atans1

Will shares always outperform bonds?

In Uncategorized on 04/06/2010 at 6:17 am

As a value, contrarian or indeed any type of serious  investor or speculator, always ask questions.

One question to ask is if equities will outperform bonds?

It was once gospel that equities out-perform low-risk bonds. But if you invested in the stockmarket around 1999 the balance of your portfolio probably suggests otherwise. During the post-war era equity returns have been positive. Enough so that the equity-risk premium, the return equities generate in excess of the risk-free rate (which is normally short-term Treasuries), is often assumed to be between 5% to 8%. In my experience risk managers go silent when asked where exactly this number comes from. Usually it is based on some historical data with a dose of “sensible judgment”. Clearly, the size of the expected equity premium depends on the timeframe you use and the manager.

… If you use recent history in your estimation, you may end up with a zero or negative equity premium. No one wants to use this in their forecasts; otherwise projections look pretty dismal. If you’re selling a financial product or strategy that involves equity investment, a zero equity premium will not entice investors.

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