Bonds helped investors to diversify equity between about 2000 and 2021, which more than covers the entire career of many allocators. Since 2022 bonds recoupled with equities as the “Great Moderation” megatrends of globalization, substantially free trade and unfettered supply chains, free movement of labour and capital, peace in most places, abundant energy supply and low inflation have all reversed.
This may prove to be a structural shift that could persist for decades: between the 1970s and 1990s equities and bonds were positively correlated. Investors are rethinking where, how and in what size bonds fit into their portfolios.
Beyond diversifying equities, Aspect Capital’s Chief Product Strategist, Razvan Remsing, decomposes the portfolio role of bonds into three other jobs: carry income, liquidity and recession insurance. All of them are open to question.
Though nominal yields are at 20-30 year highs, real yields of 1-2% fall short of many investors’ return targets and inflation-linked bond yields are also rather low. Investors are demanding a higher risk premium from bonds because G7 governments are heavily indebted due to the long term trends of growing welfare, health and pension largesse as populations age; the hangover from Covid subsidies and most recently a sharp jump in defence spending. Developed countries are now more indebted than emerging sovereigns and debt sustainability arithmetic is not compelling given a vicious circle of sluggish growth and ballooning interest service costs.
The liquidity provision role of bonds is also now doubtful due to geopolitical tensions. Russia’s bond holdings were frozen after it invaded Ukraine and China has been reducing US Treasury holdings. More recently some of the latest sanctions on Iran may also act as “secondary sanctions” applying to Iran’s trading partners. Distrust does not just exist between the West and the so called “Authoritarian Axis” since there are increasingly differences of opinion between the US and Europe. A leading sovereign wealth fund, Norges Bank Investment Management – the Norwegian oil fund – also plans to cut government bonds from 70% to 50% of its bond index, which implies a large cut in Treasury holdings. The Netherlands central bank has as well scaled back Treasuries – and along with France has repatriated gold reserves from the US. The trade war has even raised fears of possible tariffs or taxes on US Treasuries. De-dollarisation and dollar depreciation spur investors to seek alternatives to (or at least hedge) USD cash and USD denominated Treasuries.
Hence central banks (and also some commercial banks) have diversified their holdings away from G7 sovereign debt and most notably into gold, which may now be the second largest aggregate central bank holding. The biggest stablecoin, Tether, is also a significant gold buyer as it recycles some of its Treasury income into the yellow metal. Gold (held with a friendly custodian) offers an asset without sovereign or counterparty risk.
The recession insurance function of bonds is also debatable as it depends on the type of recession or slowdown. Clearly, bonds could provide protection against a demand side and deflationary shock (as they did recently in China) but since 2022 shocks in the Western world have come from the supply side and inflation has overshot developed world central bank targets for five years. Germany’s energy-intensive economy has seen flat to slightly negative economic growth for the past three calendar years and German government bonds have not been a useful diversifier.
Commodities can add some symmetry to the protection equation since they have responded well to episodes such as the Ukraine war shock of 2022 and the Iran war in 2026. “Real assets such as commodities should move from a peripheral role in portfolios to an increasingly important portfolio building block and strategic asset,” argues Remsing.
“Real assets such as commodities should move from a peripheral role in portfolios to an increasingly important portfolio building block and strategic asset.”
Razvan Remsing, Chief Product Strategist at Aspect Capital.
Commodities provide direct exposure to resource scarcity and energy security concerns that have been heightened by geopolitical tensions. The asset class also taps into trends such as green energy transition shifts and AI mania increasing demand for electricity.
All of this is palpable, yet many asset owners remain severely underweight of commodities. Pension funds, endowments and foundations have often been increasing allocations to alternatives more broadly but commodities have been something of a Cinderella. “This is partly because they cannot identify clear risk premiums for a long-term strategy of buying and holding commodities. We have some sympathy with this view and do not advocate a passive buy and hold approach nor a constant portfolio weighting since a synchronised bull market across all commodities is not the base case scenario. Commodities are a trading asset class,” Remsing asserts.
“We do not advocate a passive buy and hold approach nor a constant portfolio weighting since a synchronised bull market across all commodities is not the base case scenario. Commodities are a trading asset class.”
Razvan Remsing, Chief Product Strategist at Aspect Capital.
Aspect can follow long and short trends in commodities, which is useful since the disruptive forces underway can generate strong and sustained moves as well as boom/bust cycles in both directions.
Aspect’s systematic programmes typically run significant commodity risk on average, though that exposure can be highly variable according to the opportunity set – allowing the strategies to dynamically lean in and out of commodity themes as they emerge. This dynamic and adaptive approach responds to changing patterns of trends and correlations.
Aspect has spent years broadening out its commodity investment universe to include a variety of energy and energy derivative products – such as butane, ethane and propane – as well as carbon emissions and multiple electricity markets. Aspect was also one of the first asset managers to trade Chinese commodities. These markets, which can include some dubbed “alternative markets”, provide additional sources of return and diversification.
“Bonds are not dead and 60/40 is not dead but investors need to broaden their horizons to navigate a wider range of shocks. Diversified, dynamic, trend following CTAs are a key building block for liquid alternative allocations.”
Razvan Remsing, Chief Product Strategist at Aspect Capital.
“Bonds are not dead and 60/40 is not dead but investors need to broaden their horizons to navigate a wider range of shocks. Diversified, dynamic, trend following CTAs are a key building block for liquid alternative allocations. We can rapidly react to whatever emerges in the new regimes,” sums up Remsing.
Aspect Capital eyes its 30th anniversary in 2027 and its founders, Anthony Todd and Marty Lueck – who featured in The Hedge Fund Journal’s “50 Giants over 5 Decades series” – also traded similar strategies during the sorts of economic and financial market regimes that threaten to wrong-foot some investors today.
This article is part of HedgeNordic’s “Rethinking the 60/40 Portfolio” publication.
Note: Any opinions expressed are subject to change and should not be interpreted as investment advice or a recommendation. Any person making an investment in an Aspect Product must be able to bear the risks involved and should pay particular attention to the risk factors and conflicts of interests sections of each Aspect Product’s offering documents. No assurance can be given that any Aspect Product’s investment objective will be achieved.
