Investing is a game of relative things, at least if you do it right. Whether you have a short or long horizon, somewhere the question arises as to which asset classes are actually the most attractive. And since central banks have made it a sport since 2008 to keep inflating their balance sheets, the answer to that question was rarely, if ever, cash. Until now!
I show two charts below that show the amount of ‘yield’ for the main asset classes, adjusted for duration (interest rate sensitivity) on the one hand and volatility on the other.
The first chart shows yields in early August 2020, when US 10-year yields hit their lows. As you can see from the chart, Developed Market (DM) Treasuries offered very little yield, given their duration and volatility. The same was true for Global Corporate Bonds. And even for equities (I put the duration for Developed and Emerging Market Equities, and Real estate at 20, 16, and 12 years.), initial yields were not exactly bouncing off the shelves.
How different this is today. For all asset classes, the relationship between yield, duration and volatility has become much more attractive. But for bonds this is much more the case than for equities. This chart below shows once again clearly that TINA (There Is No Alternative) left some time ago. An example. You now get roughly 5 per cent return on global corporate bonds against about 6 per cent return on equities. But that is offset by a hefty amount of extra volatility. For risk-averse investors, that 5 per cent will look a lot more attractive.
Incidentally, that doesn’t immediately make me a fan of corporate bonds. I don’t like that they price in zero(!) chance of a US recession.
Competitors on the horizon
But it could be worse. As if the competition from bonds was not enough, equities are now also threatened by money market funds. In America, these now offer about 5 per cent returns at virtually zero volatility. I would have to raise the y-axis in the charts extremely to add those money market funds. Here in Europe, interest rates on money market funds are around 2.25 per cent. Still quite attractive at a German 10-year rate of 2.50 per cent. Given the ECB’s intentions, why would you want to have extra much duration risk on board?
The same goes for equities. These can offer significantly higher returns, but mainly if you have a rosy picture of future economic growth and earnings development. If risk-free interest rates go higher, the room for setbacks becomes significantly smaller. You shouldn’t want to say it too often, but cash is pretty much king!
Jeroen Blokland is founder of True Insights, a platform that provides independent research to build diversified multi-asset portfolios. Blokland was most recently head of multi-assets at Robeco. His chart of the week appears every Monday on Investment Officer Luxembourg.