The current environment has, understandably enough, led many investors to place a hefty premium on supposedly ‘safer’ assets but we would caution them to distinguish between safety and the perception of it. To illustrate the point, here is a chart from Bank of America Merrill Lynch, which shows 10-year US treasury yields have now reached their lowest level in their 220-year history.
US Treasury Bond Yields
Source: Bank of America Merrill Lynch Global Equity Strategy, Bloomberg, Haver, as at 4 October 2012.
This undeniably extreme situation has been driven by investors’ so-called ‘flight to safety’ after the fall-out from the tech bubble in 2000 and the credit bubble seven or so years later, which created sufficient volatility in the equity asset class to change investors’ perceptions to a meaningful degree. As we saw in Buy low, sell high, the last six years have seen them flood into bonds at the expense of equities.
And how have equities performed in the meantime? Interestingly, US stocks have outperformed US treasuries on a total return basis over the last year (returning 13% versus 4%), over the last three years (46% versus 17%) and over the last 10 years (100% versus 61%). (Data as at, 31 October 2012).
Although historic performance and investment trends are not always a guide to future results, it is a basic – if uncomfortable – truth that investor fund flows tend to follow performance very closely. People, may wish it were not the case but the correlation between flows and performance – whether one looks at asset classes, managers within asset classes, sectors, stocks or whatever – is almost perfect.
Yet, clearly, that has not been happening this time around. Again as we noted in Buy low, sell high, $731bn (£453bn) has flooded into bonds of one kind or another since 2006 while $566bn has flown out of long-only equities – a difference of $1.3 trillion.
What has happened instead is many investors have clustered in supposedly safer, and as a consequence, much more expensive assets – most obviously US treasuries and selected other government bonds but also certain equity sectors, such as beverages, food producers and other consumer staples.
Whether it is because ultimately they do not receive their money back in nominal terms, their returns are inflated away or just that other investments might perform more strongly, history would suggest that it is likely these people will, on a long-term view, be disappointed by the perceived safety of their current holdings.