around what to spend, where and why,” said Fraser Lundie, head of credit at Hermes Investment Management.
They’ll “have to get more comfortable with macro products, like index options, total return swaps, exchange-traded funds and so on,” he said.
There are signs that a shift in focus toward such products has already started. Volume in total-return swaps, a type of derivative giving investors exposure to bond indexes, hit a record of $24 billion in June, according to data from IHS Markit Ltd.
And the largest credit exchange-traded fund in Europe by assets, the $14 billion iShares Euro Corporate Bond fund, has seen increases in trading activity and inflows of new money.
Still, portfolio managers will keep trading if they see an opportunity to outpace the inflection of yields and transaction costs.
“If a trade works, you can make a lot more than the bid-ask,” said Tim Winstone, portfolio manager at Janus Henderson, which oversees $360 billion.
But Winstone concedes the new realities of Europe’s bond market make bond investing tougher.
“The current environment is challenging,” he said. “Yes, it is difficult to make money -- not impossible, but difficult.”
To contact the reporter on this story: Tasos Vossos in London at email@example.com
To contact the editors responsible for this story: Vivianne Rodrigues at firstname.lastname@example.org, Chris Vellacott
©2019 Bloomberg L.P.