Rising equity-bond correlation means it’s time to rethink portfolio construction

InvestorDaily

With the classic 60/40 portfolio now under pressure, liquid alternatives may offer investors a smarter way to diversify in uncertain markets. Compound interest has famously been heralded as the ‘eighth wonder of the world’, but the same could equally be said of asset diversification. After all, the fact that an investor could allocate to a strategy with lower returns and higher risk, relative to their wider portfolio, and both increase their overall portfolio return and lower their total risk is in many ways wondrous.

The secret to this diversification benefit is a low return correlation, with this quality forming the basis for traditional multi-asset portfolios, most notably the ‘60/40’ portfolio, composed of 60% exposure to equities and 40% to bonds. Correlation measures the degree to which asset prices move together. For much of the 20th century, a low positive correlation between equity and bond returns powered the success of the 60/40 approach, with bonds providing portfolios with income as well as partially diversifying equities in periods of market stress. This relationship intensified from the late 1990s to the early 2020s, as the low-inflation, falling interest rate environment resulted in a negative correlation between equities and bonds.

The rest of this article can be found at investordaily.com.au.