Although a company’s shares could well make more money than its debt over a prolonged period of time, with that chance of higher returns comes the significant risk of losing a great deal of money over certain periods.
This is very clear when looking at the performance of the FTSE All Share versus the IMA Gilt sector over the last 25 years. Yes, UK equities have returned more, but there are undoubtedly many cases when investors bought at the top of the market and had to wait a long time to make their money back.
Performance of sector vs index since 1990
Source: FE Analytics
This conception has stood the test of time and the security of a fixed level of income from corporate and government bonds has made fixed interest the most popular asset class over recent decades.
This notion, however, appears to be coming to an end. Given that finding an attractive level of income – after inflation – from the bond market is becoming an increasingly difficult task, the nature of risk itself seems to have shifted.
Regina Borromeo, manager of the Legg Mason Income Optimiser fund, says that investors need to reconsider how risky their portfolio is, given the uncertain outlook for the fixed income market. Past performance should not be used as a guide to future performance, but she says that more than ever before, the historical behaviour of the asset class is irrelevant to what can be expected in the future.
"Investors really need to re-evaluate what risk is," said Borromeo.
"When you look at 10-year gilt yields, the price volatility is not what you would expect from a safe-haven asset. Our view is that there is still a lot of price-risk in bonds – compared with their long-term history, they are producing abnormally low yields."
"The normalisation of those yields will be a difficult time, but investors need to realise that risk is now different. I feel bad for anyone nearing retirement age who is depending on fixed income cash-flow, as it is really eating into their returns."
Investors will be all too aware about fears over a bubble in bonds. The concerns stem from worries that when interest rates do eventually rise, bond prices are likely to come under significant pressure.
However, given the income that investors get from a bond is fixed and guaranteed – unless the company or government actually defaults – Borromeo thinks many investors will still be attracted to the asset class, even though their capital is at risk.
Such an argument, she says, plays into the hands of apparently riskier dividend-paying equities. While their yields are not guaranteed, she points out investors can often get a growing yield when investing in them, as well as the potential for capital growth.
Neil Shillito, director at SG Wealth Management, agrees that the whole concept of risk has all changed.
"I’ve actually changed my mind dramatically on risk in markets over recent times," he said.
"I’ve been doing this for a long time and I am now getting a few grey hairs. Basically, we have all been schooled in the same way, that bonds are safe and equities are risky. It’s all nonsense to be honest with you."
Shillito says that investors who think they are safe in fixed income securities have to change their mentality.
"Firstly, I don’t believe that being overweight bonds will do an investor any favours, especially as the level of yield is below the amount you can get from equities," he said. "Ok, equity funds may be more volatile, but with that there is much greater upside and a much stronger case for capital growth and dividend income."
"Secondly, on the subject of risk, all of us think and have been educated to think that volatility equals risk – it is complete and utter nonsense."
"I would quote Neil Veitch at SVM who says that risk is not volatility, risk is all in the price. The risk is that you buy an asset at too high a price."
"However, if you buy a stock at the right price using due diligence and getting the fundamentals right, given enough time – and I am not talking decades here, just a few years – it will make you money."
"To put it into context, if you were to buy a Jaguar for £5,000, you know that is mispriced and you should be able to sell it for £50,000 at a later point in time," he added.
Although past performance is no guide to the future, FE Trustnet recently showed that higher-risk portfolios such as Fidelity UK Smaller Companies, Standard Life UK Equity Unconstrained and Cazenove UK Smaller Companies have all dominated the IMA tables over the last five years.
Shillito (pictured) admits that equities are by no-means a safe-haven. However, he says that the experiences of the last five years show that they can deliver in the worst of market conditions.
"There are obviously geo-political risks out there with equity investments," he said. "But taking that aside and in the belief that there isn’t another 2008 around the corner, and please God let’s hope there isn’t another one, then equities are a better long-term choice. We need to address these issues."
"In 2008, things were horrendous. Portfolios were down 35 to 40 per cent. Basically everything fell out of bed. At that time, it was incredibly difficult to be sanguine about things. However, five years down the line, investment returns have been OK."
"My clients, who all have different goals and portfolios, have had compounded equity returns of 7 per cent net of all fees and charges over the last five years. That isn’t bad at all."
"Basically, if you haven’t made any money over that time, you have been with the wrong adviser, quite frankly," he added.
What both Shillito and Borromeo both agree on, however, is that neither equities nor bonds can be called upon as safe havens in the short-term. As referred to by Borromeo, this is causing grave problems for anyone approaching retirement.
The depressing truth is that cash remains the only asset class that guarantees capital preservation, even though holding it will erode the value of your money in real terms.
In an article later this month, FE Trustnet will offer an insight into some potential alternatives to cash to help investors preserve their real spending power in the short-term.
