The Private Investor - Spring 2018

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.