MARKETS & INVESTING
IT ’ S BECOMING INCREASINGLY EVIDENT THAT A ONE-SIZE-FITS-ALL APPROACH MAY NOT SUFFICE . WE BELIEVE IT ’ S TIME FOR INVESTORS TO RETHINK THEIR DIVERSIFICATION STRATEGIES .
US equity / US Treasury correlation has been negative – on average – over the long term
Source : Bloomberg , as at 13 May 2024
Although this emphasises the diversification benefits of bonds over the long term , it is important to note that over the shorter term there can be periods of disruption to the diversification benefits , when we see positive correlation between equities and bonds . In these periods , the two main assets of a 60 / 40 portfolio would be correlated in the same direction – not necessarily in line with the diversification ambition of the strategy . We feel it is important to recognise the potential challenges these positive correlation periods introduce , as ignoring this risk may unintentionally carry higher risk in portfolios .
Diversification to the rescue How does the team think about this challenge ? Diversification . Not just diversification into other asset classes like alternatives , especially low-correlating strategies , but also within fixed income . Adding to other assets within fixed income , such as emerging market debt , UK government bonds , UK credit and also into multifaceted , flexible fixed income sectors like strategic bonds and absolute return , we believe , can bring the benefit of improving overall diversification to the portfolio . In particular , with the latter two strategies , there are two main added benefits , firstly through accessing assets classes within fixed income that may be difficult to access by some , through limitations of availability on platforms ( for example , asset-backed securities or contingent convertible bonds ) and secondly the ability of these strategies to offer a different duration profile than other fixed income sectors . By being less reliant on one particular asset to provide diversification against risky assets like equities , we ’ re more likely to have a smoother set of outcomes . This could , in our view , allow investors to access the power of compounding returns over the long term . 2022 is one instance where a diverse exposure to a range of bonds will have offered better portfolio protection than allocating simply to US Treasuries alone . The Bloomberg Global Aggregate index hedged to USD returned -11.2 % compared to -12.5 % for US Treasuries for similar levels of duration . Whilst this is just one select period , it helps to emphasise the point that , much like how we wouldn ’ t advocate allocating to a single sector or region within equities , we would also advocate for a diverse range of exposure within fixed income . For instance , we are proponents of investing across a myriad of fixed income sub-asset classes and regions from EM debt and high yield to EU government bonds and credit in order to limit exposure to the idiosyncratic return drivers for each sub-asset class .
Delving deeper into bonds Bonds continue to play an important role in portfolios , offering balance to other risky assets . But being overly reliant on just one particular asset has its shortcomings . Diversification remains an important foundation for multi-asset portfolios , especially in times of higher volatility . We believe it ’ s no longer enough to simply spread investor capital across equities and fixed income , and hope for the best . By delving deeper into specific regions and sectors , we believe investors can unlock opportunities that may be overlooked in broad-based portfolios . For instance , by implementing a view on the relative attractiveness of UK government bonds versus European government bonds , investors can potentially capitalise on perceived mispricing and inefficiencies within the fixed income market . The growth of investment choices on UK platforms today means investors have a bigger toolkit to choose from .
It should be noted that diversification is no guarantee against a loss in a declining market .
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