Business Insights Blog

Are shares offering enough of a risk premium over bonds?

To compensate for their greater short-term volatility and risk of loss, shares should provide a return differential over a ‘risk free’ asset like government bonds over the long term. This return differential is referred to as the equity risk premium (ERP) and used to be thought of as being around 5% pa or more as this is what it had been for much of the post World War Two war period. But thanks largely to the 2007-09 global financial crisis (GFC), global shares have underperformed global bonds by around 1% pa over the last decade and Australian shares have underperformed Australian bonds by around 2.1% pa. Does this mean the equity risk premium concept is meaningless and that shares are a dud? The answer is no.

As the ERP concept relates to the very long term, the last decade or so proves nothing about its merits. Unfortunately, much confusion and disagreement surrounds the ERP. This is largely because it can refer to three different things: the historically realised return gap between equities and bonds; the gap required by investors to attract them to invest in equities; and the prospective (or likely) long-term gap based on current valuations. A key issue is not what equities have done relative to bonds in the past but what their potential is going forward. These concepts can move in opposite directions.


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*This blog is a direct excerpt from Oliver's Insights. You can view Oliver's Insights and learn about Dr Shane Oliver at the AMP website.

Oliver's Insights is a regular update from Dr Shane Oliver, Head of Investment Strategy and Chief Economist, AMP Capital. In Oliver's Insights, Dr Shane Oliver explores the latest issues regarding financial markets and the economy.

Any advice in this article is of general nature only and does not take into account the objectives, financial situation or needs of any particular person. Therefore, before making any decision, you should consider the appropriateness of the advice with regard to those matters.

Comprehensive Financial Solutions Pty Ltd ABN 42 086 989 639 as Trustee of the The Mobbs Family Trust is an Authorised Representative and Credit Representative of AMP Financial Planning Pty Limited