- Head of Multi-Asset Strategy – EMEA
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The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional or accredited investors only. This material is provided for informational purposes only, should not be viewed as a current or past recommendation and is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase shares or other securities. Past results are not a reliable indicator of future results. Forward-looking statements should not be considered as guarantees or predictions of future events.
In an environment characterised by shorter and more divergent economic cycles and the accompanying market volatility, we expect increased dispersion within asset classes and greater differentiation among countries and companies. Against this backdrop, investors need flexibility and diversification in their asset allocations to adapt to changing market conditions and exploit dislocations as they arise.
In 2022 and for a significant part of 2023, the market narrative was driven largely by persistently higher inflation, forcing the major global central banks to hike interest rates. In this macro scenario, the negative returns that many fixed income assets delivered, combined with their higher correlation with equities, brought into focus the lack of adequate diversification in many portfolios’ fixed income allocations.
Despite weaker performance in higher-rate and higher-inflation environments, bonds have proved to be a strong source of portfolio diversification over the long term. We think that a diversified mix of fixed income assets has the potential to be an attractive hedge for risk assets this year, even if the relationship between equities and bonds remains unstable and correlations are persistently higher. And if inflation continues to slow, or at least plateau, our research suggests that we can expect greater divergence between equity and bond performance. Our research on US inflation, equities and bonds over the 50-year period from 1973 to 2023 also implies that the negative bond/equity correlation is stronger when inflation falls below 3%, as shown in Figure 1.
Global inflation is now declining from its very elevated levels but is likely to remain more volatile and structurally higher than in the past. Meanwhile, the exceptionally steep rate-hiking cycle appears to be drawing to a close. As we move out of the eye of the storm, now, in our view, is an opportune time for investors to reassess their fixed income exposure and adopt a new vantage point, not just within their overall asset mix but, equally importantly, within their fixed income allocation in order to enhance portfolio resilience and achieve their income and growth objectives. In a new regime of structurally higher inflation and greater economic uncertainty, a diversified mix of fixed income allocations could offer protection against the equity price declines that often accompany the early stages of a recession.
Investors seeking a more diversified, risk-controlled fixed income exposure may wish to consider the following areas in particular:
While we think diversifying fixed income exposure is a key component of a rewarding investment approach in this new macro regime, investors should consider it as part of a wider range of potential sources of diversification such as commodities and alternatives, including strategies that could extend the opportunity set within fixed income further. In our view, the resulting portfolio, with fixed income at its heart, optimises the potential upside from both income and growth while remaining adequately defensive in today’s more volatile world.
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