Andrew Fargus

For most of the past 30 years, equities and government bonds have been negatively correlated, which means that blending them in portfolios has had diversification and volatility-smoothing benefits. But over the past three years their correlation has turned positive. If this positive correlation continues, which we think likely, then what are we using to diversify our equity exposure?  

First, we favour shorter duration government bond and credit funds, which continue to provide attractive income returns without significantly exposing portfolios to interest rate duration risk. They might also benefit if central banks continue to reduce short-term interest rates.

Second, we selectively employ alternative assets such as equity long/short and market neutral funds, hedge fund replication strategies, commodity holdings and infrastructure funds. Historically these alternatives have shown relatively low correlations to equity markets.

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