Multi-Asset Duration Returning?

Inflation and interest rates soared dramatically in the first half of 2022, sending bond markets and stocks down.

The first half of 2022 was a turbulent time for global government bonds due to the sudden uptick in inflation and interest rates, as well as the sharp decline in bond markets and stock markets simultaneously. Concurrently, we witnessed a rise in the correlations that exist between treasuries and stocks, which meant that the diversification benefit that comes with exposure to duration decreased. When we considered all of these dynamics, we came to the conclusion that it was prudent to lessen duration exposure within multi-asset strategies in favour of other diversification building components.

Since then, a lot of things have changed. The financial markets have already factored in a significantly more restrictive monetary policy from the US central bank, including the increase of 75 basis points that the Fed implemented at the end of July. In addition, yields on U.S. Treasuries have been falling in recent weeks, despite the fact that they are still very close to their 12-year highs. We believe this trend indicates investors' predictions that inflation will begin to moderate, and possibly that the economy will begin to slow down. According to the Organization for Economic Cooperation and Development, the majority of the world's major economies are currently in a period of contraction. Furthermore, recent evidence suggests that inflation is beginning to ease in significant areas including commodities, energy, and durable goods.

In this context, we see less downside risk for global government bonds, as well as stronger income potential and greater possibilities for diversification. In point of fact, when economies have sputtered and inflation had largely abated, government bonds have traditionally delivered a superior risk/reward balance than developed-market equities. This conclusion is based on business-cycle contractions that have occurred since 1990. Both of these assets have been underperforming thus far in this cycle; however, the downturn has only been going on for three months as of this writing, which includes the equity rally in July. According to that criterion, the day has not yet begun.

We believe that now is a good moment to consider increasing your duration exposure in order to diversify your portfolio against the risk of equity market volatility. This is because global government bonds have the potential to have less volatility and greater returns. The climate has already shifted since only half a year ago, and it will almost certainly continue to do so. Those who invest in several assets need to be adaptable in order to use the strategies that are most likely to be successful as market conditions change.