I’ve been somewhat dismissive of the incoming head of the Bank of England, Mark Carney.
I’m sure that Carney – currently head of Canada’s central bank – is a pleasant chap. But given the Barack Obama-style adulation he’s being greeted with, I suspect he can only disappoint us all.
However, maybe I’ve been too hasty. Maybe Canadians are genetically superior investors.
Why do I say this?
Because it turns out that just as UK pension funds are stuffing themselves to the gills with over-priced bonds, one of Canada’s biggest pension funds is bailing out.
If the bond party is over, then where does the money go?
Caisse de dépôt et placement du Québec is a bit of a mouthful. It’s also Canada’s second-biggest pension fund manager. It has more than C$160bn (in case you’re rusty on exchange rates, Canadian dollars are about the same as US dollars these days) under management.
And earlier this week, Michael Sabia, the group’s chief executive, told the Financial Times that the “party is over” for bonds.
Sabia reckons that the past three or four years have been “amazing”, with bonds delivering massive returns compared to their history. But all good things come to an end, and he clearly doesn’t want to be hanging around when the mass exodus arrives.
Now, being a pension fund, it moves at a glacial speed. So it’s not as though he’s going to sell every bond in the fund. They currently account for just over a third of its assets. That’ll drop to just under a third next year.
But it should be sobering for bond investors to see the ‘smart’ money moving away from the asset class. Earlier this month, another Canadian pension fund manager – AIMCo’s Leo de Bever – suggested that there were two scenarios for bonds.
“One is terrible, and that means sustained low yields… the other is really terrible, which means at some point yields go up, and that means returns on long bonds go down,” he told Business News Network. He added that he’d rather be in the stock market, even though he thought that was overpriced too.
If investors start ditching bonds, it raises two big questions.
The first is: where will the money go? It has to go somewhere. These funds have returns to deliver and promises to future and existing retirees to meet. They need to find investments that can generate reliable income and keep the fund growing at a rate above inflation.
Governments around the world have made that task increasingly difficult. Caisse de dépôt plans to put its money into the likes of private equity, property and infrastructure.
These are interesting ideas, if hardly new. Private equity was one of several investment options highlighted at our latest Roundtable discussion in MoneyWeek magazine – subscribers can read the piece here: The 13 investments our experts would buy into now. If you’re not already a subscriber, get your first three copies free here.)
And the MoneyWeek model investment trust portfolio includes a trust that invests in infrastructure.
What happens when bond yields rise?
The bigger question perhaps is: what else happens when bond yields start to rise? Governments will no doubt continue to try to hold them down by printing more money. But that’s a dangerous game.
One reason that ‘financial repression’ has worked so far is that governments around the developed world have all suffered a similar predicament. They’ve had low to non-existent growth, and crippled banking systems.
We’ve had a ‘race to the bottom’. Almost everyone has been printing money. So there’s not really been a ‘toxic’ currency to avoid as such. They’ve all been horribly manipulated by their respective central banks.
But if it starts to become clear that some economies – like the US, say – are recovering faster than others – like the UK, for example – then investors might become rather more fussy. Why stick with an economy fraught with political risk, increasingly unpredictable monetary policy, and little or no growth, when you can go elsewhere?
We could easily get to the point where extra money-printing by the Bank of England to buy gilts is met by a plunge in the value of the pound, which would in turn drive inflation higher. You end up faced with the unpalatable choice of tolerating inflation at levels we haven’t seen for years, or raising interest rates to defend the currency. This in turn would hammer all those zombie companies and households that are just clinging on by their fingertips.
We can’t be sure of the exact timing. But we do know that interest rates can really only conceivably go in one direction from here – and that’s up. As David Fuller puts it on Fullermoney.com, “central banks will be more concerned than most to avoid a disorderly end to the bond market bubble which they have certainly helped to create… they will need both genius and luck [to achieve this].”
Genius and luck – you don’t want to bet your financial future on central bankers possessing both of those traits. Which is why you need to invest accordingly to protect yourself. We’ll be reviewing the best ways to do so in next week’s issue of MoneyWeek magazine.
You can learn a lot more about why we’re worried about the future for Britain in our latest report. It’s controversial and it’s caused a fair bit of commotion – you can make up your own mind by reading it here.
• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .
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