This post is one of a series looking at returns in the decade after the financial crisis.
The ‘inevitable’ bond crash has been a recurring theme of the last ten years. Hysterical commentators periodically warn of Bondmageddon. Many investors were scared out of high quality bonds altogether – because interest rates had to rise.
Even Monevator wrote about the risks several times…
…but not nearly as often as some of you commenting on this website told us we were irresponsible for still recommending diversified portfolios that including ‘sure losers’ like bonds…
After all, the expected returns for bonds hovered around zero a decade ago, whereas the average historical real return has been about 1.5%.
What did that tell you?
Absolutely nothing as it turned out. As usual, Trustnet provides the chart that tells our story:1
N.B. Vanguard’s UK Investment Grade Bond tracker contains about 70% corporate bonds.
The annualised returns for the last 10 years proved to be:
- Index-linked Gilts2: 8.2% (5.3% real) – purple line B
- Investment grade bonds: 6.5% (3.5% real) – magenta line D
- Intermediate Gilts: 5.6% (2.6% real) – lime line C
Trustnet doesn’t have 10-year data yet for a pure corporate bonds tracker, a long gilts tracker, or a hedged global bonds tracker. However Vanguard’s long gilts fund is outperforming its intermediate equivalent by 9.6% vs 5.9% over five years.
So while bonds have underperformed a World equity fund’s 12.1% return over the period – just as you’d expect – they’ve exceeded their historical average tally, whilst performing their allotted role as a portfolio stabiliser and diversifier.
Anyone who dumped bonds for equities didn’t lose out, sure. But they did take on a ton of risk that wasn’t guaranteed to pay off like it has.
Things could have gone differently, and historically it often has. Luck trumps judgement until it doesn’t.
The beauty of simplicity
Indeed the last ten years have been an adventure in humility. For all my tilts towards factors and emerging markets, I’d have been better off sticking with a single total world portfolio as recommended by Lars Kroijer.
Only a foolhardy UK investor would have banked everything on the US market with its rich valuations, but its returns over the decade are surely why there are so many perky American FIRE bloggers around. There may be fewer following in their footsteps if the market mean reverts.
I was close to going into commodities but ultimately heeded the warnings – especially from Bernstein and Ferri – that the case was built on a recent period of outperformance, and that the available investment vehicles were questionable.
“Don’t invest in what you don’t fully understand” saved the day there.
The results for sector investing and megatrends proved to be a total crapshoot and I’m glad I stayed out of it. Stories are catnip for humans. If you see a product that looks like it sprang from a marketing department or a media agency (AI, robotics, big data, cannabis and blockchain ETFs all come to mind) then watch out.
The last decade of bond returns are the most instructive of all. Nothing seemed so certain as losses for that asset class and yet it just hasn’t happened.
That doesn’t mean I’m rushing into long bonds but I am upping my exposure to gilts in line with my changing risk profile.
Yes, they’re expensive but no other asset class can do the same job.
Take it steady,
The Accumulator
This is the last of our 10-year retrospectives, but you can still read the others to see how other passive-friendly strategies fared over the decade. Let’s meet here again in 2029!
That bond return came as a result of a big debt bubble and trillions in negative rates. The risk is not over.It is worse. Allocators are still doing the same thing and thinking all is ok. Did the same every other time in other asset classes. The negative people were early and look wrong. The risk is far higher.
Having spent my time investing in equities I find myself flummoxed by bonds. What I can glean is that the world is loading up on corporate debt, including ‘ covenant lite’ stuff, and that a flattening yield curve rewards duration ( while I have been assiduously going for shorter duration funds).
No alternative other than not to out think myself and carry on, but cut back on corporates.
Thanks for the article.
I guess I ‘should’ be moving more into Gilts as I get older, but really can’t see the point in putting cash into an asset class that has little headroom to increase , but a lot of downside
OK they may stay the same, but a box of cash under the bed does that without the risk (other than moths/burglars)
@Berkshire Pat – I’m in much the same frame of mind and at this point have decided to go with the comparative certainty of a 1.5% – 2.5% returns on a cash pot, rather than the brain-boggling vagaries of the current bond market; it can’t continue to defy gravity for ever IMHO…
Loving this series of posts!
