Expected Returns In A Zero Interest Rate Policy (ZIRP) Environment – Which Asset Class Is Best

Last Updated on January 5, 2021 by Oddmund Groette

The last decade has produced fantastic returns in most global asset classes (commodities excluded), helped by enormous interventions by central banks. Can we expect similar high returns in the coming decade? More importantly, what is the best asset class when the interest rates are close to zero?

ZIRP – what is it?

ZIRP is the abbreviation for zero interest rate policy. ZIRP doesn’t mean zero rates literally, but rates that are close to zero. Japan has been in a ZIRP environment for twenty years, and we can argue most of the Western world as well after the GFC in 2008/09, although the rates have been higher than in Japan.

When the Covid-19 struck in March 2020, the US FED lowered the FED funds rate to near zero. This is an unconventional monetary policy.

The low rates have resulted in negative yields in certain bonds, like for example some bonds issued by Nestle. Moreover, some bank deposits in certain countries yielded negative rates, meaning you have to pay the bank for the “privilege” of keeping your capital. It’s a pretty bizarre situation.

NIRP – what is it?

As you might have expected, NIRP is an abbreviation for negative interest rate policy. This has been practiced by both the Bank of Japan, the European Central Bank, and some others. However, this abbreviation is not widely used.

Which asset class is best in ZIRP?

A relevant question to ask might be this: How do you invest when interest rates are zero? Are there any asset classes that are better than others? What most investors like to know is of course what asset class performs the best when the rates are low or even negative.

Currently, the long-term Treasuries in the US yields about 0.75%. What does this mean? It means you get a coupon of 0.75% per year for the next 30 years. Your money is of course “safe”, but you are guaranteed to lose purchasing power. Furthermore, you are not able to reinvest those coupons at any meaningful rate of return.

Many argue stocks are expensive today, but expensive relative to what? Most of the gains in the stock market in 2019 and 2020 are due to multiple expansion – not earnings growth. In other words, the stock market is already discounting ZIRP for the foreseeable future.

But is the stock market expensive? This is what Warren Buffet said in an interview in 2017:

Buffett: Well… I’ve been talking this way for quite a while, ever since the fall of 2008. I was a little early on that actually. But I don’t think you could time it. And we are not in a bubble territory or anything of the sort. Now, if interest rates were 7 or 8 percent, then these prices would look exceptionally high. But you have to measure, you know, you measure everything against – interest rates, basically, and interest rates act like gravity on valuation. So when interest rates were 15 percent in 1982 they’d pull down the value of any asset. So, what’s the sense of buying a farm on a 4 percent yield basis if you can get 15 percent in governments? But measured against interest rates, stocks actually are on the cheap side compared to historic valuations. But the risk always is, is that – that interest rates go up a lot, and that brings stocks down. But I would say this, if the ten-year stays at 230, and they would stay there for ten years, you would regret very much not having bought stocks now.

The earnings yield in the S&P 500 is 3.2% as of writing. Is this expensive compared to a 0.75% “safe” yield in Treasuries? In my opinion, no. However, if the rates rise then of course it’s expensive.

Japanese performance during ZIRP:

Japanese investors have battled with Zero Interest Rate Policy (ZIRP) for two decades and Japan might offer some clues as to what to expect. Since 1999 Japanese government bonds have been around 1% and thus made low rates pretty “normal”. Thus, Japan could be an interesting case study. Is there anything we could learn from Japan by studying the last two decades?

Verdad, a global asset management firm, recently sent out an interesting research report via e-mail showing the annual performance of different asset classes in Japan during ZIRP (I recommend signing up for Verdad’s weekly e-mail service):


The performance of different asset classes in Japan during ZIRP. Source: Verdad.

The table shows small value stocks and real estate were the best performing asset classes. According to Verdad, the outperformance of small value was a reversal of the trend prior to ZIRP were large stocks led the way into the dot-com bubble, and real estate was beaten down in 1999 after the collapse of the real estate bubble in the early 1990s.

So, in short, small-cap and real estate were the best asset classes over the last two decades in Japan.

What about correlations during ZIRP?

Correlations during ZIRP in Japan. Source: Verdad.

Even though government bonds yield a measly 1%, it hasn’t lost its value as a tool for diversification. The correlation matrix shows that bonds produce a negative correlation, thus providing significantly less drawdown in a portfolio.

How did the Japanese banks perform during ZIRP?

In ZIRP we can expect banks to perform worse than if the rates were higher. This was certainly the case in Japan as banks underperformed dramatically, according to Verdad. The bank struggled with bad loans from the 90s and this, coupled with a low-interest margin, made most banks returning negative returns over the last two decades. Is this likely to happen in other parts of the world? That’s hard to say. The banks are in much better shape today than during the GFC in 2008/09. We can even argue that banks are more like regulated utilities.


Interest rates can of course go even lower into negative territory, as is the case in some countries. However, the performance of the last decade is unlikely to be repeated if Japan is any judge of what to expect.


Disclosure: I am not a financial advisor. Please do your own due diligence and investment research or consult a financial professional. All articles are my opinion – they are not suggestions to buy or sell any securities.