Monday, January 8, 2018

World Government Bond (WGBI) index shows how difficult it will be to get return from fixed income

There is a powerful drag on fixed income performance.  Low interest rates beget low returns since bond returns consist of the current yield and the change in price. Currently, the WGBI yield to maturity is 1.26 percent and the modified duration is 7.77 years. Lower yields also mean there is less cushion for protection from a rise in rates. We know that rates can turn negative which can support better price returns, but again there will be lower or no carry from holding bonds. The inherent price risk is higher even if volatility is lower given the extension of duration at low rates. 

No carry and more duration risk means that there is a need for other safe diversifying assets. More importantly, if there is no current yield, there needs to be diversification beyond just holding asset classes. In an overvalued equity and fixed income world, the only help for investors is to diversify across factors or time varying risk premiums that can be exploited through active decision-making.

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