@Maximus
You’re right that it can’t defy gravity forever, but as per this article, people have been saying for a decade not to invest in bonds and it has defied gravity that long. In parts of the world, interest rates are negative, so there is no reason rates cannot continue to drop for quite some years more.
I have no idea whether to choose a high interest savings account over bonds, but I doubt anyone else does either.
You can make an argument that buying bonds now is speculation that it will go down further, but you can also make an argument that avoiding them is also speculating that rates will go up sometime in the near future, and I think over the next 5 years I’d say the second is certainly not any more likely than the first.
I’m not against the idea of a high interest savings account, but this comment is framing a perspective. Saying it can’t defy gravity forever obfuscates the fact that it could defy gravity for a lot longer and only turn around in 10 years or more for all we know.
What bothers me is it’s taking capital risk with your safe money, which is not the purpose or (in theory) the best vehicle for safer risk vs a small equity plus cash, returns are nice but thats not the function of safe money, although it does help investor discipline to water down your ride and present it all like one pot
What a prescient reminder of how poor we are at reading the future !
Getting far away from the principal that Equities are for Growth and Bonds are for Safety in a Portfolio is still fraught with problems for the average investor
Accepting the above seems to sensibly lead to then buying the whole stock market if possible via a Index Fund (Equities and Bonds) and concentrating on the day job over which you have some control and certainly more knowledge
This fits with a recent article by Jonathan Clements (may be someone will provide a link) that half your portfolio growth comes from your Savings rate over which you do have control
xxd09
@xxd09. Thanks for the reference, interesting articles. Here’s one link, doubt it’s what you had in mind but there’s a whole bunch of interesting stuff by him.
https://www.wsj.com/articles/SB112881938491263813
> its returns over the decade are surely why there are so many perky American FIRE bloggers around.
I’d say the long stock market run out of the financial crash is why there are so many perky FIRE bloggers everywhere. Reversion to the mean tells us winter is coming guys. If you started ten years ago then you did well. That does not mean if you start now that it will look so good 10 years hence. In 20,30 – perhaps it’ll all come out in the wash.
I don’t think (equities anyway) have strayed from mean, really – companies have debt and leverage inflation, it’s right and proper to get those returns and market wobbles are the real deviation from mean
Bonds are appropriately priced for institutional investors (stakeholder pensions, banks, insurers), not necessarily the unregulated individual who also has savings account options or who isn’t tax-loss harvesting. I don’t forsee a bond crash although interest rates are a risk, a risk that cash could offset
This is an interesting article. I will keep an ear out for the word ‘Bondmageddon’ in the future- it could save me from pouring quite a bit of money down the drain!
looking back 10 years ago – which seems like an age.
There were people I know saying gold would be worth $5,000 an ounce or silver or platinum and bought accordingly. There were others that thought that the stock market was too risky and sold to pay off their mortgage and for me…
I was putting my money in S&S ISAs and company shares – looking back I didn’t know what I was doing and chopped and changed too much.
Am I doing any better now?
I still view long dated gilt funds as risky. Even if rates don’t move you are losing out to inflation, and if rates do move you face losses.
Outside of my fat yielding but riskier SIPP holdings I am however drip feeding my works pension contributions into a split between short dated (sub 5 year gilt and corp) and mixed duration investment grade corp bond funds that will probably be used to take the bulk of my 25% tax free lump sum against. One of the funds seems specifically for that purpose. The combined returns of the two funds barely keep up with inflation, even IG corp bond funds are yielding little over 2% at the moment.
All of the historic asset allocation maths doesn’t seem to stack up when gilts have a negative real return in our QE ZIRP world.
If I could get about 1.5% on cash (with FSCS-style backing) within my SIPP and works pension I would probably choose that instead for my “low risk/risk-free” asset allocation.
