What to do with government bonds? The yield on government bonds is historically low, while the risk is high. In the event of rising inflation, they offer little or no buffer. Nevertheless, we shouldn’t ban them completely from multi-asset portfolios just yet.
In one of my Daily Sketches I showed that, based on the Rule of 72, it would take 147 years for an investment in 10-year US Treasury bonds to become worth twice as much. The rule of 72 is where you divide 72 by the expected annual return to get to the approximate number of years it would take for that investment to double in value.
And that’s the good news. For German Bunds, for which you have to pay for the privilege of owning them, you never end up doubling your investment. It would be more meaningful to calculate how many years it would take to lose half your money.
Interest rate risk
Things aren’t much better when it comes to risk. The persistently low interest rates have caused the duration, or interest rate sensitivity, of government bonds to rise to record levels. This means that if interest rates rise, the impact on government bond prices will be greater than in the past.
These developments all come together in the chart below from Goldman Sachs. It shows that the return on a traditional 60-40 portfolio (60% equities and 40% government bonds) was just as bad in March this year as during the global financial crisis of 2008-2009. And that wasn’t due to stocks plummeting as much as they did then – on the contrary, it was due to government bonds dampening the pain in the portfolio much less this time around.
The ultimate safe haven
Do government bonds still have a function within multi-asset portfolios, with this combination of extremely low interest rates and very high risk? The attractiveness of government bonds has certainly declined, but we should not toss them overboard en masse. US Treasuries and German Bunds are still the ultimate safe havens in times when things really go wrong.
These bonds are better suited to lower the risk of a portfolio than corporate bonds, even though they are now being bought up by central banks as well. They are also better suited than gold or illiquid investments such as private equity or real estate. The extraordinary monetary policy of central banks is causing the yields on government bonds of countries such as Italy to drop sharply as well.
In addition, we cannot rule out that yields in general, including those on US and German government bonds, could still get lower after all. The bottom has been called many, many times before.
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SOURCE: Jeroen Blokland Financial Markets Blog – Read entire story here.