Asset allocation is no longer a simple choice between equities and bonds: shifting correlations, turbulence and new technologies have come into play.
The question of whether investors should shift their allocations from equity to bonds is one that comes up almost as often as the US S&P500 index hits a high. But is it actually the right question to ask? In my view, it is not a simple yes or no – the answer needs to evolve in line with events.
A shifting landscape
Looking back, 2017 saw historically and almost stubbornly low volatility. However, 2018 was a rollercoaster ending in a December when the S&P500 plunged by almost 16%. Six months later, equities have come off a two-week losing streak, the US Federal Reserve has paused its policy tightening and there is even speculation that it will cut rates in the second half of 2019.
So, is this the right moment to take profits in the 10-year equity bull market and reallocate? And are bonds the most appropriate asset class to choose?
There has been a prevailing assumption that, over the long term, the correlation between bonds and equities is negative. And for much of the 20th century, that assumption held true. However, in the last 10 years, correlations between bonds and equities have become sharply more positive.
Welcome to the new world order! The risk-reward trade-off has moved
Even more significant is the shift in the risk-reward trade-off, defined as the potential amount an investor would be willing to risk for a potential reward. Risk-reward ratios held up well until recently, when investors came face to face with such market-changing events and new investment technology as the 2008 global financial crisis, trade wars, Brexit, anti-globalisation… the list is long.
