Industry Updates

Lyxor Sees Poor Bond Performance, Attractive Equities in Coming Decades

Friday, January 20, 2012

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Opalesque Industry Update - For almost a quarter of a century, bond markets have rivaled with equity markets in terms of performance while offering half the volatility. Indeed, bond markets have benefited from a downtrend in long-term yields against a backdrop of disinflation and greater risk aversion. Meanwhile, equity markets have seen the Asian crisis, the Internet bubble and the sub-prime crisis.

Based on economic projections drawn up by key official organizations, as well as long-term statistical relationships, Lyxor’s research team has developed a model for forecasting long-run asset returns. The aim is to guide investors in their choice of assets for the coming decades, in particular making room for alternative investments. The relationships used are presented in Lyxor’s sixth White Paper: “Strategic Asset Allocation”. In light of the current debt crisis, Lyxor has updated its model and identified the following points:

> Poor bond performances expected. If the scenario of developed economies’ GDP growth steadily returning to its potential is confirmed, long-term yields will rise and weigh on government bond performance. In the longer term, as the influence of economic cycles fades, current forecasts for growth in the working population suggest yields will remain around 5%.

Should inflation climb to close to 10% by 2050, Lyxor’s model would see bond markets underperform inflation by around 3.5% a year. This makes the asset class even riskier for the decades ahead.

> Equities are attractive. If the scenario of developed economies’ GDP growth steadily returning towards its potential is confirmed, a gradual emergence from the crisis could make investors less risk averse and bring share prices back to valuations more in line with their historical levels. In the longer term, they should outperform bonds by around 5%, offering a risk premium similar to that seen up until a quarter of a century ago.

The results of this research should encourage investors to reconsider their strategic allocation for the coming decades. Indeed, the bond markets’ status is in doubt and should prompt fresh thinking on the role of equities and alternative asset classes, particularly hedge funds.

Reference: Eychenne K. and Roncalli T. (2011), Strategic Asset Allocation – An Update Following the Sovereign Debt Crisis, Lyxor Short Paper Series, November, www.lyxor.com.

(research flash)

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