tors maintain their purchasing power regardless of
the rate of inflation. In addition, when compared
to nominal bonds, they give a good indication of
the market’s expectation of the average rate of
inflation over the remainder of life. n 1990, markets
were pricing in over 4% of inflation for the next 30
years; today we are pricing in less than 2%, just
below the average of the Bank of Canada’s target.
In addition, real returns were above 4% in 1990;
today short term RRBs have real yields below zero.
Real rates are being depressed by central banks,
who have kept short term rates below the rate of
inflation since the financial crisis.
This leads us to the current dilemma facing fixed
income investors. Absolute yields are very low,
with longer term yields barely above the rate of
inflation and short term yields producing negative
real rates of return. When we take into account
annual inflation on the nominal return table above,
we get the chart that follows. Real returns have
recently been dismal for T-Bill investors (2010-
2016 has so far provided T-Bill investors with a
greater loss in purchasing power than they experienced in the 1970s), and will likely remain dismal.
With real yields so low, the current environment is
a challenge for bond returns, to say the least.
THE CLASSIC 60/40 SPLIT
While we’re taking a look back a fixed income
markets, it’s also worth taking a look at the classic
60% equity – 40% fixed income asset allocation
split over time. As you can see in the chart that
follows, the 60-40 split has served investors well
– dampening downdrafts, and until recently providing all the return. However, considering current
yields as can be seen by the very recent
return, investors may need to reset their
expectations going forward as historical
returns may be hard to replicate.
Examining Fixed Income Returns
Let’s get technical and dig a little deeper and
examine fixed income returns.
Yield is a function of price, coupon rate and
term to maturity.
Term structure, also known as the yield
curve, reflects market expectations of future
interest rates plus the term premium, which