By Edoardo Cilla, investment strategist, Investment Strategy Group, Vanguard Europe

In a low-return environment, investors may question the role of high-quality bonds in their portfolios, but our latest research suggests the diversification benefits of fixed income should remain intact over the next ten years.

Vanguard’s economic and market outlook for 2022 predicts that projected returns for bond investors, while up since last year, will remain low by historical standards.

Our latest 10-year forecasts suggest euro area-based investors can expect between -0.5% and 0.5% annually from domestic and non-euro area government bonds1.

With expected returns still at historic lows, can investors continue to count on the diversification benefits of bonds?

A buffer to equity market shocks

Since the early 2000s, bond prices have tended to move in the opposite direction to share prices, providing a buffer when equity markets fall. And while they may occasionally move in the same direction, given enough time their usual inverse relationship tends to be re-established2.

When looking back at the drivers behind equity/bond return correlations since the 1950s, we identified long-term inflation trends as the most important influence on the relationship between the two asset classes3. Specifically, high inflation sustained over a long period of time can push the return correlations positive.

Looking ahead, our analysis suggests it would require an average 10-year rolling inflation figure of at least 3% to see the equity/bond correlation turn positive by 20254. To realise that scenario, annual core inflation would need to average a minimum of 5.7% annually over the same period.

So, given our expectation for core inflation to cool in 2022, our long-term forecasts suggest the negative correlation between bonds and equities observed since the early 2000s is likely to persist, on average, over the next 10 years, as shown in the chart below based on the latest numbers from the Vanguard Capital Markets Model (VCMM), our proprietary forecasting framework.

Bonds and equities to maintain a negative relationship

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

Notes: Forecast corresponds to median estimate out of 10,000 VCMM simulations of 10-year nominal total returns in EUR for the asset classes highlighted here. See Vanguard economic and market outlook 2021 for further details on asset classes.

Source: Vanguard calculations, as at 30 September 2021.

IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results.

In particular, euro-area bonds, global ex-euro area bonds and German government bonds are expected to maintain a negative correlation with euro-area equity, global ex-euro area equity and emerging market equity. Euro area, global and emerging market credit, on the other hand, are expected to be positively correlated with equity markets.

High quality bonds: there when you need them most?

Average correlation isn’t everything, however, and multi-asset investors will be concerned primarily with how their bond holdings behave in the periods when equities perform worst.

An example of this was the Covid-19 sell-off in March 2020, when global equities fell 24% from their starting value between 21 February to 20 March, not recovering their losses until July 2021. Meanwhile, global bonds fell only 2.7% and recovered all losses by the beginning of April 20205.

Looking ahead, when we isolated the VCMM scenarios projected to have the most negative equity returns (the worst quartile of global equity returns), we found that high-quality bonds would have the highest median returns and the lowest dispersion of returns, as illustrated in the chart below.

High quality bonds are expected to diversify equity risk in the most volatile scenarios

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

Notes: Each box-whisker is the distribution of median nominal returns of various asset classes in the worst decile of global equity returns. VCMM forecasts as at 30 September 2021 in EUR for the asset classes highlighted here.

Source: Vanguard calculations, as at 30 September 2021.

IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results.

On average, euro-area government and global high-quality bonds (including investment grade credit) would be expected to deliver positive median returns in periods with the worst decile of global equity returns (when median returns are -23%).

Our analysis confirms the rationale for investing in high-quality bonds for their diversification benefits. Ultimately, we recommend investors maintain a globally diversified exposure to high-quality bonds that is appropriate according to their investment horizon and their tolerance for risk.


1 Source: Vanguard calculations, as at 30 September 2021.The forecast corresponds to the distribution of 10,000 Vanguard Capital Markets Model (VCMM) simulations for 10-year annualised nominal returns in EUR for euro area bonds and global ex-euro area bonds (hedged). Asset-class returns do not take into account management fees and expenses, nor do they reflect the effect of taxes. Returns do reflect the reinvestment of dividends and capital gains. Indices are unmanaged; therefore, direct investment is not possible.

2 Source: Vanguard calculations based on data from Bloomberg. Data between January 1988 to November 2020. Notes: Analysis found that bonds and shares were positively correlated roughly 29% of the time, but once markets are given enough time to factor in the monetary policy responses, the usual inverse relationship between bonds and shares is re-established. See ‘Hedging equity downside risk with bonds in the low yield environment ’, Renzi-Ricci, Baynes, January 2021. Equity returns are defined from the MSCI AC World Total Return Index and bond returns defined from the Bloomberg Global Aggregate Total Return Index, hedged to EUR.

3 Sources: Vanguard, using data from Refinitiv and Global Financial Data. Data between January 1950 and April 2021. Note: We used a random forest machine learning algorithm to identify the most important features that have determined stock/bond correlation regimes historically.

4 Source: Vanguard. Note: Analysis of simulated 24-month rolling equity/bond correlations under different long-term inflation trends using forecasts by the Vanguard Capital Markets Model. The 10-year trailing inflation trends simulated include our baseline forecast of 2% (-0.27 correlation), 2.5% (-0.14), 3% (0.25%) and 3.5% (0.36).

5 Sources: Vanguard calculations, based on data from FactSet. Data between 21 February 2020 and 30 September 2021. Global equities represented by the MSCI ACWI Index, global bonds represented by Bloomberg Global Aggregate hedged. All returns in EUR.


The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.

The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include US and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, US money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.


Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Simulated past performance is not a reliable indicator of future results.

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results

Important information

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