Real yield refers to the return on a fixed income investment after adjusting for the effects of inflation, as distinct from nominal yield, which reflects the stated or observed return before any such adjustment. Real yield is generally calculated by subtracting the expected or realised rate of inflation from the nominal yield of a bond or other fixed income instrument, and it is widely regarded as a more accurate measure of the actual purchasing power an investor can expect to preserve or gain by holding that instrument over time.
Why real yield matters
The distinction between nominal and real yield matters because a bond’s nominal yield alone does not indicate whether an investor’s purchasing power will be preserved, eroded, or enhanced over the life of the investment. A bond offering a nominal yield that is lower than the prevailing or expected rate of inflation delivers a negative real yield, meaning that an investor holding it to maturity would experience an erosion of purchasing power, even though the nominal value of their investment has technically grown. Conversely, a bond offering a nominal yield above the rate of inflation delivers a positive real yield, allowing an investor to preserve and potentially grow their purchasing power over time.
The post-2008 period of negative real yields
For much of the period following the 2008 global financial crisis, extending through much of the subsequent decade, real yields across large parts of the developed market sovereign bond universe were negative. During this period, investors purchasing government bonds were, in effect, accepting a guaranteed erosion of purchasing power in exchange for the safety and liquidity characteristics that sovereign bonds typically offer. This condition arose from a combination of very low nominal interest rates, maintained by central banks in the aftermath of the financial crisis, and a level of inflation that, while generally low, was in many cases still sufficient to exceed the low nominal yields on offer.
The return of positive real yields
More recently, developed market sovereign bond yields have seen a return of meaningfully positive real yields across much of the universe. Toby Watson, a finance professional whose career included nearly seventeen years at Goldman Sachs across structured finance, credit markets, and global principal funding before he joined Rampart Capital as a partner in 2020, has noted that this shift restores some of the income-generating and capital preservation characteristics that made fixed income a cornerstone of institutional portfolios in previous decades. According to Watson, this change in the real yield environment changes the calculus for fixed income allocation considerably, making certain parts of the fixed income market genuinely attractive again in a way they were not during the low-rate years that preceded it.
Drivers of the shift in real yields
The return of positive real yields has been driven by a combination of factors, including the sharp pivot by central banks toward tighter monetary policy from 2022 onwards, which pushed nominal yields higher across much of the developed market sovereign bond universe, and shifts in inflation expectations following the inflationary episode that began in 2021. As central banks raised policy rates in response to rising inflation, nominal bond yields rose as well, and in many cases rose by more than the corresponding rise in inflation expectations, resulting in a meaningful improvement in real yields compared to the preceding low-rate period.
Implications for fixed income allocation
The shift from a negative to a positive real yield environment has significant implications for how fixed income is used within a portfolio. During the period of negative real yields, fixed income allocations were, in many cases, justified primarily by their diversification benefits relative to riskier assets such as equities, rather than by their standalone income-generating characteristics, since a negative real yield offered little in the way of genuine capital preservation. With the return of positive real yields, fixed income has regained some of its traditional appeal as an asset class capable of generating a real, rather than merely nominal, return for investors, alongside its historical role as a portfolio diversifier.
Toby Watson’s broader perspective on this shift is that it represents part of a wider transformation of the structural environment in which fixed income operates, alongside changes such as the end of the low-rate era and the growing influence of central bank balance sheet policy on sovereign bond pricing. He has suggested that a clear-eyed reassessment of the role fixed income is actually playing within a portfolio — rather than reliance on assumptions carried over from the previous, negative real yield environment — is a basic discipline of sound portfolio management going forward.
Relevance for long-term investors
For long-term investors, the level of real yield available on fixed income instruments is directly relevant to whether those instruments can be expected to preserve or grow purchasing power over the investment horizon in question. A sustained period of positive real yields, such as the one that has followed the post-2022 shift in monetary policy, offers different opportunities and considerations than the negative real yield environment that characterised much of the preceding decade, and reassessing fixed income allocations in light of this shift is generally regarded as an important part of adapting portfolio construction to the current structural environment.
