Redefining Fixed Income

The golden age of fixed income is over.

The days when investors could rely on traditional bonds as safe, income-producing securities that hedge equity risk and deliver returns that keep pace with inflation are finished.

While it may not have felt like it, long-term investors had it pretty easy over the last 90-plus years. A diversified portfolio of 60% stocks and 40% high-quality bonds yielded a 9.0% annualized return between 1926 and 2019.

Even in a more granular, decade-by-decade examination, the ubiquitous 60/40 portfolio generally earned returns in the mid-single digits. In the decades when it didn’t, the 1930s and 2000s, poor stock market performance explained much of the shortfall. In the 2000s at least, that could have been addressed with broader stock market diversification — in value stocks, for example — since large-cap growth stocks endured the worst of the downturn.

Those mid-single–digit returns have largely met institutional and retail investors’ stated needs. The former often have spending policies of 4% to 5% of the portfolio’s rolling value. Add in 2% for inflation and 1% for portfolio expenses, and they require annualized returns of 7% or 8%. For individual investors, many of whom are still guided by the imperfect 4% rule, a similar 7% return is required.

In the years ahead, achieving those numbers looks much more difficult. Today’s high stock market valuations are part of the problem. Before when Shiller CAPE ratios reached these levels, returns fell far below the 10.8% long-term average. But bonds are the much bigger culprit.