A return to sound money
Today, thanks to the significant increases in rates, the income portion of bond returns has grown markedly – which we expect will not only boost total long-term bond returns but also marks a shift in the contribution of bond income to total portfolio returns.
According to our latest forecasts, we now expect UK and global ex-UK (GBP hedged) bonds to return around 4.9% and 5.0%, respectively, on an annualised basis over the next decade, compared with our previous 10-year annualised forecasts of 1.3% and 1.3%, respectively, before the rate-hiking cycle began. Importantly, we expect global bond returns to rival those of global equities, which we believe will deliver a median annualised total return of around 6.1% over the same time period, but with a higher level of volatility than global bonds3.
Expected 10-year annualised asset class returns for UK investors
Notes: The forecast corresponds to the distribution of 10,000 VCMM simulations for 10-year annualised nominal returns in British pounds for the asset classes highlighted here. The median 10-year annualised nominal return forecasts as at the end of September 2023 are shown by the white lines and as at the end of December 2021 are shown by the gold lines. Median volatility is the 50th percentile of an asset class's distribution of annualised standard deviation of returns. Asset-class returns do not take into account management fees and expenses, nor do they reflect the effect of taxes. Returns do reflect the reinvestment of income and capital gains. Indices are unmanaged; therefore, direct investment is not possible. Benchmarks used for asset classes: UK bonds: Bloomberg Sterling Aggregate Bond Index; Global ex-UK bonds (GBP hedged): Bloomberg Global Aggregate ex-Sterling Bond Index (GBP hedged); UK government bonds: Bloomberg Sterling Gilts Total Return Index; UK credit: Bloomberg Sterling Aggregate Credit Bond Index; UK cash: Bloomberg Sterling 3-Month Gilt Index; Global credit (hedged): Bloomberg Global Aggregate Corporate Bond Index (GBP hedged); Emerging market sovereign debt (hedged): Bloomberg Emerging Markets USD Sovereign Bond Index 10% Country Capped (GBP hedged); UK inflation: Consumer Price Index.
Source: Vanguard calculations in British pounds, as at 30 September 2023.
IMPORTANT: The projections and other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Results from the model may vary with each use and over time.
Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
A bumpy transition
This doesn’t mean volatility is behind us. Markets are eagerly anticipating rate cuts by central banks in 2024. A fall in rates will push up the price of existing bonds, which will benefit bond investors – but it’s unlikely to be a smooth transition.
Among the risks that could rattle bond markets is the unwinding of major central banks’ bond-buying programs, which could raise volatility, particularly at the longer end of the yield curve, by reducing liquidity and increasing the term premium demanded by investors. (The term premium is the additional yield required to compensate investors for the added risk of interest rate changes over a bond’s lifetime.)
Even though we expect major central banks to start gradually cutting rates from the middle of next year, short- and long-term rates will, in our view, settle at higher levels than we’ve become accustomed to in the past decade. While this will limit the potential gains from bond price increases, we believe the persistence of higher yields – a strong predictor of long-term bond returns – will ultimately benefit disciplined investors over the long run.
The bottom line
For bond investors, timing potential shifts in bond markets with asset allocation decisions is extremely challenging. It’s far better to focus on what investors can control – such as calibrating the duration of their bond portfolios to match their time horizons, which can help optimise investment outcomes while reducing exposure to interest rate and reinvestment risk.
The transition to a higher-for-longer rate environment has not been easy over the last few years. The good news is we’re nearing the end of this structural shift; which should ultimately provide a more solid foundation for delivering long-term bond returns.
The bottom line: Rather than a bane, the rise in interest rates is the single best development for investors in 20 years.
1 Source: Vanguard calculations based on data from Refinitiv. The 10-year annualised total return of the Bloomberg Global Aggregate Bond Index (GBP hedged) from 31 December 2007 to 31 December 2017 has been 4.4%, while the yield on US 10-year government bonds at the start of that period was at 4.0%. After 2008, the yield on US 10-year government bonds remained below 4% until the start of 2022. Details of our forecasted returns can be found in .
2 Hypothetical portfolio of bonds is represented by the Bloomberg Global Aggregate Bond Index (GBP hedged).
3 Based on the VCMM 10-year annualised nominal return forecasts as at 30 September 2023 and as at 31 December 2021 for UK and global ex-UK bonds (hedged) and global equities. UK bonds are represented by the Bloomberg Sterling Aggregate Bond Index, global ex-UK bonds (hedged) are represented by the Bloomberg Global Aggregate Bond Index (GBP hedged) and global equities are represented by the MSCI AC World Total Return Index.
