How to Invest Amid a Negative Interest Rate Environment

Japan is one of the countries that has adopted a negative interest rate policy. Photo: Reuters.

The financial market volatility at the beginning of this year was partly due to investors’ concerns that a negative interest rate would be broadly adopted.

Although such a move aims to stimulate economic activity, investors worry about banks’ earnings and solvency ratios and the impact on the confidence of consumers and firms.

A negative interest rate is an unconventional measure. It’s like doing an experiment, and investors can’t know for sure how the policy will affect the market.

In most economies, the yield curves for government bonds become flatter.

It will suppress the willingness of banks to lend. Their net interest margin is likely to narrow, as the lending rate will be reduced while the deposit rate for retail clients remains above zero.

Investors should be clear that a negative interest rate is intended to encourage people to pursue risky economic activity instead of holding cash.

Identifying the long-term investment and economic theme is necessary to guide investors through a situation of low returns and high market volatility.

Uncertainties will come from negative interest rates, energy prices, China’s economic transformation and geopolitical issues, such as Brexit.

Besides accepting credit risk from the fixed-income market, investors can also make use of the risky nature of the stock market and the liquidity risk of alternative investments to realize higher potential return.

Valuation of stocks is at an attractive level now, especially in emerging markets and in Asia.

As for alternative investments, investors may consider private equity investments or hold physical assets.

Investors should focus on the contribution of the return from certain asset classes to the overall portfolio.

For example, in the past 10 years, the compounding effect of stock dividends and the return from reinvestment of the dividends provided over 60 percent of the overall return in Asian stock markets and 40 percent of the return in the Standard & Poor’s 500.

So, in the face of negative interest rates, market volatility will remain at a high level.

A super loose monetary environment will lead to lower expected returns and drive investors to make longer-term investments while taking market, credit and liquidity risks to enhance overall return.

We believe that fixed-income products and stock dividends will make bigger contributions to portfolio returns. 

This article appeared in the Hong Kong Economic Journal on April 11.