INVESTMENT FOCUS-Persistent lure of 'safety' over returns
By Mike Dolan LONDON, Feb 22 (Reuters) - As effervescent new year markets turn flat in February, doubts have resurfaced about whether the mass exit this year from hyper-expensive government bonds feared by some will occur. Few strategists doubt investors with long horizons who are willing or able to tolerate the more volatile world equities will eventually be rewarded if they emerge blinking from likely loss-making "havens" of U.S., German or UK government bonds. But if, as many insist, safe-haven bond demand is structural, increasing and relatively insensitive to returns then, rather ominously for savers and underfunded pension plans, ultra-low benchmark bond yields may be more accurate and durable and suggest low long-term returns everywhere else too. In several deep-dive studies into decades of investment returns, few doubt the relative return picture. Over 5, 10 or even 30 years, the chance of losing money by remaining in Treasuries, bunds or gilts - which have historically low yields even as central banks policies press furiously for reflation - is higher than moving to equity. As part of its 58th annual "Equity Gilt Study" released this week, Barclays reckoned over the next five years, low returns everywhere would remain the norm. But inflation-adjusted annual losses of 1.5-2.0 percent for cash and "safe" government bonds would be outstripped by gains of 3-4 percent in equity. A 10-year view from Standard Life Investments last month concluded best-case real total returns on U.S., UK or European government bonds would be little over 1 percent per annum but annual losses could be up to 4 percent in Treasuries and gilts. Credit Suisse/London Business School's Global Investment Returns Yearbook looked out 20 years and said an historically pale 3-3.5 percent annual equity return forecast would still exceed the zero yields on 20-year inflation-linked U.S. Treasuries or negative yields on 20-year index-linked UK gilts. WHY NOT ROTATE? So, should the herd scatter then in this year's much-vaunted "Great Rotation" and will bonds quickly unwind their 20-year bull run with a sharp spike in yields on the horizon? For a start, households and pension funds will at least be hesitant exiting the bunkers after the credit crisis air-raids of the past five years. This week's wobbly global business surveys for February and political stand-offs across Europe and in Washington are all reminders that economic recoveries never happen in straight lines or are guaranteed. And even if the U.S. Federal Reserve is thinking aloud about how and when it might wind down its bond-buying, or quantitative easing policy, few see it doing so this year. The Bank of Japan is ramping up its QE programme in the meantime and even the Bank of England governor is still in favour of another UK round. But the biggest barrier to a mass withdrawal from return-free bonds is the still-growing demand for "safety" from players relatively insensitive to prices and returns. Barclays economist Marcus Gapen focusses on three big buyers of U.S. Treasuries on "safety" grounds - reserve managers at foreign central banks intolerant of risk, commercial banks under regulatory pressure to build "safer" liquid assets and bolster capital ratios, and aging households unwilling to risk retirement savings in more volatile equity. Gapen calculates that the pace of reserve accumulation by China and others - and hence their demand for government debt to bank that hard cash - may have peaked as they liberalise and rebalance their economies. However, the other two sets of buyers would more than offset set any drop-off in bond demand. BANKS, BOOMERS AND BONDS Even given last month's extension of deadlines for new Basel Committee bank rules, Gapen estimates domestic and international regulatory pressures could see U.S. banks alone increasing holdings of liquid securities by $100-200 billion per annum. And as the peak retirement period for the U.S. post-war baby boom generation around 2020 approaches, these older households will be less willing to put or leave savings at risk as they prepare to draw on them for consumption within 10 years. Gapen shows that by 2010 'older' households - defined as those headed by someone aged 55 or over - already made up almost two thirds of total household net worth in the United States and almost two thirds of total financial assets. And this grouping - projected to be nearly half of all U.S. households by the end of the decade - will shorten its investment horizon and most likely step up bond buying in the coming years. "Demand for safe havens will remain robust, even in an environment of low to negative inflation-adjusted returns," Gapen concluded, adding this added market support to structural drop in the supply of top-rated "safe" assets. Along with central banks' QE, this goes some way to explaining what appears in historical perspective to be bubble-like pricing in bonds, the Credit Suisse/LBS report said. "Many alleged distortions are likely to be permanent," wrote authors Elroy Dimson, Paul Marsh and Mike Staunton. This "safe-haven demand for bonds could even increase."
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