The trend

  By Guest Blogger Doug Rowat

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During the bull-market years of the 2000s, Bay Street investment firms were freely throwing money around to win business. Sometimes literally.

I remember visiting the Sprott Asset Management office near King and Bay during the mid-2000s commodity boom. Priceless artwork lined the walls (like, Van Gogh priceless) and a massive pure-gold coin sat perched in the lobby. Incredibly, it weighed 100 kg and had a face value of $1 million, but even more spectacularly, it had a bullion value of probably closer to $4 million.

Such were the Bay Street extravagances in those days.

And about the money being thrown at me? When I arrived at their office, they handed me a 1-ounce silver coin. Just for visiting. My colleague, who was a Bay Street veteran, said that he already had five of them. I still have mine:

Around this time, there was also a rumour that Eric Sprott had hosted a Bay Street event wearing a T-Shirt emblazed with Bonds Are For Losers. I don’t know if this was actually true, but it certainly fit with the bullish excesses of Bay Street at the time.

Though the T-shirt’s sentiment was infinitely less accurate once the financial crisis hit less than a year later, there was definitely—and still is—a kernel of truth to it.

Make no mistake, your portfolio needs bonds. They offer stability and guard against the unexpected (Covid—to highlight a perfect and very recent example). And if we were all dispassionate investors we could do without bonds, but we bring—especially new investors—our irrational fears and biases to every investment decision that we make. Though the returns for bonds over the long term are inferior to equities, the ability of bonds to control volatility (and therefore our emotions) is invaluable. It does no good to hold only equities if you sell them at every hint of trouble.

So are bonds for losers? Definitely not. However, they certainly aren’t for winners either. Take it from one of the biggest financial-market winners of all time, Warren Buffett. He had this to say in his latest Berkshire Hathaway shareholder newsletter:

Bonds are not the place to be these days… In certain large and important countries, such as Germany and Japan, investors earn a negative return on trillions of dollars of sovereign debt. Fixed income investors worldwide—whether pension funds, insurance companies or retirees—face a bleak future.

In terms of having negative (or at least near-zero) bond yields, Japan and Germany aren’t alone. They’re joined by France, the Netherlands, Switzerland, Sweden, Spain and Portugal, which all have, for example, flat-to-negative yields on their 10-year benchmarks.

While the recent rise in US bond yields gives some hope to yield investors, over the long term, it’s a losing battle. The chart below indicates the steadily diminishing returns for US bonds over the decades. Buffett also highlighted in his newsletter that the yield on the US 10-year Treasury was actually 15.8% in 1981! Those days are ancient history. Bond yields have plummeted more than 90% since.

The steadily diminishing return of US bonds

Source: Bloomberg; Turner Investments

And while there are a multitude of reasons for the long-term decline in bond yields, perhaps the biggest factor is simply an ageing population. Older investors, understandably, gravitate towards safer investments and the below chart shows the inexorable trend that bond investors are presently up against. This trend isn’t changing.

The lesson of these charts is simple: investors (of any age) need equity exposure in addition to fixed income. Your long-term results will almost certainly disappoint otherwise.

Long term US government bond yields (red line, RHS) vs US population age 55 and older (blue line LHS)

Source: Federal Reserve Economic Data

Naturally, as we struggle through a global recession, investment firms no longer throw money at me just for walking through the door. Those days are over.

But realizing meaningful returns from bond-only portfolios? Those days are over too.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.