by Marco Bonaviri, Senior Portfolio Manager at REYL & Cie
Since the beginning of the year, US 10-year Treasury yields have increased from 2.4% to 3.1%, driving the year- to-date return in these bonds– which have been considered a safe asset for over 30 years now- beyond -4%. Furthermore, during Q1 2018, for only the fifth time in 20 years and the first time in almost 10 years, US sovereign bonds fell in tandem with equities by more than 1%. More generally, the number of downturns in equities and bonds1 occurring simultaneously among developed markets has trended higher lately. Are we at the dawn of a change in paradigm in the relationship between equities and bonds, which could have major implications for multi-asset class portfolios – also known as “balanced” portfolios?
Asset allocation, i.e. the proportion allocated to each asset class, is the very essence of the dilemma facing most investors. It also represents the core business of wealth managers. The objective of the allocation process is to achieve a level of diversification which enables a reduction in portfolio risk and optimises risk-adjusted returns. However, the benefits provided by diversification depend on the relationship between asset classes, gauged notably by the statistical concept of correlation, which determines the direction and strength of the relationship between two variables. The viability of the portfolio construction process therefore draws heavily on the correlation between equities and bonds, which are the two major components in balanced portfolios. Ideally, this correlation would be negative, enabling bonds to partially offset equity drawdowns and reduce portfolio volatility. Meanwhile, the negative contribution from bonds to portfolio returns during bullish equities/bearish bonds phases should remain marginal.
Globally, there has been a negative correlation 2 between equities and bonds for more than 20 years in most developed economies 3. Multi-asset class investors have therefore been able to rely on the complementary performances staged by equities and bonds- the yin and the yang of the financial markets- enabling a reduction in both volatility and drawdowns. Moreover, the spectacular bull market observed among bonds over the past 30 years or so has enabled risk reduction for a negligible cost in terms of performance. Since 2000, the benefits of diversification between equities and bonds have been particularly notable during periods of financial crisis (2000-2002, 2007-2009), with bond allocations acting as a key stabilising factor in portfolios.
The negative correlation which has prevailed over the past several decades gradually led portfolio managers to rely on the benefits of diversifying between equities and bonds, to the extent of ascribing to this strategy the status of absolute truth, based on the flight-to-quality narrative. According to this almost dogmatic rationale, bonds are always inversely correlated to equities and must therefore represent the main (and often the only) risk management measure. As the Nobel prize-winning behavioral economist Daniel Kahneman highlighted, people naturally need to understand the world in simplified narratives, which can sometimes interfere with rational decision-taking processes. As is the case with all types of dogma, this thought process is harmful, particularly since finance remains a human science.
Financial reality is, of course, more complex. Acknowledging that correlations are dynamic and can change over time is essential to the portfolio construction process. The wealth of academic research devoted to this subject has revealed no less than four different stock-bond correlation regimes in the US during the past 90 years, all characterized by a specific macroeconomic context and spanning several decades. Since the global financial crisis, massive intervention by central banks via quantitative easing programmes has heavily impacted certain economic variables influencing the level of correlation between equities and bonds. One hypothesis formulated from recent studies claims that inflation and its volatility are determining factors in the equities- bonds relationship. On the one hand, rising inflation negatively impacts nominal bonds and, on the other hand, macroeconomic uncertainty triggered by inflation volatility weighs on equity valuation.
In the current global context of tapering monetary stimulus measures within a mature economic cycle, we believe that a normalisation of certain economic factors is probable: gradual rise in inflation, heightened volatility of the latter and macroeconomic data, higher equity volatility regime and rising short-term rates. This situation would imply an increase in the correlation between equities and bonds and a decrease in the diversifying power of bonds. Given the current level of bond yields – which appear to have reached a secular low point in 2016 – and their upward trend, the capacity of bonds to offset an equity drawdown is diminishing and the asset class could even weigh on portfolio returns. To illustrate this point, a drop of 120 basis points would be required in current US 10- year yields (i.e. to below 2%) to fully offset a 10% downturn in equities in an equally-weighted portfolio. The situation is different in the Eurozone where there has been a positive correlation between equities and bonds for over 3 years now, and where bond yields have been unattractive for quite some time. Consequently, most investors are already heavily underweight in this asset class which, fortunately, has nonetheless gained over 3% during this period.
