ECB Stimulus Pushes Investors to Riskier Bonds

Updated March 23, 2015 8:19 p.m. ET

Bond investors are going long. The question is whether they will regret it.
The European Central Bank's colossal dose of monetary stimulus has crushed the yields available on
bonds, encouraging investors to buy longer-term debt that offers higher rewards.
But that strategy comes with a risk: The longer the life of a bond, the higher its sensitivity to
changes in interest rates. For debt that isn't due for decades, even a small rise in interest rates can
drastically erode its value.
"Never in history have fixed-income allocations been so risky," said Franck Dixmier, chief investment
officer for European fixed income at Allianz Global Investors, which oversees EUR1.8 trillion ($1.95
trillion) in assets.
"Even a small rise in yields" could lead to heavy losses in investors' portfolios, he added. Bond yields
rise when prices fall.
The ECB on March 9 began buying government bonds maturing in two to 30 years, in a program
known as quantitative easing, or QE, that will take the central bank's monthly asset purchases to
EUR60 billion. The drop in yields in reaction to the program has been most pronounced on longerdated bonds.
The yield on 30-year German government bonds plummeted to 0.63% Monday, from 2.49% a year
ago. Investors buying these long-dated bonds receive only an extra 0.85 percentage point of yield
over buying two-year bonds, compared with about 2.28 percentage points a year ago.
Buying longer-dated bonds increases a bond portfolio's average duration, which Vanguard Group
defines as the time that an investor can expect to wait to recoup the true purchase price of the
bonds, including interest payments. If a bond matures many years in the future and pays little
interest, the duration is high, which increases the debt's sensitivity to changes in interest rates.
For instance, the duration of the 30-year German government bond is currently 22, according to
FactSet, up from 20 a year ago. This means a one-percentage-point rise in interest rates will cut
about 22% off the price of that bond. The duration of the 10-year German government bond, which
pays nearly no interest in its 10-year life, is just under 10.
Large demand among investors for high-yielding bonds has encouraged countries to lock in record
low borrowing costs for increasingly longer periods. As a result, over the past year, the average
duration of the iBoxx eurozone sovereign-bond index has risen from 6.3 years to 7.34 years, its
highest point since the euro was launched in 1999, according to Markit.
Investors are facing a conundrum. If inflation rebounds, which is the stated aim of the ECB's
program, then long-term yields should increase. Meanwhile, though, the ECB's buying is forcing
funds into riskier investments to earn what they consider adequate returns.
"If QE works, investors could take substantial losses with the 30-year yield so low," said Philipp de

Cassan, head of core euro rates trading at Nomura. "All traders need to know is when the ECB will
stop buying: That is what's driving prices."
Some analysts believe this could come to a head sooner rather than later. Justin Knight, a rates
strategist at UBS, argues that the market has become fixated on the ECB buying while ignoring the
increasingly compelling reasons to sell bonds, such as a rise in investors' expected levels of inflation
in the future.
Investors also will be tempted to sell since eurozone-bond yields have fallen so far that they offer the
least attractive returns of any government bonds across the globe after taking currency effects into
account.
"At some point soon, we expect investors to sell bonds and yields to rise," Mr. Knight said.
Some investors aren't so sure, seeing any caution on buying bonds as an ill-fated fight against a
powerful ECB program. Nick Gartside, head of fixed income at J.P. Morgan Asset Management,
noted that the scarcity of German bonds should continue to drag down yields.
Duration "is a risk," Mr. Gartside said. "But what would cause that [risk to materialize]? The ECB
stops buying bonds. That seems unlikely right now."
Even so, some analysts and traders said the sharp fall in bond yields could be overdone.
Andrew Millward, European head of rates trading at Morgan Stanley, said current yield levels look
"stretched" as they imply that Europe's economic troubles will last for "decades."
"No one really believes that 30-year Germany bonds at 0.6% are a good investment," added Zoeb
Sachee, head of European government-bond trading at Citigroup.
Write to Christopher Whittall at christopher.whittall@wsj.com and Tommy Stubbington at
tommy.stubbington@wsj.com
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