There are risks to playing it safe.  That’s the overarching conclusion of a seven-year economic and financial market forecast from Wilmington Trust Investment Advisors, the newly named investment advisory and asset management arm of M&T Bank Corporation.

The firm gives investment-grade bonds and other financial assets often described as safe an unambiguous thumbs-down.  According to its seven-year projection, investment-grade bonds, both taxable and tax-exempt, are expected to earn annualized total returns of 2% over the 2012 – 2018 time period, “far below what investors have earned on these bonds in recent decades,” the firm says in a statement.  Moreover, with a projected annualized inflation rate of 2.3%, “investment-grade bonds are expected to lose purchasing power over the seven-year horizon,” according to the firm. 

The firm also identifies inflation-hedging assets, including inflation-linked bonds and commodity- and real estate-related securities, as relatively unattractive, with annualized returns projected in the 1% - 5% range. 

“A large number of investors may be underestimating the risks of bonds held as core positions in their portfolios.  We expect falling bond prices to offset much of the income that investment-grade bonds pay in the coming years, leading to weak total returns,” according to Rex Macey, Wilmington Trust Investment Advisors’ chief investment officer. 

It’s not all gloom and doom for all bonds, though.  Wilmington is sanguine about certain categories of bonds, such as high-yield municipals and corporates, floating-rate notes and emerging-market debt, which are forecast to deliver annualized returns in the range of 6% - 8%. These categories of bonds “can offer higher yields and less interest-rate sensitivity than investment-grade issues, though they are likely to be more sensitive to market shocks or economic downturns,” the firm says.

The firm also favors large-cap U.S. stocks, expected to earn annualized returns of about 8.5%, and developed international and emerging equity markets, which have expected returns “north of 10%,” according to Wilmington.

Despite its grim outlook for investment-grade bonds, Wilmington still “retains a place for them in its asset-allocation strategies,” it says, as “they are expected to remain far less volatile than equities.”