Bond investors should not expect returns for the next 11 years to be as good as those of the previous 11, and severe drawdowns are possible when inflation is rising, according to the annual
Credit Suisse Global Investment Returns Yearbook 2010.
Bonds in 19 developed markets worldwide outperformed stocks in the 11-year period ended Dec. 31 by an average annualized 3.2 percentage points, according to the report, released Feb. 21. That's in sharp contrast to the outperformance of stocks over bonds in the same countries by 3.8 percentage points since 1900.
Because stocks carry greater risk than bonds, investors can't expect bonds to outperform forever, Paul Marsh, emeritus professor of finance at London Business School and one of the report's authors, said at a news conference in London.
“That does not mean that [bonds are] in a bubble,” he said, adding that the market may be correctly pricing them. “But those correct prices cannot possibly mean that you will get the same returns.”
The authors found that historically, bond losses can be larger — and last longer — than stocks'. For example, U.S. 20-year government bonds fell 67% in real terms from December 1940 to September 1981 and returned to their 1940 level only in 1991.
“If you thought about bonds as the safe asset, this would be disastrous to your prior beliefs,” Mr. Marsh said.
The authors found that a 50/50 mix of stocks and bonds over the entire 111-year period of their yearbook reviews mitigated drawdowns for both stocks and bonds through diversification. However, in times of market stress, correlation between the two asset classes rose, weakening diversification.
The authors also found that bonds in countries with the lowest inflation rate performed best over most 25-year periods they studied. But that approach would require an investor to predict inflation correctly in each country every year. Instead, the authors found an easier approach.
“It's not quite as simple as saying inflation is bad news for bonds,” Mr. Marsh said. “Unexpected inflation is bad news for bonds,” but once inflation has set in, countries with the highest inflation outperformed. That's because investors demand a higher premium from high-inflation countries' bonds because they are riskier, and greater risks result in greater returns, Mr. Marsh explained.
Drew Carter is a reporter with sister publication Pensions & Investments.
