(Bloomberg) -- There are lots of reasons to hate the stock rally, but one looks more menacing by the day: Investors have few tried-and-tested hedges for its collapse.
As fixed income and equities move closer together and yields fall back toward historic lows, faith in the hedging magic of government bonds is vanishing. Big-name investors like Man Group Plc’s Chief Executive Officer Luke Ellis warn the rationale of simply owning sovereign debt as a long-term investment with a nice yield no longer applies.
For decades, the traditional mix of 60% stocks and 40% bonds has been a bedrock strategy for millions of retirees, with debt touted for its potential to cushion equity losses. But with yields at historic lows and unprecedented monetary and fiscal stimulus, all bets are off.
All that is forcing money managers to dig deeper for assets that diversify the sensitivity of their portfolios to risk, from private equity and hedge-fund strategies to gold.
“Central banks cannot ease policy rates further and therefore bond yields cannot rally much,” said John Normand, head of cross-asset fundamental strategy at JPMorgan Chase & Co. “Bonds will not provide as much protection as they used to. Think of it like an insurance policy that might not cover the full value of the house.”
During the current economic crisis, U.S. government debt has been a terrific investment and the iShares 20+ Year Treasury Bond ETF is up 20% this year. However, there’s not much room left to go with yields on 10-year bonds at 0.7% and the Federal Reserve seemingly unlikely to allow negative rates.
“We’ve ended up at this place where the amount of upside in owning Treasuries is extremely limited, or government bonds anywhere over time,” Man Group’s Ellis told Barry Ritholtz on a podcast earlier this month. “You obviously have a downside if the central bank ever loses control.”
That’s part of the reason why investors are going elsewhere. Gold held by exchange-traded funds is now at an all-time high, and cash is flowing into private equity. Hedging strategies like option overlays, gold and high-quality stocks have worked better than the traditional 60-40 portfolios this year, according to research from Goldman Sachs Group Inc.
“Gold has a good place to play in portfolios. It’s a better stabilizer than government bonds,” said Suzanne Hutchins, who manages the BNY Mellon Global Real Return Fund for Newton Investment Management in London. She raised the fund’s gold allocation to about 15%, close to the highest ever.
There are plenty of reasons for investors to want protection against a stock market plunge. Worries are running high about about a second virus wave and how the Fed will be able to withdraw stimulus without setting off panic.
A record 78% of investors in Bank of America Corp.’s latest survey believe the stock market is overvalued. More than half called it a bear market rally.
And even with meager yields, there’s fierce demand for fixed income. Government bond and Treasury funds took in $1.5 billion in the week through June 17, the most in almost two months, according to data from Bank of America.
“The long bond is still a diversifier and still a place where you want some of your money,” said Charles Day, managing director at UBS Global Wealth, where he oversees $600 billion in New York. “Wherever the Federal Reserve is going, it’s safe to be there.”
Still, Day says he’s advising wealthier clients to diversify into private equity, and acknowledged that government bond holdings could fall.
“Don’t say that the 10-year is dead as a diversifier and I don’t need to own it anymore,” he said. “Maybe trim it a little bit and that’s all.”
--With assistance from Justina Lee.
To contact the editors responsible for this story:
Lynn Thomasson at [email protected]