Being Realistic about Bond Returns

Abstract

Long-term expected returns for bond investments are an important component of the actuarial assumptions of pension funds around the world. Similarly, banks and investors around the world need realistic long-term return assumptions to decide on the optimal share of bonds in a multiasset portfolio. Given the current low interest rates in most developed countries, we calculate expected returns for government bonds in four regions and compare these to long-term historical returns. It seems clear that over the next decade government bond returns will be significantly lower than the historical average. In light of these results, it seems astonishing that many banks, pension funds and investors still seem to use the same long-term bond return expectations as before the current period of monetary easing. According to our calculations, this practice implicitly assumes that—at least for the U.S., the U.K. and Switzerland—long-term government bond yields are based on unrealistic scenarios.