negative interest rates

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First, the illiquid and long-term nature of the private equity asset class, significant dispersion in returns across funds, as well as bilateral and relationship-driven fundraising, creates scarcity in access to individual funds, giving private equity funds the bargaining power when splitting the returns. As the industry’s growth deaccelerates, the pendulum of bargaining power will start to shift to limited partners, but more permanently than what we saw during the GFC.
Second, we will see larger scrutiny of the cost structure and the industry’s value-add. Put simply, it is an expensive asset class, with the net returns to limited partners lacking consistency in beating public benchmarks (e.g. Harris et al. 2014).³ A central tension is large funds’ management fees, which typically run at 1.5% to 2% of committed capital already in the first five years of the fund life.⁴ This structure is lucrative for managers but underscores the disconnect between the private equity firm’s income stream and its fund performance, especially for large funds.
Third, such pressures would make new and smaller funds particularly vulnerable. The proliferation of new funds, especially generalists’ funds, in the past decade was partly explained by the strength of capital flow and investment managers’ desire to capture a more significant share of fund economics. These funds have a higher embedded cost structure. Larger funds, therefore, have more room to compress the fees and have a higher ability to experiment in the investment space. All this gives larger-scale firms a better chance to withstand adverse pressures, resulting in market consolidation.

Author(s): Victoria Ivashina

Publication Date: 24 Feb 2022

Publication Site: VoxEU

What does risk really mean?

January 24, 2022January 24, 2022 Mary Pat Campbell

Link: https://allisonschrager.substack.com/p/known-unknowns-c60

Excerpt:

In Bloomberg last week, I argued that the price of safety is mis-priced. Real yields have been negative for the better part of the last 10 years, and have been very negative since the pandemic. And the Fed has no plans to bring it above zero. I can understand a market negative real yield from time to time for convenience reasons. But all of the time? For decades? How can you explain that? Well, I blame the Fed and regulatory policy, as well as other countries buying lots of safe assets to manage their currencies. Lately, it’s been a lot of the Fed.
The risk-free rate is always being tinkered with by policymakers. Maybe it never actually equals the market price, but sometimes it’s more distorted than others, and it seems like it’s really off right now. And if that’s true, what does that say about the price of any risky asset? Perhaps that explains why crypto currencies are worth so much despite not offering much inherent value and having such a high Beta. When celebrities are hawking an esoteric risky asset, you know something is wrong.
Risk-free assets are the most systematically important asset in markets. They touch absolutely everything. And when it goes wrong, things get real. When market prices are not market prices for years at a time, risk gets distorted, and people subsequently take on more risk than they realize. I’m not predicting a financial crisis, but I do reckon that this could be why markets are just so weird right now.

Author(s): Allison Schrager

Publication Date: 24 Jan 2022

Publication Site: Known Unknowns

Inflation Surge Whips Up Market Froth

November 15, 2021November 15, 2021 Mary Pat Campbell

Link:https://www.wsj.com/articles/inflation-surge-whips-up-market-froth-11636817049

Excerpt:

Last week, real yields, which take into account the corrosive effects of inflation, hit some of their lowest levels on record. One measure of real yields, 10-year Treasury inflation-protected securities, fell to minus 1.2%, according to Tradeweb. That is the lowest on record, according to data going back to February 2003.
In essence, with real yields negative, the purchasing power of money invested will decline over the lifetime of those bonds.
Real yields have fallen because of colliding factors. These include the highest inflation rate in over three decades combined with nominal bond yields that have risen only modestly as central banks hold back from raising rates.
The prospect of negative returns on super safe inflation-protected bonds has pushed investors to buy riskier assets.

