Global Head of Quantitative Research, Asset Allocation and Investment Risk Management - Citi Investment Management
Parul Gupta, Global Head of Strategic Asset Allocation
March 18, 2016
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History suggests that today’s low fixed income yields could be followed by low returns in the decade ahead.
The global fixed-income market is in uncharted territory.
As of the end of January 2016, some US$7.1 trillion of government bonds worldwide had negative yields-to-maturity*. In other words, buyers of these bonds are paying borrowers for the privilege of lending to them. Even where yields are still positive, they are low by past standards. This could have an important impact on future returns.
The chart below shows the relationship between current yields and future fixed-income returns over time. When yields were high – as they were at the start of the 1980s – fixed-income returns over the next ten years were also high. And when they were low – as they were at the start of the 1950s – returns over the next decade were also low.
Source: Citi Private Bank Global Asset Allocation Team. Data as of 31 October 2015. Chart shows US Government Fixed Income Yields to Maturity adjusted for default rate and subsequent annualized returns over 10 years (rolling ten-year return). For illustrative purposes only. Past performance is no guarantee of future returns.
So, what might fixed income returns look like over the coming decade? Citi Private Bank’s own strategic asset allocation methodology divides fixed income into three asset classes: Global Developed Investment Grade, Global Developed High Yield and Global Emerging. Estimated annualized returns for the coming decade are shown in this table:
Source: Citi Private Bank Global Asset Allocation Team. SREs and historical returns over last 10 years as of 31 October 2015; Returns estimated in US Dollars; All estimates are expressions of opinion and are subject to change without notice and are not intended to be a guarantee of future events. Strategic Return Estimates are no guarantee of future performance. Past performance is no guarantee of future returns. SREs for all 9 AVS profiles are available upon request from your banker or investment counselor.
We estimate that all three fixed-income asset classes will deliver lower returns over the next ten years than they did over the last ten. In particular, Global Developed Investment Grade’s estimated return of 2.1% is less than half its return of 4.7% during the previous decade. For the ten broad asset classes that our methodology addresses, only the estimates for commodities and cash are lower.
Our methodology uses these estimates to help decide how much to allocate to each asset class. Lower return estimates likely lead to a smaller allocation to an asset class, while higher estimates likely lead to a bigger allocation. By contrast, some methodologies simply assume that future returns will look like past average returns and allocate accordingly. Especially at times of stretched valuations, this can be a risky assumption.
And we’ll be exploring the outlook for returns in other asset classes – and their impact on allocations – in coming posts.
Fixed income investments are subject to credit and interest rate risk. As interest rates rise, the price of fixed income securities falls. Credit risk, which is the possibility that the issuer of a security will be unable to make interest payments and repay the principal on its debt.
*Source: Bloomberg, 2 February 2016.