This year has been extraordinarily tough for investors as major asset classes declined in response to an environment of elevated inflation and central bank tightening. In sympathy with the drawdown in equities, fixed income investments were also weighed down by the rapid rise in yields in response to the rate hikes. As a result, multi-asset portfolios are on track to suffer one of the biggest annual declines in decades.
The correlation between the fixed income and equities has generally been negative, where one acts as a buffer for the other, resulting in attractive risk-adjusted returns for balance portfolios. In a weakening economy, stock prices typically fall, but the downside is usually dampened by the fixed income component of the portfolio as it generates income and could see bond prices rise due to the prevailing risk-off sentiment and potential for interest rate cuts. On the flip side, a booming economy tends to boost equities, but often occurs alongside rising rates and higher inflation, both of which are negative for bonds. The stability of bonds thereby helps temper the inherently higher volatility of stocks in a portfolio. The 60/40 mix between stocks and bonds has traditionally been the go-to portfolio for investors, partly because the medium risk asset mix provides the biggest enhancement in risk-adjusted returns, hence the most diversification benefits.
In 2022, the correlation between the two turned overwhelmingly positive. Many areas of the bond market faired worse than equities and naturally investors are questioning if the gold standard 60/40, 60% global equity - 40% fixed income, barbell approach to investing is dead.
Read on as our partners at NEI discuss this subject and help put perspective on why this correlation turned positive and why the 40% bond position of your balanced approach will likely let you sleep at night as you embark into 2023.