That’s about the same as interest on my mortgage and Cash ISA. However even on my low risk pension funds the tax relief still tips things in favour of making pension contributions over mortgage overpayments or ISA contributions.
P.S. I fully realise in another 10 years when gilts are yielding -2% but we have -3% deflation The Accumulator will dig this comment up to humiliate me.
That’s not really his style. 🙂 I might though… 😉
The fact is the conditions you guys are bemoaning have reigned for most of the past 10 years. Throughout it people derided government bonds as “no return” assets. And yet here they are, returning.
The maths of bonds at low yields is counter-intuitive. We wouldn’t need deflation of -3% to make government bonds significantly more valuable that they are now.
Also, perhaps @ZXSpectrum will be along shortly to explain again why short-dated bond funds aren’t quite the harbour we might think they are…
Don’t get me wrong, I currently have a bare smattering of government bonds and prefer cash for private investors myself. But I can see a case for both, as always, not either/or. (Probably more cash admittedly.)
However I’m an active investor whose portfolio wouldn’t know a benchmark from a Black and Decker workbench.
Passive investors who (rightly) decide they probably haven’t got an edge in stocks but who are hyper confident about their ability to call the most deep and liquid markets in the world (government bonds) overvalued are something of a contradiction IMHO. 🙂
But I say that not unkindly, and definitely concur these are odd and difficult times!
“The maths of bonds at low yields is counter-intuitive. We wouldn’t need deflation of -3% to make government bonds significantly more valuable that they are now”
Go on then – explain! In my simple world the ceiling for bonds should be the sum of future cashflows – so for a Gilt with seven £5 coupons left the max price is £135. Because of the time value of money you would be almost certain to lose money in real terms at that price, rather than just breaking even. If you approach this limit, the downside is massive, the upside minimal – so not a great investment if the aim is to smooth out portfolio returns. I’d rather invest in fixed term savings accounts etc to be honest.
I’m sure someone will be along to put me straight…
Do bonds still have more levers to pull? How much lower can rates go? Can we rely on QE to sustain them? How can it ever get back to better rates without pain? (A major difference with equities)
I admit I (and lots of people) are suprised they eked out this much. Unlike equities its hard to even feel like past performance could predict the future, like it’s force has already been spent and here we are.
I wouldn’t predict bondmageddon or boom, I predict stagnation at the low/moderately negative yields backed up by QE and institutions
The bond market is trying to cater to 3 very different types of customer – unregulated individuals, institutions that are forced to buy them, and QE which underwrites demand
Our allocation to bonds is treated on a ‘need for the product’ basis – i.e. risk tolerance, a truely passive approach would be to see that the bond market cap vs stock market cap is a 3ish:1 ratio and so tou’d have 75% bonds
Ie the purely passive approach accepts that things are priced appropriately but ignores your actual needs of the product
I.e. Next time I’m in Tescos I’ll buy 1 of each item assuming theyre appropriately priced for what they are :p
Even in 2009, we’d been in a secular bond bull market for over 20 years. The inflation that appeared in the 70s, as a result of the failure of Bretton-Woods, resulted in very high and steep bond curves in the 80s. Central banks responded by introducing inflation targeting; to anchor long-term inflation expectations at lower levels with lower volatility. This reduced bond yields but also flattened the curve as term premia collapsed. Add to that importing disinflation from EM economies and the stage was set for a much lower yielding world. If you could have invested in a long-duration (15y+) Gilt tracker in 1989, you’d have delivered returns of over 9%/annum by 2019. Who needed the FTSE.
The 2008 crisis didn’t change any of that; it just gave it an even bigger tailwind. Deflationary fears pushed inflation expectations down, secular stagnation lead to lower real yields. Front end policy rates were slashed to the ZLB or negative. Multiple rounds of QE, Operation Twist, TLTROs. Huge bond demand from aging demographics. Basel III made it more attractive to for banks to buy bonds than lend to SMEs. Prudential regulations forced insurers/pensions to hold more bonds. And the coup de grace: a lack of bond supply; governments unwilling to fiscally stimulate because of a misplaced desire for “austerity”.
