By Dorian Raimond, Head of Fixed Income Strategy and Trading, Hilbert Investment Solutions
As we have entered a new regime of higher inflation and higher yields, decades-old templates of portfolio construction might be worth reconsidering. Bonds yields have become more attractive again, while the product seems to have lost some of its diversification appeal. Could structured solutions well come out as the welcomed saviour?
Typical pension allocation follows portfolio theories like Markowitz’s (backed by a few decades of historical evidence), with the aim to balance volatility (‘risk’) and returns by attributing a risk-weighted exposure between equities (higher and more volatile returns), and bonds (less volatile and yielding less, with a defined capped upside).
The lower rates / lower inflation regime experienced since the ‘80s has proven to be a great soil for risk parity and 60/40 portfolio constructions. As many professionals of the sector have reported, the negative correlation of rates and equities during that time was a function of several factors – from the introduction of inflation targeting by central banks which had gained their independence, to deflationary pressure from globalisation, to quantitative easing by central banks after the 2008 financial crisis, and a self-fulfilling market mechanism.
The ‘Everything Rally’ brought on by the years of quantitative easing (QE) began to challenge the theory; a correlation between equities and bonds started to turn positive as each shock brought ever faster quantitative easing, leading to longer periods of positively correlated (positive) returns. But returns were positive, and we looked elsewhere. Then, in 2022, came the “Everything Sell-off”. While 2023 was good overall, intra-year sell-offs saw once again bonds and equities go down in tandem.
What fuelled the success of these strategies is just not there anymore. Those portfolio constructs do not achieve their aim in a regime of higher inflation, since bonds and equities are likely to remain positively correlated.
But inflation is going down, so surely, it’ll go back to normal?
It’s hard to dismiss the case against it. Globalisation is not in vogue anymore and 40% of the world population voting this year is likely to confirm this trend. At the same time, between the exponential growth of public debt on the back of fiscal stimulus, and the quantitative tightening of central banks (reversing their monetary stimulus), bond yields might easily be floored.
Geopolitical tensions remain on the rise and will keep being the tailwind for inflation (and deglobalisation). As long as central banks keep their independence (a debate gaining traction in fact), we should not expect rates to go aggressively lower. Should inflation make a comeback, rates might in fact rise further.
While bonds might not work as a risk offset to equity exposure, the investment itself is still very much an attractive proposition. Especially if corporate earnings start to deteriorate and weigh on stock prices. Bonds just need to be considered for what it says on the tin; fixed income. The great reset in yield has made for more attractive nominal returns for bonds – but also for structured products.
Under a low-rate regime, structured products were mostly for yield enhancement as investors looked for ways to add leverage. But as rates rose, the issuance of structured products rose as well. The higher yield regime created new opportunities for structured products; total or high capital protection.
Structured products are now offering close to 10% return with high capital protection. An attractive proposition versus typical 60/40 portfolios, especially as you get closer to retirement age in a high inflation environment. Such coupons offer a higher chance of a positive real yield on your life-long investment, while the capital protection is key to protect against a 2022 redux.
This has always been the crux of the matter; participating in equity upside, clipping high fixed income coupons, while not risking life-long invested capital, and even more so as one gets closer to retirement age. As portfolio construction itself is not trusted to provide this protection anymore, pension solutions like Hilbert Protect 90 offer 90% capital protection. This capital is invested in equity and fixed income ETFs, and every quarter, returns making for a new high-water mark of investment values are also protected at 90%.
For more information about Hilbert Investment Solutions’ retirement products with capital protection, please call +44 20 3808 7138
The value of investments can fall. Investors may not get back the amount invested.
For Financial Advisors only. This is not investment advice.