The Present is the Future (at least in bond land)

In our long-term assumptions, we generally assume that the total return in fixed income is pretty close to its starting yield. That’s because a bond’s total return is a function of two variables: yield and re-investment yield. As yields move up and down, bond prices move inversely, down and up, but the re-investment rate moves positively with yields. In the short-term, changes in prices have a large impact on total return, but given enough time, the re-investment yield (almost) completely offsets the price/yield function.

The table below (courtesy Morgan Stanley), shows the effect of interest rates rising from 3% to 8% at 50 basis points a year over 10 years. The total return over this decade works out mathematically to 3%, (not) coincidentally the starting yield.

There are risks to owning bonds, primarily higher inflation, and to a lesser extent default risk. But the laws of mathematics make us highly confident that the long-term nominal return for bond investors will be right around today’s yield.

• 21 Dec, 2016

  Shock, Part 4 (Divided We Are)

  We began this series with a review of the likely economic policies and their implications of the new Trump ...

• 18 Nov, 2014

  Spreads

  An interesting graphic from Ken Leech of Western Asset showing that spreads in Bondland this year are pretty much ...

• 17 Oct, 2014

  Shades of 2007?

  Nice graphic in today's FT showing the spike in vol and sell-off in risk (Greek bond yields jumped from 5.5% to 9% in ...