“Since the financial crisis, Italy hasn’t undertaken the labor reforms that we’ve seen in Spain, for example,” he says. “Spain has implemented a lot of labor reforms to make it a more interesting place for manufacturing.”

Negative Yields

Following the 2008 global financial crisis, major central banks around the world—including the Federal Reserve, Bank of Japan and European Central Bank—took drastic measures to revive their economies with ultra-low interest rates and bond-buying programs. This boosted bond prices and, correspondingly, pushed down government bond yields to record lows. In the case of Japan and certain European countries, that has resulted in negative yields. Negative sovereign bond yields have become an epidemic, and Deutsche Bank said that $15 trillion in government bonds, or roughly 15% of the market, offered negative rates as of this summer. Yields are turning negative in corporate and high-yield bonds, too.

Germany, France, Switzerland and the Netherlands were among the European nations that recently had 10-year government bonds offering negative rates. Obviously, this makes for a sticky situation for global fixed-income fund managers such as Lynda Schweitzer, leader of the global fixed-income team at Loomis, Sayles & Co. and co-portfolio manager of its Global Bond Fund, which has roughly $813 million in assets and holds mainly investment-grade fixed-income securities worldwide.

She notes that Europe is a big piece of that fund’s benchmark, the Bloomberg Barclays Global Aggregate Index. While the Loomis Sayles Global Bond Fund is actively managed, it still needs to conform to the overall benchmark to some degree. So it has a weighting toward Europe that’s comparable to the index, but with some flexibility.

But the seesaw structural underpinning of bond investing—i.e., lower yields result from higher prices, and vice versa—creates a conundrum. For example, Schweitzer notes, the price of Germany’s 10-year sovereign bond has been on a roll with a 5% year-to-date return through July.

“We’ve had such a massive rally this year that if you didn’t hold European bonds you’ve underperformed your benchmark,” she says. “That’s the challenge that we face. We’re short-duration because our view is that bond prices are extremely rich and the negative yields don’t make a lot of sense to us. But it has been a detractor for the fund. We’ve had other things in the fund to offset it, but the short-duration stance hasn’t worked this year.” The fund’s institutional share class had gained 6.6% through August 8, versus a 0.14% loss for its index.

Italian bonds are another balancing act. Schweitzer says she has concerns about the stability of that country’s government and the amount of its outstanding debt. And like the rest of the eurozone, Italy is impacted by slow growth. Given these woes, investors demand extra premium to hold Italian bonds.

“We have some structural concerns about Italy, but right now we hold its bonds because Italy has some yield,” she says. The Italian 10-year government bond had a yield of 1.8% as of early August.

Entrenched Overseas