So yes, the performance of long-duration government bonds has been amazing, but given the setup in 2009, I argue that isn’t the biggest surprise. It was the perfect environment for bonds. Perhaps the real surprise is the performance of equities in a world of low growth, stagnation and poor productivity.
At this point government bond yields seem too low but what factors are going to make them rise? Is growth or inflation going to explode higher forcing yields up? Is the demand for bonds going to fall suddenly when every year, every lifestyle fund has to sell ever more equities to ever buy more bonds? Is regulation going to change?
Realistically for a major bond bear market, you’re going to need regime change. That might be a change of central bank inflation targeting, it might be a move to heterdox economic approaches such as MMT. Most likely it will be the decline of monetary dominance to be replaced by fiscal dominance. Very low bond yields are making fiscal expansion more palatable to governments. Why is Lagarde replacing Draghi at the ECB? Because Lagarde’s role is to convince northern european states like Germany to fiscally expand.
Even then you might still want bonds. In late 2018, 10y US Treasury yields breached 3% on the expectation that the Fed would continue hiking. Within a month the S&P was down 20%. So don’t assume that other asset classes will be immune to higher bond yields. Yes, you might lose money owning bonds, but they might lose less than other asset classes and isn’t that their point?
Why would a private investor – say aged 50-ish like myself- want to follow the ‘rule’ and have 50% of their portfolio in bonds, when Gilt valuations are bumping into the ceiling and the majority of possible outcomes are a loss ?
“Yes, you might lose money owning bonds, but they might lose less than other asset classes”
Well I can do better than that with a fixed term savings account paying well over 1% and no chance of a loss (within FSCS limits…) The argument for bonds in a passive portfolio seems to be that they damp everything down, and can have a good year when equities are doing badly. How can they have a ‘good year’ when they have effectively run out of steam? Seems like they can either do as well as a normal savings account, or crash spectacularly.
Personally my non-equities dollop is made up of ;
Investec High 5 (about 1.4%)
Cash ISA (NS&I) (0.9%??)
HTB ISA (2.5%)
NS&I Index Linked bonds (bought years ago and rolled over every time)
SLXX corp bond fund
Plus load of cash in my equities ISA earning 0%, waiting ….
Cheers!
What low rates are telling us is that governments and companies have a lot of capacity to spend that they are just not doing, and that like Japan we are just saving too much as a country (mean average wealth that includes the top 1%, not the median average)- companies must be seeing no growth to be had which to me implies the rich aren’t really spending their wealth, so its just eroding to inflation in fixed income
And just wait for a government spending spree and the inflation that would be primed to deliver – its almost as if the BoE said to gov “here’s your stimulus” but it’s just sat in the gilt piggybank and not made it into the economy
Hope you don’t mind if I share this article which I just read this morning:
https://www.cityam.com/the-death-of-yields-in-six-charts/
A bit scary perhaps thinking about the end game.
Berkshire Pat, in the ETF world alongside SLXX ishares’ shorter dated GBP corp bond ETF, ticker IS15 is also worth a look at for a pretty low risk option to get 1.64% (weighted average YTM) and at least keep within spitting distance of CPI inflation. DYOR of course.
Thanks, good Halloween reading!
Will have a look at IS15 also
What’s the view on preference shares?
Bond like in nature.
Currently ~6% yield.
Irredeemable (probably!)
I sold a BTL and switched into a mix of RSA, Aviva, Santander 3 years ago.
They feel more robust than P2P lending, but admittedly much larger long term inflation risk.
Another BTL is being sold next year and I’m tempted to double up.
To me if feels sensible for <20% of my portfolio especially since bank accounts and bond returns are negligible. And FTSE etc all feel toppy.
Wise comments appreciated.
B
@ Berkshire – you’re already losing money after inflation on your cash accounts barring the NS&I index-linked certificates that are no longer being issued.
