Impact of Recent Romantic Relationships and Present Economic Conditions on the Performance Across Diverse Investment Sectors
In the aftermath of the 2008 Global Financial Crisis, the traditional relationship between major equity markets and their 10-year government bond counterparts has significantly shifted, impacting the performance of multi-asset class funds.
Traditionally, equities and long-term government bonds exhibited a negative or low correlation, providing a cushion for balanced funds during market downturns. However, in recent market cycles, this correlation has become less stable and at times positive, reducing the diversification benefits.
Several factors have contributed to this dynamic. Low and compressing yields on 10-year government bonds, changing correlation patterns, persistent equity market strength, portfolio drift and currency effects, and credit and duration risks have all played a role in this evolving relationship.
The low yields on government bonds, particularly in the post-2008 era, have resulted in bonds offering lower income and less capital appreciation potential. This has reduced the traditional hedge that bonds provided during equity downturns, complicating the risk management role of bonds in multi-asset portfolios.
Moreover, the correlation between equities and 10-year government bonds, while typically negative pre-2008, has at times trended toward zero or positive during certain post-crisis periods. This shift has reduced the traditional hedge that bonds provided during equity downturns, making it harder for multi-asset funds to provide stable, risk-adjusted returns.
In response to these challenges, fund managers have turned to alternative assets like private equity, infrastructure, and emerging market bonds to sustain returns and diversify risk beyond the traditional equity-bond mix. These alternative investments have helped offset the reduced diversification benefits provided by traditional bonds.
The author strongly believes that hedge funds have a crucial role within an investor's portfolio due to their unique liquidity, tradeable markets characteristics, and ability to trade within non-traditional markets. Hedge funds are considered part of the 'alternatives asset class' due to their lack of market exposure to the traditional asset classes.
In today's macroeconomic climate, equities are in their longest ever bull-run, widely considered as the 'most hated bull run' due to the artificial nature brought by central bank monetary policy. The author suggests expanding into more non-traditional markets to find truly uncorrelated returns, as the traditional asset classes have become increasingly correlated with each other.
The author also believes that family offices and institutional investors should increase investments into more uncorrelated products to lower the hurt from an equity correction. The author does not consider hedge funds, in general, to be their own asset class but rather a valuable tool for portfolio diversification, especially in today's macroeconomic climate.
In summary, the evolving relationship between major equity markets and their 10-year government bond counterparts has challenged the conventional diversifier role of 10-year government bonds in multi-asset funds post-2008. This dynamic has prompted fund managers to seek alternative diversification strategies and rely more on equities and alternatives to achieve target returns, as reflected in strong fund performances reported through the early 2020s.
Institutional investors are increasingly looking beyond traditional asset classes like finance and investing in business diversification options such as private equity, infrastructure, and emerging market bonds, recognizing the reduced diversification benefits provided by traditional 10-year government bonds in the post-2008 era.
Family offices and institutional investors should consider expanding their portfolios with more uncorrelated products, as suggested by the author in today's macroeconomic climate, to mitigate the potential losses from an equity correction while also seeking truly uncorrelated returns in non-traditional markets.
