Research Affiliates: Death Of The Risk-Free Rate

August 08, 2016

Conclusion

The persistence of negative real interest rates across developed cash and government bond markets contradicts our conventional understanding of a risk-free rate. We must therefore abandon our assumption that a positive real risk-free rate of interest undergirds the long-term returns of our investment portfolios. Central banks have engineered these negative rates through large-scale purchases of securities from the market and the corresponding creation of bank reserves. If and when they take the next step of direct money creation, as is increasingly being discussed, long-run risk of inflation will rise. Investors should consider repositioning their portfolios now to avoid the zero to negative returns of cash and government bonds and to protect against long-term inflation. Investors should diversify away from government bonds and U.S. equities into higher-yielding inflation-sensitive asset classes such as commodities, bank loans, high-yield bonds, REITs, and emerging market equities.

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References

Brightman, Chris. 2015. "What's Up? Quantitative Easing and Inflation," Research Affiliates Fundamentals, January.

Dudley, William C. 2016. Remarks at the Federal Reserve Bank of Atlanta 2016 Financial Markets Conference, Fernandina Beach, Florida, May 1.

Flanders, Stephanie. 2016. "The Hurdles to 'Helicopter Money' Are Shrinking." The Financial Times, May 11.

Reinhart, Carmen M. and Kenneth S. Rogoff. 2009. This Time Is Different, Princeton, NJ: Princeton University Press.

Disclosures

The material contained in this document is for general information purposes only. It is not intended as an offer or a solicitation for the purchase and/or sale of any security, derivative, commodity, or financial instrument, nor is it advice or a recommendation to enter into any transaction. Research results relate only to a hypothetical model of past performance (i.e., a simulation) and not to an asset management product. No allowance has been made for trading costs or management fees, which would reduce investment performance. Actual results may differ. Index returns represent back-tested performance based on rules used in the creation of the index, are not a guarantee of future performance, and are not indicative of any specific investment. Indexes are not managed investment products and cannot be invested in directly. This material is based on information that is considered to be reliable, but Research Affiliates® and its related entities (collectively "Research Affiliates") make this information available on an "as is" basis without a duty to update, make warranties, express or implied, regarding the accuracy of the information contained herein. Research Affiliates is not responsible for any errors or omissions or for results obtained from the use of this information. Nothing contained in this material is intended to constitute legal, tax, securities, financial or investment advice, nor an opinion regarding the appropriateness of any investment. The information contained in this material should not be acted upon without obtaining advice from a licensed professional. Research Affiliates, LLC, is an investment adviser registered under the Investment Advisors Act of 1940 with the U.S. Securities and Exchange Commission (SEC). Our registration as an investment adviser does not imply a certain level of skill or training.

Investors should be aware of the risks associated with data sources and quantitative processes used in our investment management process. Errors may exist in data acquired from third party vendors, the construction of model portfolios, and in coding related to the index and portfolio construction process. While Research Affiliates takes steps to identify data and process errors so as to minimize the potential impact of such errors on index and portfolio performance, we cannot guarantee that such errors will not occur.

Research Affiliates is the owner of the trademarks, service marks, patents and copyrights related to the Fundamental Index methodology. The trade names Fundamental Index®, RAFI®, the RAFI logo, and the Research Affiliates corporate name and logo among others are the exclusive intellectual property of Research Affiliates, LLC. Any use of these trade names and logos without the prior written permission of Research Affiliates, LLC is expressly prohibited. Research Affiliates, LLC reserves the right to take any and all necessary action to preserve all of its rights, title and interest in and to these terms and logos.

Various features of the Fundamental Index® methodology, including an accounting data-based non-capitalization data processing system and method for creating and weighting an index of securities, are protected by various patents, and patent-pending intellectual property of Research Affiliates, LLC. (See all applicable US Patents, Patent Publications, and Patent Pending intellectual property located at http://www.researchaffiliates.com/Pages/legal.aspx#d, which are fully incorporated herein.)

The views and opinions expressed are those of the author and not necessarily those of Research Affiliates, LLC. The opinions are subject to change without notice.

©2016 Research Affiliates, LLC. All rights reserved.

Chris Brightman, Chief Investment Officer, Research Affiliates, LLC

 

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