Looking for a Haven from Stormy Markets?

It’s easy to understand why investors are seeking a safe haven now. The 2008 financial crisis is still a fresh memory, and the global economic recovery appears to be losing steam. Meanwhile, politicians in both Europe and the US cannot decide how to address their pressing problems. Every bad piece of news seems to push investors further toward supposedly safe assets.

But what investments are really safe?

  • US Treasury bonds? Standard & Poor’s has downgraded Treasury bonds, and the yield on 10-year Treasuries has been yielding around 2%, its lowest level in 70 years. With such a low yield, Treasuries now offer little upside potential—but plenty of downside risk if inflation rises.
  • Gold? Investors seeking safety pushed its price per ounce close to $2,000, triple its level five years ago. Yet gold is a volatile asset with poor long-term returns. (In fact, it has slid precipitously in recent weeks.) Is it really safe to buy gold when it’s near an all-time high and possibly on the way down?

Looking at the longer-term safety track record of various asset classes reveals some big surprises (Display).

Gold Has Disappointed Far More Often than EquitiesAfter adjusting for inflation, gold has delivered negative real returns in 58% of all rolling 10-year periods since 1971, faring far worse than stocks or bonds. Even more astonishing, gold’s purchasing power declined 20% or more in 47% (nearly half!) of all rolling 10-year periods.

Why? The demand for gold can be influenced by speculators. When speculators flock to gold as a disaster hedge, demand outstrips supply and the price soars. When fears abate, demand drops, and gold prices fall.

It may be more surprising that 10-year Treasuries have lost purchasing power in 12% of the 10-year periods since 1971, and in half of those cases, the loss in purchasing power was 20% or more.

Why? Because Treasuries pay a fixed interest rate in nominal dollars, they lose purchasing power when inflation rises more than investors expect. Most of the 10-year rolling periods with steep losses for Treasuries ended in 1981, just after the sustained high inflation of the 1970s.

The current mania for gold and Treasuries, like other “crowded trades” (trades in which most investors are on the same side), is a self-fulfilling prophecy in the short run. But ultimately, crowded trades always reverse. Investors who rush in also stampede out, and many get crushed.

We think a better strategy for surviving financially in perilous times is to maintain a diversified strategic asset mix, while also dynamically managing risk in the short term.

Depending on their objectives and risk tolerance, most of our clients generally target between 40% and 70% in bonds, and the remainder in riskier, higher-growth assets, such as stocks.

As shown in the Display below, a balanced mix of stocks and bonds provided good protection against drops in purchasing power, declining in just 10% or 11% of the rolling 10-year periods. That was far less often than gold and even less often than Treasuries. Adding additional asset classes can provide further diversification and mitigate risk even more.

 A Diversified Portfolio Provides Better Protection

Of course, the strategic mix won’t protect investors from rocky results in the short term. That’s where dynamically adjusting the asset mix comes in. Sifting the market mix in reaction to changing market risk and return potential can significantly moderate risk for investors, without reducing long-term returns (as described in detail in our research paper Balancing Risk and Return Using Dynamic Asset Allocation. However, it’s not something most investors can do on their own.

In sum, to mitigate risk, investors should stick to a well-designed long-term plan and employ a skillful investment manager to navigate the path through short-term shocks. They should not make panic-driven changes in portfolio strategy.

The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Seth J. Masters is Chief Investment Officer—Asset Allocation at AllianceBernstein.

Seth J. Masters

Seth Masters is Chief Investment Officer of Asset Allocation, Defined Contribution Investments and Bernstein Global Wealth Management and a Partner at AB. He oversees the firm’s asset-allocation portfolios, including Private Client, Target Date, Target Risk, Dynamic Asset Allocation, Inflation Protection and Risk-Management Strategies. In June 2008, Masters was appointed to head AB’s newly formed Defined Contribution business unit. He became CIO of Blend Strategies in 2002 and launched a range of style-blended and asset-allocation services that have since become a significant portion of the firm’s assets. From 1994 to 2002, Masters was CIO of Emerging Markets Value Equities. He joined Bernstein in 1991 as a research analyst covering global financial firms. Over the years, Masters has published numerous articles. Prior to joining Bernstein, he was a senior associate at Booz, Allen & Hamilton from 1986 to 1990 and taught economics in China from 1983 to 1985. He earned a BA from Princeton University and an MPhil in economics from Oxford University. Location: New York

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2 thoughts on “Are Bonds Really Less Risky than Equities?

  1. Hi Patrick,

    Fascinating study. Thank you for sharing it. I was wondering, when you show real returns of stocks broken down by capital gain and dividend yield, are you subtracting the rate of inflation from the capital gain or from the dividend yield or both? In other words, are you showing nominal yield and real capital gain? Or real yield and nominal capital gain? Or some type of adjustment in between. Thanks again for sharing.

    • The methodology applied by the authors of Triumph of the Optimists: 101 Years of Global Investment Returns is to measure real equity total returns and real equity capital gains. I show the dividend yield as the difference between the two. For example, the real equity total return from 1900 to 1910 was 6.8% annualised; the real equity capital gain was 2.0% and we show the difference between the two of 4.8% as the real yield. Incidentally, the returns to the world equity series comprises a seventeen-country, common-currency (US dollar) index and hence real returns are after US inflation.

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