Welcome To The New Normal, Where 3x More Risk Gets You The Same Returns As Twenty Years Ago

As we touched upon earlier, central banks have created an unprecedented disaster for investors and savers alike.

One critical point in what has happened since central banks have intervened in the markets and distorted prices, is that savers have been destroyed and investors are now exposed to significantly more risk. For example, in order to make a 7.5% return in 1995, research from Callan Associates Inc found that an investor could own a portfolio consisting entirely of bonds with a standard deviation of about 6%. However, to make a 7.5% return in 2015, an investor would have to shrink the allocation to bonds down to just 12%, and allocate funds into other riskier assets, increasing the portfolio's standard deviation (risk) to 17.2%. In other words, we're at the point where it takes nearly 3x the risk in order to generate the same return as twenty years ago!

This presents the ultimate dilemma for large investors such as the California Public Employee's Retirement System (CalPERS), the nation's largest pension fund. In order to hit a target return of 7.5% the fund would would have to lower its allocation to bonds and take on significantly more risk - the trade off is, of course, not introducing so much risk of loss and living with lower levels of returns. CalPERS is already significantly underfunded as it is, but so far it has not been willing to expose its members to even more risk of loss so it has kept its bond allocation to 20%. The result is that the fund is down 1.3% since July 1 according to the WSJ.

Then again, there are other institutional investors such as New York Life Insurance Co. who are bound to hold a certain percentage of fixed income due to regulatory guidelines. Low rates essentially eliminate the ability for these types of investors to generate returns.

The insurer has "looked under rocks, far and wide" to find suitable fixed-income investments said Tom Girard, who leads New York Life's fixed-income team. "I can't just reach out and grab a high-quality bond that's yielding 6% or 7%. They don't exist." Girard added.

BlackRock's Larry Fink said "Not nearly enough attention has been paid to the toll these low rates and now negative rates are taking on the ability of investors to save and plan for the future." However, we would suggest that plenty of attention has been paid to the toll low rates are taking on savers and risk averse investors, and the reality is that central banks don't care about that. All central planners do care about is pushing rates to artificially record low levels, keeping markets and asset prices record high, and hoping that one day they'll be proven right - everyone else, most certainly savers, be damned.