An upside-down world

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An upside-down world.

The thought of buying bonds for a capital gain and shares for their yield would seem quite strange to most (the author included). But in a world of low and sometimes negative bond yields, this is exactly what has been driving investment flows of late.

Bonds have churned out another year of solid returns, outstripping share market returns in many cases. But what’s far more remarkable is that over 80% of the returns generated by US, UK and German Government bonds have come from gains in their price (i.e. capital gains). No longer are bondholders the patient income-seeking bunch they used to be.

Low bond yields are proving to be a rather persistent phenomenon. The benchmark ten-year German government bond for example has now spent the last two years offering investors less than a 1% yield. It’s this persistence that has caused many to rethink their investment strategy – looking instead to shares as a source of higher income.

The hunt for yield as many call it is a very real and powerful market dynamic that’s expected to grow stronger over time. The world’s population is ageing and as people near retirement they typically seek to replace, or at least supplement their work income with investment income.

Shares offer income through the distribution of dividends, and on the surface the income they offer does indeed look attractive. However, this is neither certain (management can stop paying dividends at any time) nor is it without risk (share prices have historically been more than twice as volatile as bond prices).

To some, the upside-down strategy where bonds and shares play quite different roles than typically expected may seem like a logical response to a changing investment environment. But this line of thinking deserves a word of caution. History suggests that when asset classes become overrun with non-traditional investors (who are typically there for a good time not a long time) volatility ensues. There is no reason to expect anything different this time.


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