With the possibility of seeing the diversifying virtues of bonds evaporate, the question of their exclusion from a balanced portfolio now has to be considered. This is particularly the case as other sources of diversification and alternative risk management mechanisms are now accessible to most investors. These alternative sources of diversification may also have some major advantages: attractive valuation, stable low or inverse correlation with equities, increasing diversifying powers when needed during bearish equity phases. Examples of these instruments include certain alternative strategies (relative value), some currency pairs (short AUD/JPY), long volatility strategies and relative value equity strategies (long defensive sectors/short market).
The correlation between equities and bonds – the cornerstone of traditional balanced portfolio construction – is unstable throughout economic regimes, and investors would be wiser to no longer assume that bonds will continue to protect their equity exposure in the future. Although we are not predicting an imminent return of a positive4 correlation regime between equities and bonds, which would require an overhaul of strategic asset allocations, it would undoubtedly be more prudent to take the initiative and consider this correlation to be zero. In the end, sustaining a traditional equities/bonds mix as a primary source of diversification and risk reduction amounts to implicitly betting that the negative correlation regime in place over the past 20 years will endure. Changes in correlation regimes, a long-term phenomena in general, however have the potential to do more harm than a rise in volatility. Multi-asset class investors should consider alternative sources of diversification in order to maintain a truly “balanced” portfolio. We also believe it is essential to complement this broader diversification with active risk management.
- In this article the term “bonds” refers to sovereign 10-year bonds, which generally incur low default risk and serve as a benchmark for high-quality bonds.
- We measure the correlation between equities and bonds on a 5-year rolling basis with monthly data.
- The correlation in the Eurozone has been positive since 2015.
- According to one current theory, a significant increase in inflationary pressures and macroeconomic volatility could lead to a positive equities-bonds correlation regime.
Is It The Right Time To Invest In Gold?
By Zoe Lyons, Hatton Garden Metals
The current climate is one of uncertainty, so it can be difficult to know what to do with your money, particularly investments. When faced with the decision on what to do with your savings, there are a number of options, but one investment which many have opted for over the years is gold buying.
Purchasing gold can be a great investment. Although the price of which can fluctuate just like anything else, the value of gold has generally tended to increase at a good rate and many prefer it over other saving options. With bank interest rates currently at a low and discussions of negative interest rates, many are opting to purchase gold as a way to earn money on their savings.
So is gold buying right for you? We take a look at some commonly asked questions when it comes to purchasing gold.
Why Should I Buy Gold?
Buying gold is often seen as a good investment due to value increases, so you may be able to make a profit from selling it on if the price of gold increases after you have purchased. The price can fluctuate, so profit is not guaranteed and is based on a number of factors. Looking back over previous years since the 1970s, the value of gold has prospered compared to other investment types, albeit with some dips in value at certain points over the past 50 years.
Buying gold also allows you full control as you are the owner. So you can choose if and when you want to sell.
Buying Gold Vs ETFs
When looking at investment opportunities, you may consider ETFs. An ETF is an Exchange Rated Fund, which when purchased is similar to buying stocks and shares. They can be a good investment, but is it more beneficial than purchasing gold?
When purchasing physical gold you will need to consider where to store it. This can incur charges, whereas with an ETF there is no need for storage, but an ETF can come with admin charges and investment management costs. When you choose to sell an ETF, you may also be required to pay a commission, which are often small amounts, but can add up if you are an active trader. There is also less control with an ETF as the price of which can change and is based on the company’s actions.
Gold Bars Vs Gold Coins
If you do choose to purchase gold, you will be faced with the option of whether to buy gold coins or gold bars. Although similar, they have varying benefits.
- Gold Coins
The purchase of gold coins are often favoured by those who appreciate the historic value of the coin. Many people collect coins, so an investor may be inclined to pay more if they are a keen collector of such. Many may also pay more for gold coins based on their rarity. These factors can affect the price you pay or sell at, meaning the value of gold coins is not solely deemed by the live price of gold, so you may receive a higher price, dependent on the investor. This allows the price of gold coins to be more fluid than gold bars.
- Gold Bars
Gold bars are not seen as a collectors item and don’t tend to have historical attachments. Because of this, the price is not influenced by these factors and is based on the weight, purity and the live price of gold at the time of selling or purchasing. This allows for a more accurate estimate of the price of your gold bars.
Where Should I Store Gold?
One of the most frequently asked questions when it comes to gold buying is storage. If you do choose to purchase gold, you will need to consider storage. Just like anything else of a high value, it needs to be stored securely. Simply keeping gold stored at home could be risky. When kept in your property, if not stored in the correct conditions, it is more susceptible to damp and corroding. There is also the possibility that your home insurance does not cover your gold, so if you are burgled, you could lose your investment. Because of this, it is wise to protect your gold with proper secure storage. Look for companies that offer storage abilities that are covered by insurance and be sure to do your research on pricing and look for cost effective storage as the fees incurred can soon add up. You may also want to look for a company that allows you quick and easy access to your gold to ensure you can buy and sell with ease.