Author(s): Anna Hirtenstein

Publication Date: 14 Nov 2021

Publication Site: Wall Street Journal

It’s Worse than “Reverse” – The Full Case Against Ultra Low and Negative Interest Rates

June 28, 2021June 28, 2021 Mary Pat Campbell

Link: https://www.ineteconomics.org/research/research-papers/its-worse-than-reverse-the-full-case-against-ultra-low-and-negative-interest-rates

Paper: https://www.ineteconomics.org/uploads/papers/WP_151-White-NegativeInterestRates.pdf

Abstract:

It is becoming increasingly accepted that lowering interest rates might at some point prove contractionary (the “reversal interest rate”) if lower lending margins cut the supply of bank loans. This paper argues that there are many other reasons to question reliance on monetary policy to provide economic stimulus, particularly over successive financial cycles. By encouraging the issue of debt, often for unproductive purposes, monetary stimulus becomes increasingly ineffective over time. Moreover, it threatens financial stability in a variety of ways, it leads to real resource misallocations that lower potential growth, and it finally produces a policy “debt trap” that cannot be escaped without significant economic costs. Debt-deflation and high inflation are both plausible outcomes.
https://doi.org/10.36687/inetwp151

Author(s): William White

Publication Date: 5 March 2021

Publication Site: Institute for New Economic Thinking

May 7, 2021May 7, 2021 Mary Pat Campbell

Link: https://www.kamakuraco.com/wp-content/uploads/2021/01/Kamakura-NegativeRatesIACPM20200722v2.1.pdf

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What Can Go Wrong?
• Rate and Default Interaction
• Impairment to the Banking System
• Massive challenges to the Insurance Industry and Pension Funds
• Central Banks cannot force institutions to lend or creditworthy borrowers to borrow
• Huge overhang for refi in next 5 years
• “Negative Rates Cannot Cure Problems that Caused Rates to go Negative”

Author(s): Prof. Robert Jarrow, Donald R. van Deventer, Martin Zorn

Publication Date: 22 July 2020

Publication Site: Kamakura Corporation

Flood of Cash Pushes Borrowing Costs to Unusual Lows in Europe

March 3, 2021March 3, 2021 Mary Pat Campbell

Link: https://www.wsj.com/articles/flood-of-cash-pushes-borrowing-costs-to-unusual-lows-in-europe-11612780202

Excerpt:

Italy’s Enel SpA, one of Europe’s biggest electricity producers, has short-term commercial paper that recently offered an annualized yield of minus 0.61%, according to FactSet: That is 0.11 percentage point lower than the ECB’s deposit rate of minus 0.5%.
When interest rates are negative, borrowers pay back less than they were lent when their debt comes due. At Enel’s rate, if it borrowed $100 for a year, it would pay back $99.39. For the lender, in this case the money-market funds that buy commercial paper, the opposite is true. They get back less money.
“It took a couple of years for clients to get their heads around the idea that they’d have to pay to leave money in a safe spot,” said Kim Hochfeld, global head of State Street’s cash business. State Street’s EUR Liquidity LVNAV Fund — worth 6.6 billion euros, equivalent to $7.9 billion — yields minus 0.68% after fees, but that compares with total costs on large bank deposits of up to 1%, she added.

Author(s): Paul J. Davies

Publication Date: 8 February 2021

Publication Site: Wall Street Journal

Banks in Germany Tell Customers to Take Deposits Elsewhere

March 2, 2021March 2, 2021 Mary Pat Campbell

Link: https://www.wsj.com/articles/banks-in-germany-tell-customers-to-take-deposits-elsewhere-11614594601?mod=djemwhatsnews

Excerpt:

Germany’s biggest lenders, Deutsche Bank AG and Commerzbank AG , have told new customers since last year to pay a 0.5% annual rate to keep large sums of money with them. The banks say they can no longer absorb the negative interest rates the European Central Bank charges them. The more customer deposits banks have, the more they have to park with the central bank.
That is creating an unusual incentive, where banks that usually want deposits as an inexpensive form of financing, are essentially telling customers to go away. Banks are even providing new online tools to help customers take their deposits elsewhere.
Banks in Europe resisted passing negative rates on to customers when the ECB first introduced them in 2014, fearing backlash. Some did it only with corporate depositors, who were less likely to complain to local politicians. The banks resorted to other ways to pass on the costs of negative rates, charging higher fees, for instance.

Author(s): Patricia Kowsmann

Publication Date: 1 March 2021

Publication Site: Wall Street Journal