Commodities, TIPS and fixed-income hedging strategies are some of the options for managing risk in this environment.tadamichi/iStockPhoto / Getty Images
Bonds have long been buffers in investment portfolios, providing reliable income and typically moving independently of securities, although that has not held true over the past few years.
Some advisors have turned to different hedging strategies, especially with the recent sell-off in the bond market, while others see opportunities in bonds now that starting yields are higher.
“Investors are going to have to get creative,” says Rob Van Wielingen, president, chief executive officer and portfolio manager at Viewpoint Investment Partners Corp., an investment-management firm in Calgary.
He sees commodities as a good replacement for bonds, although Viewpoint does hold bonds in two specialized risk-parity strategies.
In 2022, rising inflation hit stocks and bonds simultaneously, bringing investors to rethink the 60-40 balanced portfolio. “The stock-bond correlation has really come into question,” he says.
Liquid alternative funds with hedging strategies and private market funds focused on infrastructure, private credit and private equity have proliferated. But Mr. Van Wielingen questions their stability and transparency, pointing to some recent examples with the gating of private market funds.
He sees “real opportunity for [portfolio] managers and advisors to use commodities as a hedge,” with massive fiscal deficits globally.
“Commodities do well in that kind of environment,” Mr. Van Wielingen says, pointing to gold, precious metals, livestock, industrial metals, copper, oil and gas, coal, wheat, grain and “even a little bit of crypto.”
David LePoidevin, founder and lead portfolio manager with LePoidevin Group at Canaccord Genuity Wealth Management in Vancouver, started his career as a bond trader. But since the global financial crisis in 2008-09, he says, “bonds have been a terrible investment,” which is reinforced by the current “bond chaos.”
His fixed-income allocation in recent years has been focused predominantly on preferred stocks, although many of those bought at 50 to 60 cents on the dollar have now been redeemed at par.
Today, his group is diversifying client stock holdings with Treasury inflation-protected securities (TIPS), which are backed by the U.S. government, with select maturities currently trading between 2.5 to 3 per cent, plus inflation.
“This is the anti-bond,” Mr. LePoidevin says, noting that TIPS are solid because “countries don’t tend to default in their own currency but tend to inflate, or print money, if the debt becomes unmanageable.”
He notes this is the highest real yield available in 26 years and represents an “outsized opportunity.”
Darcie Crowe, a senior investment advisor and senior portfolio manager with the LePoidevin Group, notes that TIPS are tax-efficient, with select maturities trading at 47 cents on the dollar and “completely liquid – you can sell them on the market on any given trading day.”
She says liquidity is “paramount to ensure that we’re able to offer clients the protection that’s needed in volatile markets.”
Ms. Crowe points out that people looking to private markets as diversifiers or to protect wealth through down markets need to take into account the fact that they can be gated and their true value isn’t marked on a daily basis.
Brennan Carson, partner and portfolio manager at Equate Asset Management Inc. in Oakville, Ont., says bonds continue to have their place among client portfolios, although he favours active management in fixed-income holdings.
“Correlations between equities and bonds have been higher since 2018 than they have been for the 60 years before that,” he says, noting it’s tied to interest rates.
“You’re getting the same tail wagging both dogs, and that’s not great when you’re trying to do portfolio construction because, ultimately, you have the same risk parameter that’s driving too much of your portfolio.”
Equate leans on money managers who manage credit risk and duration risk through a mix of long corporate bond, short government bond, going long on short duration and going short on long duration, Mr. Carson says. “For the investor, they’re taking away the duration risk and ultimately trying to hedge away the credit risk that exists.”
The current sell-off is “an environment to do a reset and grab some higher yields,” says Mr. Carson, who thinks interest rates will stay high. “As a manager, there’s lots of selectivity in terms of looking for good credit with good yield. This is a situation in which you’re getting new issuance from high-quality issuers.”
Mr. Van Wielingen notes that commodities aren’t a hedge against a growth shock, “so if you went into a true recessionary environment, commodities probably wouldn’t do well. But, in that case, bonds would probably do well again.”
He feels we’re still in the “beginning innings” of an inflationary and “geopolitically extremely fragile” business cycle, with much volatility ahead.
“The administration in the U.S. is going to change. What’ll happen with the Federal Reserve? What’s going to happen with the Ukraine War, Iran, the oil market?” he asks, adding that deficits are the elephant in the room.
“No government is attacking these massive deficits, and so the bond market is really starting to buck, to push back and, in large part, that’s why yields are rising.”