“Seldom is the case made that stocks are also a low risk asset class in a long-term perspective and that’s exactly the case I want to make for you today,” said Dowey while speaking at the Neptune Investment Management multi-asset roadshow.
The standard practice of measuring risk takes the variability of short holding period returns, using tools like standard deviation or worst outcome scenarios, “which paints stocks in a bad light”, he said.
But by extending the time horizon, the established narrative of bonds as safe haven assets and equities as inherently risky flips, according to Dowey.
Citing data from the Barclays Equity Gilt Study, he noted that UK stocks and gilts both had a standard deviation of 5.2% annualised over a shorter, 10-year period.
However, after extending the holding period to 20 years, stocks become less risky than bonds on the standard deviation measure.
This contrast is even more stark when simulating a “worst case” drawdown scenario for each asset class. The worst real total return for UK stocks on an annualised basis over 20 years is -4.28% compared with gilts at -10.58%.
And during the last 115 years, gilts have delivered a negative real return over half the time across a 10 and 20-year holding period (shown below) versus 15% and 2% of UK equities, respectively.
Dispelling myths
Dowey also dispelled the notion that retirement savers should pile bonds into their portfolios on the basis that they are strong diversifiers.
“We have seen that for sure during the past 15 years or so, but more generally, there has actually been quite a strong correlation, around 0.6%, between total returns of stocks and total returns of bonds in real terms,” he noted.
The reason for the widespread misconception about the long-term risks of stocks and gilts, Dowey thinks, is that “within living memory, you have got away with not thinking about this risk because we have been in such a strong bull market for bonds.”
“But here comes the punishment,” he added. “With yields where they are today, it will be extra difficult for bonds to deliver positive real returns. The starting yield over any 10-year period is around an 8% variation for returns historically and we’re starting from a rock bottom point, so if we get any kind of inflation at all over the next 10 to 20 years, it’s going to erode the gains from that type of strategy.”
