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Historical returns from corporate bonds

We’ve previously looked at why corporate bonds should theoretically underperform stocks over longer time periods.

But is the theory right? How have corporate bonds done in reality?

I’ve found it very hard to get figures on the long-term performance of stocks versus bonds. Perhaps the financial community would rather sell us corporate bonds than explain why we should or shouldn’t buy them? (Perish the thought!)

However, the new 2009 Barclays Capital Equity Gilt Study does give the past 10 years of UK returns for corporate bonds as an asset class — and the past 20 years for the US — which I’ll share below.

Before we get to the numbers though, let’s very briefly recap on what we expect to get from holding corporate bonds versus holding equities.

Stocks vs bonds: Risk vs rewards

Corporate bondholders theoretically trade some long-term rewards for taking less risk, as discussed.

Both individual corporate bonds and shares in the same company can become worthless if the company goes bust.

Bonds are less likely to lose all of their value than shares, however, since bond holders rank ahead of shareholders in recovering any assets from a failed company.

And while both bonds and shares can stop paying coupons and dividends, share dividend cuts are more common than bond defaults, for legal as well as other reasons.

In aggregate then, the risks are less for corporate bonds than equities.

Moreover, the nature of bond investment (fixed income and eventual return of capital) mean that corporate bonds are less volatile than equities. (Risk and volatility are often confusingly entwined in investing speak!)

These factors mean that over time we’d expect to see:

  • Corporate bonds as a class being less volatile than equities (less risk)
  • Corporate bonds delivering lower annual returns than equities (less reward)

Corporate bonds versus equities: The actual returns

Uh oh!

Despite all the theory above, corporate bonds have actually beaten equities over the past ten years, as the following numbers from the Barclays Equity Gilt Study 2009 show.

Note: All returns are real returns — i.e. they have been adjusted for inflation.

UK real investment returns by asset class (% per year)

                   2008         10 years
Equities           -30.5         -1.5
Gilts               11.7          2.4
Corporate Bonds   -11.0          1.2
Cash                 4.2          2.4

Source: Barclays Capital

Obviously the bear market of 2008 hit equities very hard — much worse than corporate bonds, which also suffered steep falls due to the credit crisis.

Even over ten years, equities have posted a terrible negative real return of -1.5% per year, whereas corporate bonds have returned a positive 1.2% a year.

Of course, there have been two huge bear markets for shares in the past decade; so what about the longer term?

Unfortunately Barclays Capital has only been tracking the UK corporate bond market since 1990, but for the U.S. it has obtained 20-year data as follows:

US real investment returns by asset class (% per year)

                   2008         10 years    20 years
Equities           -38.9         -2.7       5.6
Treasuries          24.6         5.7       6.8
Corporate Bonds    -5.3          2.3       4.9
Cash                 1.4          0.6       1.3

Source: Barclays Capital

Here we see US equities edging ahead of US corporate bonds over 20 years, thanks to the bull market in shares in the 1990s offsetting the more recent bear markets.

US equities have done much worse than corporate bonds over the past decade, just like shares in the UK.

Again, it’s not what you’d expect to see, and if I’d written this article in 2007 it would have been a different story.

What can we learn from these longer-term returns?

For anyone who hadn’t noticed, the figures are another reminder that stock markets have delivered terrible returns in recent years.

Corporate bonds have done much better, but I don’t expect this situation to last.

Rather, I think the past couple of years have been true outliers that are playing havoc with the medium term data.

To quote the Equity Gilt Study:

Gilts [UK government bonds] were the main beneficiary of the financial turbulence of 2008.

With a real annual return of 11.7%, they were not only the best performing asset of the year, but produced the best average annual return over 20 years.

The 20-year average annual return was 5.5% for gilts and 4.6% for the FTSE All Share.

Forget about corporate bonds for a moment — it is extremely rare and entirely counter-intuitive that the super-safe security of gilt investing has also delivered better long-term gains over 20 years than equities.

In fact, there have only been three previous occasions when gilts have beaten equities over a 20-year holding period —  1932, 1939 and 1940.

Note that even saving cash has hammered holding shares over the past decade in the UK as well as the US. That’s very rare indeed.

My conclusion is that it’s a good time to buy equities, not corporate or government bonds.

Certainly corporate bonds have rallied hard since I wrote my corporate bonds article in January 2009 saying it looked like one of the rare times when it was a good idea to invest in them on a risk/reward basis.

As a result of the subsequent bond rally, we’ll see lots of corporate bond fund advertising around over the next 12 months quoting impressive figures.

However, I wouldn’t expect corporate bonds to very often beat equities over 10 years, and there’s even less sense in chasing out-performance from here.

I don’t know how the correction will come — negative news for bonds like inflation or rising defaults, or maybe a big bull market in shares — but I’ll eat my hat if corporate bonds continue to beat equities over the next decade.

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{ 7 comments… add one }
  • 1 Brian August 27, 2009, 3:03 pm

    I would think that even 10 years is too short of a time period to compare these asset classes. Over 20 or 30 years, I would expect that bonds would almost always underperform stocks as an asset class.

    And if mean reverting means anything, look for equites to bounce back in the future.

  • 2 The Investor August 27, 2009, 4:37 pm

    Thanks for your comments. I agree that bonds should underperform equities — that’s why I think it’s very interesting that over 20 years in the US (and in the UK, though I don’t show the 20 year data here) government bonds (treasuries in my table above, as you probably know) HAVE beaten equities.

    Totally agree that this is very bullish for equities for the next ten years. 🙂

  • 3 Len Penzo August 28, 2009, 12:27 am

    I don’t know if this makes me a contrarian, but I have a funny feeling that we in the US are smack dab in the middle of a secular bear market that started in 2000. In the US there have been three secular bear markets (1906-21, 29-49, and 66-82) where the Dow and S&P averaged annual returns of less than 2% over very long stretches of time.

    I have a sneaking suspicion that there are still one or two bear traps ahead of us over the next five to ten years. While there will be plenty of buying opportunities ahead of us, the danger, of course, is getting caught in those traps.

    That’s my $0.02 (0.12 pounds) after taxes,


  • 4 The Investor August 28, 2009, 7:32 am

    Len, I think that’s a very good point about the bear market stretching back to 2000, that a lot of people forget. (I *cough* *cough* have written about it here though…) That said I don’t see why it should continue for another ten years – it might, naturally, but the fact gilts (and US treasuries) have beaten equities over 20 years shows we could potentially be near the end.

  • 5 Niklas Smith September 1, 2009, 11:12 am

    Another point that comes out of these data is that if you want bonds you might as well buy safe government bonds (i.e. not Russian!) rather than corporate bonds. The higher risk of default does not seem to be compensated by higher return, and both gilts and Treasuries offer the possibility of index-linking.

  • 6 The Investor September 1, 2009, 4:32 pm

    Good point and I couldn’t agree more Niklas.

    As I vaguely suggested in the first post in the series (partly on the back of reading Yale fund manager David Swenson’s findings on subject), corporate bonds are not investments I typically reach for.

    I just wish government bonds looked cheaper at the moment because I know I’m taking a risk sitting them out at today’s prices.

  • 7 Ivana November 22, 2015, 10:33 pm

    Good that the situation with the corporate bonds is horrible so you don’t have to eat your hat 😀

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