Assets including gold and US Treasuries failed to provide the hedge in September that they normally do in a stock market rout, compounding investors’ woes in the worst month for global equities since the coronavirus nadir in March.
Global equities, as measured by the MSCI All-Country World index, fell 4 per cent last month as the pandemic flared again in Europe and nerves grew about a potentially destabilising presidential election in the US.
Yet fund managers running diversified portfolios were left disappointed by a drab performance in defensive assets and in the traditional “safety trades” they use to try to limit such pain. US Treasuries, which have historically rallied during a flight to safety, provided close to zero return, and gold declined. The experience offers fund managers the first taste of the challenge of balancing out market risks in the low-rate post-Covid environment.
Defensive strategies are working “about as well as fire insurance that covers just one bedroom in the house”, said John Normand, JPMorgan’s head of cross market strategy. “Among safe assets, few are moving in the expected direction.”
An analysis by the bank suggested that traditional hedges failed almost across the board. Sovereign bonds, the Japanese yen and the Swiss franc were among those that lagged behind the average returns they have managed in other bouts of equity market turmoil since mid-2009.
One haven trade that did work, buying the US dollar and shorting a basket of emerging markets currencies, brought in 2 per cent in September, but even that lagged behind its average return of 3.5 per cent during previous bouts of risk aversion.
The contrast with the market downturn earlier this year is particularly marked.
The trading strategy of buying quality stocks and selling value stocks failed to generate a positive return in September, compared with 8.6 per cent during the turmoil of February into March.
And a Bloomberg Barclays index of Treasury debt was close to unchanged in September, whereas it gained 6 per cent during the market turmoil of February and March, when US interest rates were cut by the Federal Reserve. Bond prices rise as yields fall.
T Rowe Price’s Sebastien Page, head of global multi-asset at the fund management group, said it was debating how effective Treasuries could be as a traditional hedge against moves in the stock market now that the Fed is holding interest rates at zero.
Yields have little room to fall unless the central bank begins to countenance negative rates, Mr Page said. “We think bonds can still hedge equity risk for one more big crisis but after that it gets a lot more complicated,” he said.
“Treasuries are more fragile in this environment than in a normal environment where they would hedge equity risk really well.”
Other investors pointed to ultra-low interest rates around the world for the collapse in correlations between stocks and bonds.
“The recent unusual behaviour of traditional haven assets is likely to persist as long as the current management of bond markets lasts,” said Oliver Jones, senior markets economist at Capital Economics.
The shock of September’s failed safety trades has accelerated portfolio managers’ efforts to find alternative hedges beyond bonds.
Jack Ablin, chief investment officer at Cresset, said “we prefer to hedge the equity side of portfolios via options, rather than relying on income assets” to offset bouts of market turmoil.
Not everyone is convinced that traditional correlations are broken forever, though, and some do see further upside potential in Treasuries, if downside risks materialise to the global economy.
“A rolling back of expectations for a vaccine to be production ready in 2021 would certainly skew the path of rates lower,” said Ian Lyngen, strategist at BMO Capital Markets, “as would an especially rocky election tallying process and any potential transition of power.”
Kristina Hooper, global market strategist at Invesco, agreed. “In this environment, I would expect gold and Treasuries to perform well,” she said.
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