Bonds Behaving Badly

In Virtus affiliate AlphaSimplex’s latest paper, Kathryn M. Kaminski, Ph.D., CAIA^®, Chief Research Strategist & Portfolio Manager, and Jiashu Sun, Research Scientist, examine the recent performance of bond markets and their changing benefits as a tool to diversify equity exposure. They also explain why, in an environment where inflation is higher than it has been, the traditional 60/40 portfolio may be more incomplete than it has been historically.

• Since 2020, two key properties of bonds have shifted significantly: their correlation to equities and their volatility.
• Bonds may be more attractive when yields are higher, but they lose some of their diversification properties and provide more volatility. This is an example of bonds “behaving badly” -- exhibiting negative returns, minimal safety properties, and overall positive correlation.
• Investors could consider adding dynamic and multi-asset class alternatives that have the potential to perform well during equity drawdowns to bring some negative correlation into a traditional 60/40 portfolio.
• Alternative asset classes (like commodities) and alternative investment strategies (like trend following) have historically captured correlation benefits during periods where bonds “behaved badly”— helping to complete a traditional portfolio in a higher inflation environment.

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