Why it's time for the great rebalancing out of core bonds

Global investment strategist says asset class is diminished and others should play a greater role

Why it's time for the great rebalancing out of core bonds

It’s the end of an era – and time for a great rebalancing of portfolios out of core bonds. That’s the view of HSBC GAM’s global chief strategist, who believes investors must face up to a monumental shift in asset-class strategy.

While government bonds have been one of the best asset classes to own in the last decade, offering positive returns and negative correlations to equities, current low yields and macro interest-rate policy mean their properties – and perhaps relevancy – are set to diminish.

Joseph Little believes that, within traditional asset classes, inflation-linked bonds and some commodities, like gold, can help to build resilience. Alternative strategies, a long-time favourite of institutional investors, are another attractive option, he said.

“Although returns of strategies that offer low beta to equities, low duration, and moderate volatility have been low in recent years, poor prospective returns on government bonds favour the increase of the allocation to liquid alternatives.

“Illiquid alternatives should also play a greater role in investment portfolios. Current macro challenges and the low-return environment mean that long-term investors have a good entry point into private equity and venture capital, especially to funds exposed to Asia growth and technologic dynamism.

“Meanwhile, investors willing to exchange portfolio liquidity for income can benefit from investments in securitised debt and infrastructure where valuations are attractive.”

Meanwhile, HSBC’s baseline swoosh-shaped recovery is now entering its second phase. The first resulted in a faster-than-expected recovery across global economies, driven by large scale income support, but we are now entering a flatter phase with growth expected to moderate.

Little said mobility data already shows the speed of recovery slowed in Q3 and the previous strength in consumer spending is also starting to slow, and that further recovery is more dependent on services sector spending, which remains compromised by social distancing measures.

He said: “Meanwhile, Covid-19 is still with us, unemployment rates are abnormally high, and savings ratios are elevated. All of these factors tell us that we face a prolonged phase of low output ahead. Our working assumption is that the economy will be operating at 90-95% of pre-Covid-19 levels over the next six to 12 months.

“The market needs to adapt to this new reality. We think it implies a new, range-bound scenario and, for investors, a focus on carry and income - which we describe as a coupon-clipping environment. Going forward, investors need to be realistic about the investment returns that are achievable from here.”

Compounding this is the “major downside risk” of fiscal support. While there is room to manoeuvre, Little believes it’s likely that in developed markets, this support will be withdrawn prematurely because of a “combination of stimulus fatigue and conventional thinking about the deficit and political gridlock”.

He said: “That risk will vary country to country, with the US being in the strongest position as it has already made progress on its second fiscal package.”