Fixed-income has been a saviour in previous downturns, but this time is different — via financialpost investor
The problem is the aggressive monetary easing we’ve seen over the past decade, something that rapidly accelerated following the COVID-19 shut-downs. Interest rates were pushed to record low levels, flirting with negative territory in some instances, leaving little to no room to fall further. This limitation is important because yields need to drop in order for bonds to offer meaningful downside protection during market corrections.
Then something happened that we were told was supposed to be temporary, thanks to large fiscal deficit spending paired with supply disruptions. That something was inflation. Rising prices can wreak havoc on a bond portfolio by creating large losses, as central banks have little to no choice but to raise interest rates as their primary inflation-fighting mechanism. For example, we calculate that a U.S. 60/40 portfolio is down over 12 per cent this year with the Fed rate simply moving to 1.
Things will get particularly troubling if this turns out to be a secular shift like the one in the 2000s, when according , 60/40 investors suffered a “lost decade” in which they earned a meagre 2.3 per cent annual return that was actually negative on an inflation-adjusted basis.Article contentHere is where risk-management expertise comes into play. Having someone who understands portfolio construction and position intercorrelations is imperative when it comes to replacing some or all of one’s fixed-income allocation.
Such a shift can include the use of alternative investments such as market-neutral strategies, private equity, even a slice of commodities. One has to be especially careful in managing this category for liquidity risk, the use of leverage, transparency and other factors.
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