Lots of people were making exactly the same points 10 years ago about bonds and, well, they were wrong. You may well be right over the next 10-years, but perhaps you won’t. That’s the point of the series… to compare the prevailing narratives a decade ago to what happened. Maybe diversifying isn’t such a dumb move after all.
What’s being overlooked is that government bond prices have the potential to increase in a recession while cash does not. That’ll give you more of a cushion in a downturn and more ammo to buy cheap equities. Mitigating losses in a crisis may also prevent you panic-selling.
I’m not saying you need be 50% in bonds, and I hold plenty of cash myself, but bonds have their place even today.
” you’re already losing money after inflation on your cash accounts barring the NS&I index-linked certificates that are no longer being issued.”
So, how would bonds be different/better exactly? Are bonds protected, but somehow cash in a savings account isn’t?
“What’s being overlooked is that government bond prices have the potential to increase in a recession while cash does not”
How, without going into negative yield territory? There doesn’t seem to be much headroom left. Equities can lose 100% (hello Carillion!) or enjoy unlimited gains, whereas bonds have a (theoretical) upper limit which they seem to be getting close to.
I seem to recall seeing a graph of yields over 100 yrs or more on this very site which showed that we are in uncharted territory – the current run of near-zero interest rates is unprecedented. OK we might see some bizarre situation where forced buyers turn yields negative, but I’m not going to bet on it for a paltry sub 1% yield when I can get more elsewhere without the downside.
All interesting stuff though
Cheers!
(call me Pat, I live in Berkshire 🙂 )
There are riskier bonds with more headroom you could use (corporate, emerging, mbs) but if the safest ones hit a minimum, they might all get a bit stuck too trying to keep their risk premiums, if there is a limit as to how negative rates can actually get – I imagine there is a limit and that duration is an important factor in how much rope they have. Also consider linkers for inflation protection…
Perhaps consider gold instead of gilts if you want a counterbet on fear if you want to rebalance into dips, with no cap on value, but it’s far from stable – possibly all the more reason it might actually give a rebalancing bonus. I don’t really believe rebalancing is a bonus in the very long run although it certainly controls risk and certainly has its moments of outperformance
Remember too that a gilt is more like a cash savings account if you hold to maturity – its a fixed savings you have the option, but not obligation, to sell off if rates do drop, or just hold on if they rise – cash fixed savings look relatively worse if rates rise too, it’s just you’re not considering the market value of fixed cash accounts you can’t sell
“Remember too that a gilt is more like a cash savings account if you hold to maturity – its a fixed savings you have the option, but not obligation, to sell off if rates do drop, or just hold on if they rise – cash fixed savings look relatively worse if rates rise too”
True, but if rates rise you are stuck with the bonds at a low YTM, or you take a big capital loss if you sell. With a cash savings account you are unlikely to be stuck in one account for more than a year or so, and can roll into higher rate accounts as they become available. My Investec High5 actually links its rate to the top five savings accounts so it’s always ‘competitive’ (currently 1.42%) Not sure if it’s still available, but Investec do fixed term deposits up to 3 years at 1.7%. Big downside for me is it’s taxable.
I’ve never fancied gold – I agree with Mr Buffet on that one…
Investec is a South African Bank
I think I would borrow money from them but be wary of giving them any of my hard earned pennies
xxd09
@pat – a bond fund would roll over into higher rates as they rise, especially short duration bonds, which are more like cash and its capital value would be less affected by rates than long duration bonds, which are more defined by interest than returning the principle. On the downside no bond fund is something you can hold to maturity, but you could roll over short duration bonds yourself, if you had the money to still be diversified doing that
I wouldn’t want to be market timing with gold either, over straight owning productive assets, I’m just saying that it rallies in a crash, and if quality bonds can no longer do so, then gold might start to replace them as safe haven (lol) of choice, but gold (or betting on failure) is generally not a good long term thing.
