The 10 largest asset managers in the world, a list that includes BlackRock, Vanguard, State Street, Fidelity, Allianz, UBS and JP Morgan Asset Management have some $32 trillion assets under management (at the end of 2017). The entire space of asset managers have around $65 trillion of assets under management.
Fund managers have over $3 trillion of new inflows a year, primarily down to private pensions (governments keep pushing it given the looming state pension crisis). These fund managers get paid as long as they invest the money. There lies the problem – they have to invest it. It isn’t as simple as it sounds.
These fund managers have around $25 trillion to invest in bonds and since bonds mature and there are new inflows they must invest up to $6 trillion a year in new bonds. Why is that a problem? Well, if you have money in Euros to invest in bonds you have two options for shorter maturities (typically 2-year bonds), you can invest at a negative yield in the Euro currency or you can invest in another currency (say US dollars) in another country. If you invested in US dollars your holdings on the currency impact itself would have meant you lost over 13% over the last one year. You can argue they can buy a currency hedge but that would effectively yield even worse that investing in a negative yield Euro bond.
From June 2008 till about December 2016, the Euro was largely declining all the time against the US dollar. That situation turned at the end of 2016. A Euro was worth 1.60$ in June 2008, it fell to 1.06$ in December 2016 and has climbed to $1.23 currently. Beginning December 2016, bond yields started falling across the Eurozone. The 10-year bond yield for Greece is 4.32%, down from 14.6% in July 2015 and 12.6% in February 2016. 2-year bond yields for Germany, France, Netherlands, Italy and Spain are all negative at between -0.2% to -0.6%. Even 2-year Greece bond yields at 1.44% are the lowest in 13 years. The ECB bond buying program has helped but asset managers have invested too. They have no choice, they have to invest. A 2-year US bond yield of 2.25% is great but taking a 2-year currency hedge would probably cost around 3% a year so it isn’t really worth it.
Think of it – the best Euro denominated North American equity fund has returned almost nothing over the past year (down to currency movements) as against the 10% the S & P 500 has returned over the year. Even though European equity markets have returned nothing to 2% over the past year, the best Dollar denominated European fund has returned some 20% (Equity funds don’t normally hedge as they are meant to hold investments for the long term).
The divergence of interest rates, bond yields, inflation, currency strength, budget deficit/surplus and total debt of countries around the world has never been bigger (read here). Effectively, private money is keeping Euro yields low, what would happen if the currency changes direction? Yields might rise, and we might head into another crisis in the Eurozone unless the ECB steps in.
Central banks have printed loads of money since the last financial crisis, add to that money from asset managers and individuals and you get the perfect bubble. A bubble that isn’t in the form of equities, property or bonds but a bubble of money itself.