By Bilal Hafeez 07-08-2019

Top of the Morning: ‘Assessing stock-bond portfolios’ (UBS On-Air, 14 min listen)

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(You can listen to the podcast by clicking here)

A simple 60/40 portfolio holding consisting of S&P500 equity and US government bonds would have performed impressively both last year (+13%) and in the past twenty. Jason Draho, who is Head of Asset Allocation America at UBS, starts with the basics: the strong performance is not only due to the general bull market in equities and bonds, but also because bonds show less volatility than stocks. This reduces overall portfolio risk. Furthermore, Draho points to a negative correlation between the two products, offering a natural hedge. But he raises an important point: not all safe treasury bonds are made the same when it comes to portfolio diversification. In theory, longer-term bonds return more, with strips reaching yields of 20%. Draho recommends adjusting the type of government bonds you hold based on how much equity risk you are willing to take. The more stock with which you fill your portfolio, the riskier the bonds you should hold. Diversification isn’t always perfect, however – bonds sell-off when interest rates are rising, but rate hikes are also generally bad news for equities, as we saw in 2018.

Why does this matter? This week we saw investors fleeing to safety spooked by escalating trade wars, with gold up 2% – hitting its highest level in six years – and treasury bond yields sliding. Volatility indexes such as the VIX are surging. In light of the recent Fed rate cut, investors can protect themselves against a stock market rally by allocating the right type of treasuries. UBS recommends shifting away from shorter-dated bonds into much longer-term debt or even strips to offset the equity losses that they see incoming.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)