But if you were a short term market timing trader, rebalancing frequently between 2 or more volatile things is more likely to suceed, because 1- it’s rules based and ignores the news that all other traders are listening to, or making any judgement and 2- it’s not what most traders do, so you’re more likely to beat them. Also gold might be more productive than it appears if you are basically supplying something tangible in times of crisis
Although I assume that was discovered and arbritaged away long ago, otherwise you’d see a hedge fund outperforming (shock!).
Also it is too much like hard work and indexing is sure to capture whatever successful thing people are doing
@ xxd09 – Investec Bank plc (Reg. no. 489604) is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered at 30 Gresham Street, London EC2V 7QP
Were the Icelandic Banks the same situation?
Punters got their money back but it took time-no use for funding cash flow!
I always worry when an investment is paying out so far ahead of the curve.
xxd09
I had a few quid with Kaupthing Edge (which I made a lot of money on, and ended up with an ING account) but I don’t think Investec are in the same category (1.7% 3 year rate is hardly an outlier)
@pat – check out Al Rayan bank’s 12 month deposit, 2.09% (profit, NOT interest! – so not guaranteed but always paid so far), fscs protected so in the hypothetical scenario of a loss its your choice if you accept it, you dont have to
https://monevator.com/what-is-the-minimal-risk-asset/
https://monevator.com/should-you-invest-in-short-or-long-term-government-bonds/
Couple of Lars Kroijer articles which are worth a read (as always)
Not sure about what determines an investors ‘time horizon’ – when you need to start drawing money out ?
@BerkshirePat. With regard to the time value of money. Yes, in a world of positive definite inflation, £1 today is worth more than £1 in n years time. Discount factors are =1.
I agree that G10 government bonds are expensive (but not EM bonds) but you need to focus on the drivers of that pricing change, not the level of yield. Buying a 10-year bond with a yield of -0.3% may seem illogical to a cash constrained investor like yourself but many investors in the bond market operate on a leveraged basis. If the investor can borrow the money to buy that bond (using a repo, the bond collateralizes it’s own borrowing) at say -0.8%, and the margin that investor needs to post is only 4%, then that investor can leverage such a transaction 25x to earn 25x(-0.3% – (-0.8%))=12.5%. It’s economically no different to buying a bond that yields 5% when borrowing at 4.5%. In both cases the spread between borrowing and lending rates is 0.5% and it’s the spread that matters, not the outright level of yield.
The problem with bonds having “run out of steam” is people have said that for about two decades. Back in 2009, the passive tracker part of my portfolio was relatively simple: 50% S&P, 20% EM $ sovereign bonds (duration 7), 30% Long-duration Govt bonds (10% Gilts, 10% ILGs, 10% Global, duration 21). I’ve not touched that allocation over the last decade (albeit new money has gone into different assets) so it’s easy to calculate the returns: 13.1%/annum with a volatility of 7.6%. That’s 3.3% less than the S&P but 1% greater than the MSCI World Equity index, with about two thirds of the volatility and 50% smaller drawdowns. Gilts outperformed the FTSE ASX by >1% per annum. EM bonds outperformed the MSCI EM by >2.5%/annum. Who would have thought that a decade ago?
Lastly, I’m no fan of short-duration bonds. I don’t understand why retail investors get told to buy short duration bonds. I think it’s because authors of retail investor books are equity types and don’t understand yield curve dynamics in an inflation targeting regime. Given the choice of £100 in bonds with duration of 3, I’d much prefer 80% in cash (duration zero) and 20% in bonds with a duration of 15. The weighted duration of the cash/bond barbell is still 3 but if rates rise, you’ll be far less vulnerable.
I have 60% in a low-cost global equity index fund 20% in an intermediate term gilt index fund and 20% in cash ISA’s. It’s simple, I spend hardly any time thinking about it and accept what the market gives me. I used to spend hours looking at various permutations, and fretting over how I could maximise my returns,but then realised I was effectively trying to beat the market and stopped ; It was very liberating!
@ Berkshire – I read this and thought of you:
https://www.morningstar.com/articles/945408/how-to-diversify-assets-like-a-pro-when-you-own-a-lot-of-equities