Fixed interest is generally included in an investment portfolio as a defensive asset to reduce volatile returns, while equities are included in a portfolio as a growth asset, with the aim of producing higher returns.
Equities versus Fixed Interest: Rolling Annual Returns
Source: Bloomberg as at 31 October 2010
Australian Fixed Interest is represented by the UBS Composite Bond Index
Source: Bloomberg as at 31 October 2010
Australian Equities is represented by the S&P/ASX 200 Index
The charts reveal two main points:
- Fixed-interest returns have peaked at around 20 per cent while equities have reached as high as 40 per cent.
- Equities have delivered more periods of negative returns than fixed interest. There are only four periods of negative returns produced by an investment in fixed interest compared to 43 periods of negative returns from equities in the same time frame. Those negative equity returns were as high as 42 per cent whereas the negative fixed-interest returns were less than 7 per cent.
We can also look at global asset returns to understand how an allocation to both fixed interest and equities can help to smooth portfolio returns.
Over the past 20 years, global equities have returned 5.87 per cent a year while global bonds have returned 9.17 per cent a year. If you invested in global equities, the risk exposure, measured by standard deviation of returns, is 14.49 per cent over the last 20 years. However, if you invested in global fixed interest the risk you would incur over the same time is 3.07 per cent. So, equity returns can swing from positive one year to negative the next with much greater frequency than returns generated by fixed interest investment.
The chart below shows the returns for global equities and global fixed interest over a number of different periods.
If we use the returns over a three-year period as an example, we can see that global equities produced an annualised negative return of –11.63 per cent. Therefore, if an investor had invested $100 in global equities on 30 October 2007, they would have had just $69 three years later. If, however, they had invested one-third of their capital in global fixed interest they would have partially offset this loss, finishing the three-year period with $87. As a result, they would have been much better positioned to capitalise on any sustained recovery in global share prices.
More Predictable Returns Around the World: Global Fixed Interest versus Global EquitiesSource: Bloomberg as at 31 October 2010
Global Equity is represented by the MSCI World Index hedged into AUD. Global Fixed Interest is represented by the Barclays Capital Global Aggregate (AUD Hedged) Index
More Predictable Returns at Home: Australian Fixed Interest versus Australian EquitiesSource: Bloomberg as at 31 October 2010
Australian Equity is represented by the S&P/ASX 300 Index. Australian Fixed Interest is represented by the UBS Composite Bond Index
The other potential return paid to investors from owning shares and bonds is income. Traditionally, investors hold bonds for income. A bond is a loan; and a bond investor can expect to receive a steady stream of interest payments for the life of the loan.For investors seeking regular income and certainty of return from their capital, fixed income provides a superior alternative to equities, which tend to provide a higher return over the longer term, but without the certainty of regular income.
Past performance is no guarantee of future results. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. This material contains the opinion of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. The content of this material remains the property of PIMCO. No part of this publication may be reproduced in any form, or referred to in any other publication, or conveyed to a third party without express written permission. Copyright 2011, PIMCO.