Much has been written already about the death of the 60/40 portfolio and we have also talked about it on our daily morning podcast and on our Special Edition post from March 25 called Roundtable on the crisis and its aftermath where our CIO Steen Jakobsen talks about the need for long volatility components in portfolio construction.
Low interest rates
Central banks around the world have doubled down on their monetary policy since the Great Financial Crisis pushing down rates again and substantially increased their asset purchase programmes. In their forward communication with the market rates will stay compressed for a long time as the global economy will take time to heal from the Covid-19 induced economic crisis. The latest strategy change is the concept of average inflation targeting which means that the Fed will allow inflation to overshoot and thus accepting deep real negative interest rates. A potential next step in this logic is the concept of yield curve control in the case the bond market pushes up interest rates on inflation or fiscal deficit worries.
Overall, it is reasonable to assume that expected returns on government bonds will be close to zero for many years. One thing is the low expected returns, but what is more frightening is what we saw yesterday where governments bonds offer limited negative covariance to equities when we have a tail-risk event (a large daily negative return in equities). In most crisis events since 2008 the long end of the government yield curve has provided that, but no longer. The chart below shows how European government bonds were flat as a pancake. Only long volatility expressed through long VIX futures provided protection. Our view is that there will be a historic rotation in asset allocation strategies and the hedging and derivatives strategies will be reborn to accommodate portfolio managers.