Even as equities-dominated portfolios have failed to bring home impressive returns for at least a decade, a structural change in the supply of low-risk assets -- such as U.S. Treasury bonds -- has eroded income potential from risk-free investments as well, according to the annual Barclays Equity Gilt Study.

Barclays -- the bank behind the iPath family of ETNs and former owner of the world's-biggest ETF company, iShares, before BlackRock bought it  -- pointed out in its 57 ^th annual Gilt Study that investors' aversion to risk has fueled unusually high demand for low-risk investments, causing supplies to tighten and yields to plummet .

The scarcity of the so-called safe haven assets has caused these assets to become "intensely" negatively correlated with risky assets, making them even more valuable as risk mitigators, Barclays said in the report. And that scarcity is likely to remain in place for years to come even if investor jitters abate sooner than that.

"The extremely high price of 'safe' assets undoubtedly reflects, in substantial part, still fresh memories of the 2008 financial crisis, anxiety generated by the very slow recovery from recession in many of the advanced economies, and tail risks associated with the European fiscal crisis," Barclays said in the report.

Treasurys and Treasury inflation-protected securities, or TIPs, for instance, rallied aggressively in the second half of 2011, generating the strongest returns seen since the height of the 2008 credit crisis, the report said.

Indeed, eight out of the 10 top-performing ETFs in 2011 were focused on U.S. Treasurys, led by the Pimco 25-Year Zero Coupon U.S. Treasury ETF (NYSEArca:ZROZ), which returned nearly 52 percent on the year, according to data compiled by IndexUniverse. Ten-year U.S. Treasury note is now yielding around 2 percent.

"Bonds issued by solvent governments are no longer just low-beta, they offer mark-to-market portfolio insurance that they did not offer in the 1990s or before," the report said. "It is not clear why this has happened."

Rates of return on the so-called risk-free assets remain "abnormally low" by historical norms, with 10-year inflation-linked bond yields now negative in the United States, the U.K. and Germany.

Moreover, while the Federal Reserve has signaled it intends to keep rates low through at least 2014, the market now seems to be pricing in an extended period of very low real rates. Barclays said the low-rate trend is so firm that it considers very real the possibility that real rates will remain low for perhaps the next 10-20 years.

"The collapse in government bond yields over the past decade marks a rupture with post-war financial history," Barclays said.

Equity Risk Premia Soar

By comparison, 2011, U.S. equities in 2011 were the worst-performing asset class of the year, underperforming even cash by more than 1 percent, the report said -- a clear reminder of the downsides of owning an equities-only portfolio.

The rush to bonds has pushed equity risk premia - the difference between the expected yields on equities and risk-free assets -- to historically high levels, but that is in no way a reflection of cheap valuations, the U.K-based bank said.

On the contrary, current equity prices are largely in line with projected future returns, which themselves are not far from historic norms, Barclays said.

"Investors may now be willing to pay for the mark-to-market insurance that bonds offer, driving bond yields down and the measured equity risk premium up, even if equity valuations themselves are not importantly changed," the report said.

"Financial markets have settled into an equilibrium that appears as abnormal, from an historical perspective, as the equity bubble of the late 1990s."

Barclays sees equities yielding long-term inflation-adjusted returns of about 5 percent in the United States, with Japan coming in at 4 percent and the U.K. and Europe at 6 percent.

"If forward-looking total returns seem roughly congruent with history, the same cannot be said for the implied equity risk premium," Barclays said. "Even a seemingly modest rise in the equity risk premium has big implications for equity valuation."

Demographics A Key Factor

Demographic trends have a direct impact on asset supply, demand and valuation, Barclays said.

"The integration of the Chinese labor force into the world economy was probably instrumental in raising corporate profitability from the historically low levels of the 1980s," the report said. "It radically altered the international division of labor."

Countries like the United States benefitted from that new workforce, which is now part of the global economy.

But that reality is changing because the working-age group is a declining demographic in most industrial countries, a fact that could shift the distribution of income from companies toward households in years ahead.

While that demographic trend only holds true for much of the developed economies and China, whether other growing populations in other emerging nations will be able to become global players remains to be seen, Barclays said.

"The question is:Will other regions of the world, where population growth remains robust, be able to integrate themselves into the global workforce as effectively as China has done?" Barclays said.

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