Diversification and agility

The beginning of 2021 has seen a continuation of the reflation trade and renewed calls for the end of the multi-decade bull market for bonds. Fixed income investors know better than to be distracted by the prevailing narrative but nonetheless face a daunting challenge to match the performance of 2020, which was yet another good year for bonds.

Global bond investors could in some cases have received double-digit returns last year because, in dollar terms, the total returns for US, China and Eurozone aggregate indices were 7.3%, 10.4% and 14.3% respectively. The important lessons from 2020 were the importance of global diversification, and – as shown by the developments last March – agility to take opportunities when they arise.

Bond diversification should be considered both in the context of how fixed income is integrated into a multi-asset portfolio, as well as the global mix of bonds. The move in Treasury yields away from the zero bound is especially important to diversification when the Fed has been so adamant not to consider negative interest rates. Similarly, the adjustment in forward yields makes the market look more reasonably priced within the framework for valuations we are using (see US, page 7).

The lesson on agility applies to all bonds but especially credit. We started 2020 with credit spreads tight, only for them to move dramatically wider in March. Taking aside the sector and regional preferences, the general observation is that these opportunities to move to a maximum overweight in credit markets come all too infrequently, maybe once every few years.