Should I Invest In Silver Too?
Although gold is often a more popular investment option, many choose to purchase silver alongside it. The price of silver tends to be much more volatile than the price of gold, for this reason, many see gold as a safer choice. The price of silver will still have an intrinsic value but may be more worthwhile for those looking into long term investment options due to its VAT charges.
Negative Interest Rates
Although it is not a current practice, there has been recent talk of banks in the UK potentially introducing negative interest rates. If a savings account has a negative interest rate, this could mean you are charged for keeping money in the bank. If introduced, this could mean savers lose out. Instead of receiving interest on your savings, you may be charged a rate for keeping your money in the bank.
Could purchasing gold be a better option for your savings? Possibly, but this will depend on how much you have saved and the rates of the negative interest (if they are introduced). They may be minimal, but if you have a large amount in a savings account, this could add up to an expensive charge. If you choose to use your savings to buy gold, you may make a profit upon selling, but you will need to consider costs of storage as well as the chances of the price decreasing in the future.
So, is it the right time to invest in gold? It’s a very popular question. Hopefully the above will give you a bit more insight into gold investing and how it may work for you, but with any investment, there is never a guarantee that it will generate profit, so take careful considerations when diversifying your portfolio.
Private public investment is more inter-dependant than ever
By Konstantin Sidorov, CEO and Founder of London Technology Club
Today, one thing unites the majority of governments around the world: their fiscal position is destitute. COVID 19 has seen an extraordinary, forced expansion in public sector expenditure, which has come just as the world was getting back on its feet following the Global Financial Crisis. The financial strains are already showing and will become more apparent as we move through the pandemic into social and economic recovery.
If you want to understand the impact that the re-focusing of public sector spending is having, then there is no better example than the space economy. In the US and Europe, we are becoming increasingly reliant on the space rockets and space launch companies pioneered by private investors and entrepreneurs.
NASA, that powerhouse and flag bearer for American national pride, is having to partner with the private sector in order to fulfil their missions. Private investors, the likes of Elon Musk, and Jeff Bezos alongside smart use of new technologies have brought the economics of space down and the excitement around what’s possible up. With it comes a whole satellite manufacturing, launch and servicing industry growing to $271bn in revenues in 2019. Of the total revenues in the space economy ($366bn in 2019), government space budgets made up $95bn of that.
Commercial entities, being patiently built and backed by private capital willing to dig deep and progress their own missions has helped fuel the space economy. Many are realising now just how crucial space is for the future of a country’s protection, position in the world and prosperity. In China, India and Russia we still see significant public sector expenditure in space projects as an agent for military and economic expansion. The role of private investors in plugging major gaps in public sector funds and national pride in Western economies is therefore increasingly important.
Private and public investment must be seen as a partnership. We should not forget that Elon Musk’s SpaceX survived from the brink of collapse only because of a ten-figure NASA contract awarded at the last minute. Musk, since then, has looked for public infrastructure contracts to fuel his companies, the likes of The Boring Company winning the contract to build a downtown-to-airport loop, a government program for high-speed transport in Chicago. Musk proves his products and services work and then secures lucrative government contracts in order to quickly scale which in turn leads to transforming whole industries.
It’s not just space infrastructure where we see this redefinition of the role of public and private finance. The Chinese have invested at least US$160 billion in infrastructure projects as part of the Belt and Road Initiative, creating roads, ports, energy infrastructure and providing aid to foreign governments to create the most ambitious infrastructure project the world has yet seen.
For Western countries, access to that scale of public finance is not fiscally-possible, a new solution is needed and just as the space race has been redefined by private capital, so will the development of new industries, infrastructure and the reinvigorating of economies facing structural change that has been accelerated by COVID.
Private capital has the huge advantage of being driven by conviction and competence. It can cost-effectively be deployed, fast and targeted with a laser-like focus by entrepreneurs who know exactly what they want to achieve. Private capital, currently, is also in abundance.
In a world which is providing slim returns across multiple traditional asset classes, private capital is being stockpiled and is waiting for the opportunity to be invested for growth. We need private investors to have the confidence to deploy their capital to fuel the system once again.
