Lance and Purves: Don't just assume bonds are less risky than equities

RWC Partners’ Ian Lance and Nick Purves are urging wealth managers to consider three questions before following the consensus view that bonds are less risky than equities.

The managers of the RWC Income Opportunities and RWC Enhanced Income funds warn of the dangers of following the consensus view, with the FSA allegedly telling some wealth managers that client portfolios are excessively risky and are holding too much in equities.

Lance (pictured) and Purves said investors need to ask whether bonds are less risky or actually just less volatile than equities. According to a study, a buyer of UK government bonds in October 1946 had lost 73% of their real value by December 1974 and was underwater in real terms for 47 years until December 1993.

The managers said: ‘The results here should be quite eye-opening for those who have recently purchased government bonds in the belief they have de-risked their portfolio.’

The second question investors should ask is whether they are guaranteed capital back in the bond market and therefore is it worth accepting lower returns.

Lance and Purves said: ‘We caution against simply extrapolating the recent benign experience in to the future when considering the riskiness of bonds, in particular given the current highly indebted state of many developed market governments.’

The third question for investors is whether they can improve upon the average return of the equity market.

The managers said: ‘We estimate that both equities and bonds are priced for 3-4% nominal returns for the next 10 years. With UK RPI currently above 5% this represents a negative real return but as equities are more volatile, one can see how investors might currently have a preference for bonds.

‘This ignores the point that individual equities may have very different risk return profiles from the index average. Even at the March 2000 equity market peak, some stocks were priced for attractive future returns which they have subsequently delivered. We believe this is also true today, where overlooked large cap quality is priced to deliver returns significantly in excess of the market.’