What speaks for swiss bonds Even in the face of zero interest rates
By mid-June, the Swiss National Bank (SNB) might once again lower the key interest rate. Despite this, the CHF bond market can still offer an attractive yield. Several factors contribute to this, as analyzed by Martina Zimmermann.
Martina Zimmermann, Product Specialist Fixed Income
The return to zero interest rate territory seems imminent in Switzerland: the market anticipates another key interest rate cut by the Swiss National Bank (SNB) at its next monetary policy assessment on June 19. Consequently, the SARON rate is already back in negative territory on this horizon.
In short: after roughly two and a half years, the phase of positive interest rates in the local bond market could already be coming to an end.
Is this the end of the attractiveness of Swiss bonds? We think otherwise, because even if key interest rates return to near zero, CHF bonds still exhibit a significantly positive yield to maturity of 0.7%, as measured by the Swiss Bond Index (SBI®) AAA-BBB. This yield is composed of a positive term premium and a credit risk premium (chart below). This excess yield distinguishes the Swiss market with its high average rating of AA.
CHF bond market with positive risk premium (in %)
Mind the rolldown effect
The expected total return is also significantly higher than the yield to maturity might suggest. This is due to the so-called rolldown effect: it describes the change in the price of a bond over time, assuming the yield curve remains unchanged. The steeper the yield curve at the time of maturity, the more this effect contributes to the total return.
This can prove to be an important yield factor. A portfolio with the characteristics of the SBI® AAA-BBB benefits from the current steep yield curve, particularly in medium maturities, with a rolldown effect of 0.5% p.a., which adds to the yield to maturity.
Total return exceeds interest rate level (in %)
To cushion the impact of lower interest rates, global satellites with higher credit risk premiums, hedged in CHF, can be added. Simulations show that this can result in an expected total return approximately 30 basis points higher, while the risk taken on is even slightly lower (see table below).
|
SBI AAA-BBB TR |
80% SBI AAA-BBB TR und 20% Global Credit Risk Categories* |
Expected Return p.a. |
1.05% |
1.34% |
Expected Risk p.a. |
4.04% |
3.94% |
Source: Zürcher Kantonalbank
* Credit Risk Categories: 5% each of Foreign Currency High Yield Bonds hedged in CHF (ICE BofA 50% Secured HY EUR & ICE BofA 50% Secured HY USD (TR) hedged in CHF), CoCo Bonds hedged in CHF (ICE BofA Contingent Capital Index Hedged in CHF), Convertible Bonds hedged in CHF (Refinitiv Global Focus Convertible Index (TR) hedged in CHF), and Hybrid Bonds hedged in CHF (ICE BofA Global Hybrid Non-Financial Corporate TR hedged in CHF)
Conclusion: Significant Total Return Possible – Almost Without Inflation Disadvantage
Even if the CHF key interest rate is likely to fall back to zero soon, the expected total return in the local bond market is still around 1.2% due to the steep yield curve, credit risk premium, and rolldown effect. This is particularly noteworthy given the low expected inflation.
And that's not all. By adding global credit risk premiums with currency hedging, further excess returns could be realized – and this with reduced risk.
Legal disclaimer:
Legal disclaimer:
Past performance is no indication of current or future performance, and the performance data do not take account of the commissions and costs incurred on the issue and redemption of units.
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As at 01.06.24
The investment opinions and assessments of securities and/or issuers contained in this document have not been prepared in accordance with the rules on the independence of financial analysts and therefore constitute marketing communications (and not independent financial analysis). In particular, the employees responsible for such opinions and assessments are not necessarily subject to restrictions on trading in the relevant securities and may in principle conduct their own transactions or transactions for Zürcher Kantonalbank in these securities.