This new world, post COVID, won’t see public capital replaced. Its role is likely to focus more heavily on health, welfare and critical infrastructure. However private investors will step in where gaps appear. Ten years ago, the scale and ambition of private space companies would have been greeted with snorts of derision and looks of disbelief. Today governments embrace the private capital, and regard the companies that have deployed it as systemically important national assets.
As we look to the future, huge macro trends emerge that demand significant investment: the aging population, the threat of pandemic, the drive to create a sustainable economy and lifestyle, the need to decarbonise, the digital revolution. The list goes on.
Public finance cannot hope to provide the finance and pioneer the bold thinking and accept the risks required to find new solutions that drive us forward in a world of change. That role goes to the private investor and private capital.
For the investors themselves the opportunities are immense, and for society as a whole they are just as big. As we look forward public and private sector needs to embrace private capital. Rather than fearing private investors as locusts who strip organisations and opportunities of profit then fly away, a narrative that gained traction after the last great economic crash. This time we need to see private capital as agents for positive transformation. Private-public partnerships fuelling each other.
Private money is already building rockets that send people and payloads into space, but that isn’t the final frontier for entrepreneurial investors or the societies and economies that benefit from their boldness.
What should I invest and How do I invest
By Imogen Clarke, The Fry Group
With all the uncertainty that has arisen from 2020, with lockdown threatening businesses and the warning of a second wave, the topic of investments has taken on new meaning. Nowadays, more people are concerned with what makes for a good investment, or, if you’re a novice, how to best invest.
For instance, you might be unsure about the reliability of the company you’re looking to invest in, as well as the long-term prospects of your investment.
If you are unsure of your investments, then it is best to seek advice from financial experts like The Fry Group, who deal with tax, wealth and estate planning. They will see that you have a strong financial plan in place to help meet your objectives. They will develop a strategy that is built around your needs and asses any risks that could hinder your plans.
There are some things you’ll need to consider for your strategy; for instance, are you looking to make investments that are more of a risk and will take longer to come to fruition? Or, alternatively, are you wanting a faster approach that will result in a steady income? Whether or not you decide to play it safe all depends on your current financial situation and whether you have the means to take more of a risk. Do you have any other debts that take precedence over your future plans? Is your investment strategy realistic?
With the aid of a specialist – or investment manager – you can design an investment concept that works for you and your goals, and start to build a regular income from your investments. There are four main areas when it comes to assets (groups of investments) that you can consider:
Your investment manager will test the risks associated with your investment, and if it proves to be a positive investment choice, then you will be able to invest more over time.
So, how do you decide where to invest?
According to The Fry Group, ESG investing (Environmental, Social and Governance) is a good option for investors looking to support businesses that meet their similar ethics.
The main areas of ESG investing include:
- Environmental challenges (climate change, pollution, etc)
- Social issues (human rights, labour standards, child labour, etc)
- Governance considerations relating to company management
According to The Fry Group, “Many investors choose to consider ESG investing in order to ensure any investment decisions reflect personal beliefs and values. As a result, they choose to support companies who are making informed, responsible decisions which take into account their wider societal and global impact. In this way investors can achieve peace of mind that their investments are creating a positive effect.”
ESG investing is also more relevant now than ever, as more businesses are looking to present themselves as an environmentally conscious corporation that recognises the values of their consumers.
As The Fry Group puts it, “In the past, ESG investing has been seen as a niche investment approach, for a relatively small number of people with specific requirements. This has changed significantly in recent years, with a growing awareness of environmental issues such as climate change and an increasing understanding of social issues and human rights. As a result, many people are increasingly interested in reflecting their opinions and lifestyle choices through the way they invest.”
So, if you want your investments to pave the way for your personal values and reflect your own morals, then this is the route to go down. But how does it all work?
There are four areas of ESG investing:
- Responsible ownership and engagement: when companies are encouraged to make necessary improvements.
- Avoidance or negative screening: whereby businesses are ‘graded’ based on how ethical their business practices are and are avoided altogether if their methods are not approved.
- Positive screening strategies:when companies meet the ESG goals and are approved for investments.
- Impact investment strategies: the purpose of this is to use investment capital for positive social results such as renewable energy.
You will need to take into account your own personal objectives as well as the objectives that meet the ESG investment criteria. And, in terms of financial performance, ESG investing can be hugely beneficial. Those who opt for ESG investing perform a more in-depth analysis into long-term and future trends that affect industries, meaning that they are better prepared for changes in consumer values when they arise. And, with all the unpredictability that this year has offered us so far, isn’t it better to do the research and have all angles covered?
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