Norway expects 2.7% real return from global bonds

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Hallman
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Norway expects 2.7% real return from global bonds

Post by Hallman »

I don't know what to make of this. Anyone care to comment?

"Global bonds include credit bonds with a share about the same as in the GPFG"s fixed-income portfolio. Expected real return on government bonds is 2.5 per cent, while the real return on credit bonds is about 0.5 percentage points higher."

"Expected real return and volatility in the long run

Government bonds (in the form of a globally diversified government bond portfolio with a duration of around 5 years, and country weights approximately as in the GPFG"s strategic benchmark) is expected to provide an annual real return of 2.5 per cent 1 and volatility of 6 per cent, according to Table 8.1. The expected real return is higher than the historical average for the period 1900-2009, which is 1.1 per cent, according to annual data from Dimson, Marsh and Staunton (2010), see Table 8.3 which shows the historical returns and volatility. At the end of 2007, before the financial crisis had fully impacted the financial markets, the historical average real return was marginally lower (1 per cent). The low historical real return shows that government bonds were a bad investment during several periods in the last century, due to high inflation (or hyperinflation) and wars.
However, the Ministry"s estimate is considerably lower than the real return on government bonds after 1975 (after the collapse of the Bretton Woods fixed exchange rate system), which is a period that may be more relevant to compare with (5.3 per cent real return at the end of 2009, and about the same at the end of 2007). The high real return during this period reflects the battle against inflation and the decline in inflation expectations through the 1980s and 90s, which more than offset losses in the bond markets during the period of high inflation in the 1970s. Given the current situation, where central banks largely aim for low and stable inflation, a recurrence of a similar disinflationary path is not considered the most likely scenario for the coming decades.
The Ministry"s estimate of future long-term real return on government bonds (2.5 per cent) therefore seems reasonable, even after the experiences of 2008 and 2009. The estimate lies between the very low average for the period 1900-2009 and the very high average for the period 1975 to 2009. The estimate is consistent with an expected real return on short duration government bills of 1 to 2 per cent and a term premium of 0.5 to 1.5 per cent. Historically (1900-2009), this term premium has been about 1.4 per cent according to the data set from Dimson, Marsh and Staunton (for government bonds with long duration).
The expected volatility of bonds (6 per cent, see Table 8.1) is lower than the historical volatility, which has been 8.9 per cent in the period 1900 to 2009, see Table 8.3. In the period 1975-2009 volatility was about the same (8.3 per cent). However, the average duration of the GPFG"s government bond portfolio is significantly lower than the duration of the government bonds that are part of the historical return series of Dimson, Marsh and Staunton. It is therefore reasonable to assume a lower volatility for the GPFG"s bond portfolio.
The Ministry therefore keeps unchanged its estimates of the expected real return and risk on the bond portfolio.
Equities (in the form of a globally diversified equity portfolio with country weights approximately as in the GPFG"s strategic benchmark) are expected to yield an average annual real return of 5 per cent (geometric), according to Table 8.1. The historical data set of Dimson, Marsh and Staunton shows that the corresponding historical average for the period 1900-2009 is about 6.3 per cent, as shown in Table 8.3. At the end of 2007 the historical average was 6.7 per cent."

http://www.regjeringen.no/en/dep/fin/Do ... ?id=604755
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jeffyscott
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Re: Norway expects 2.7% real return from global bonds

Post by jeffyscott »

Well, they explain their thoughts pretty clearly it seem:

The expectations are intended to apply over very long investment horizons. They represent estimates for average annual real return and volatility over a period of many decades, or over a period that is long enough to encompass many economic and financial cycles. Such long-term expectations are often called unconditional, since they are little affected by time varying factors. In the medium term, for example the next 10 to 20 years...

Since the unconditional expectations are for very long time horizons, the threshold is relatively high for making major changes solely based on market developments over the past two years.

...

Market expectations for a medium investment horizon (next 10-20 years) are therefore discussed in the following.

The real return on the bond portfolio will depend on the nominal interest rate today, the future interest rate path, and inflation. Current interest rates on U.S., European and Japanese government bonds are low, which is partly due to the financial crisis. The real interest rate on a government bond portfolio with 3 to 5 years duration (as in the GPFG) is significantly lower than 2.5 per cent, which is the Ministry"s long-term projection. If one assumes that the real interest rate remains as low for the next 10 to 15 years, the expected real return on government bonds will be substantially lower in the medium term than the long-term estimate of 2.5 per cent. However, it seems more likely that the real interest rate will gradually move back to a higher level. Such a course could push up the expected real return in the medium term, since bonds can be re-invested at higher real interest rates. By how much the expected real return will increase depends on the assumptions for the interest rate path.
Topic Author
Hallman
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Re: Norway expects 2.7% real return from global bonds

Post by Hallman »

jeffyscott wrote:Well, they explain their thoughts pretty clearly it seem:

The expectations are intended to apply over very long investment horizons. They represent estimates for average annual real return and volatility over a period of many decades, or over a period that is long enough to encompass many economic and financial cycles. Such long-term expectations are often called unconditional, since they are little affected by time varying factors. In the medium term, for example the next 10 to 20 years...

Since the unconditional expectations are for very long time horizons, the threshold is relatively high for making major changes solely based on market developments over the past two years.

...

Market expectations for a medium investment horizon (next 10-20 years) are therefore discussed in the following.

The real return on the bond portfolio will depend on the nominal interest rate today, the future interest rate path, and inflation. Current interest rates on U.S., European and Japanese government bonds are low, which is partly due to the financial crisis. The real interest rate on a government bond portfolio with 3 to 5 years duration (as in the GPFG) is significantly lower than 2.5 per cent, which is the Ministry"s long-term projection. If one assumes that the real interest rate remains as low for the next 10 to 15 years, the expected real return on government bonds will be substantially lower in the medium term than the long-term estimate of 2.5 per cent. However, it seems more likely that the real interest rate will gradually move back to a higher level. Such a course could push up the expected real return in the medium term, since bonds can be re-invested at higher real interest rates. By how much the expected real return will increase depends on the assumptions for the interest rate path.
Maybe I should have made myself more clear. What I'm looking for is opinions on their reasoning. Is it logical? Should we expect higher returns than the past? What do other 'experts' think?
livesoft
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Re: Norway expects 2.7% real return from global bonds

Post by livesoft »

Other experts are expecting 1.7% return from US Bonds, see e.g.
https://personal.vanguard.com/us/insigh ... nds-032013
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grok87
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Re: Norway expects 2.7% real return from global bonds

Post by grok87 »

livesoft wrote:Other experts are expecting 1.7% return from US Bonds, see e.g.
https://personal.vanguard.com/us/insigh ... nds-032013
yep. and that's 1.7% nominal over the next 10 years. So around -0.6% real over the next 10 years.
RIP Mr. Bogle.
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jeffyscott
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Re: Norway expects 2.7% real return from global bonds

Post by jeffyscott »

For 30 year Rick has figures that are a bit lower for bonds: http://www.portfoliosolutions.com/2013marketforecast/

Not sure what is in the Norwegian portfolio, but guessing Rick would be maybe around 1% lower? This is offset by being more optimistic on stock returns, so probably would end up pretty close on the portfolio return. Not sure how he can expect 30 year TIPS to earn 1.9% real over the next 30 years, though?
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Random Musings
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Re: Norway expects 2.7% real return from global bonds

Post by Random Musings »

Cheerful folk, those at the Norwegian Ministry. Have they recently checked their LUX settings on their light boxes in the forecasting division?

RM
I figure the odds be fifty-fifty I just might have something to say. FZ
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