Looking back at bond performance
The annual Credit Suisse Global Investment yearbook was released last week. This report tracks the performance of 19 markets with data compiled going back from 1900 to the end of 2010. The report computes a 19 country world equity and world bond index in a common currency.
Over the 111 years the real return on the world index was 5,5% per year for equities and 1,6% per year for bonds. On a cumulative basis this additional 3,9% over an extended period makes a big difference.
We all know the long term story for equities – i.e. investors who maintain a long enough investment horizon will invariably be rewarded for the additional risk taken on.
But there have also been protracted periods of time where this has not held true and the performance from supposedly lower risk bonds has been on a par with that of global equities.
In fact we are coming out of such a period.
Bonds have been excellent performers over the last decade and indeed from 1980
In the US from 1980 to the end of 2010, the inflation adjusted return from government bonds was an annual 6%. This a far superior return compared to the preceding 80 years where the real return was only 0,2% per annum.
A similar result occurred in the UK where from 1980 to 2010 government bonds produced an annual real return of 6,3%. Over the preceding 80 years UK government bonds had produced an annualised real return of -0,5%.
Therefore in these 2 countries at least government bonds have exceeded investor expectations over the last 30 years, while the performance from equities has generally been disappointing, especially when both these asset classes are adjusted for risk.
Taking all 19 countries into account, over the 111 year period, equities have produced an annual 3,8% superior performance. However over the last 10 years for the most part government bonds have been a better asset class than equities, with equities producing an a -3,2% equity risk premium.
Looking back there are good reasons why government bonds have done well over the last 10 and indeed 30 years. Structurally the US and UK started moving away from big government to smaller government in the late 1970’s to early 1980’s. By starting to squeeze down inflation, boosted with China starting to come on board as a production powerhouse, the environment was created for interest rates to drop from high to low rates. Lenders to government benefited as interest rates fell.
There are periods when bonds can be very risky in real terms.
Looking back in time at the cumulative percentage decline in real terms for an investment in US equities and US bonds, gives an indication of just how risky bonds can be.
The chart below reflects that after the 1929 stock market crash, shares (in blue) fell to a low in July 1932, which in real terms was 79% below the September 1929 peak.
This was extreme. But look at bonds in red, where the major decline started in December 1940 declining some 67% in real terms to 1981. The UK had a similar experience where bonds slid from 1946 to 1974 – losing 73% of their value.
Should investors be wary of bond performance
As with all investment asset classes the returns are not experienced in a linear fashion. This also holds true for bonds where there have been extremes in real return performances.
We have generally come through an extended “golden era” period for bond performance – see the chart below.
The danger now is that investors look back over the last 10 years and even up to 30 years and extrapolate the superior bond performance into their projections. Given the much higher base, lower value, it is highly unlikely that these same returns will be repeated again over the next 10 years.
Source: Credit SuisseMon, 07 Mar 2011
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