![]() ![]() We have moved into an environment of exceptionally low government bond yields and in many cases negative interest rates. The problem with most places outside Japan is the future is not going to look like the past. Japan: Bond performance in equity sell offs In the higher interest rate volatility environment, bonds on average rallied 3.7% when equities sold off 37%, but in the lower rate and volatility periods yields rallied on average only 0.5% while equities sold off 24%. The chart shows in a low volatility world the effectiveness of interest duration to hedge out equity volatility is substantially reduced. We have roughly divided them into periods of higher interest rate volatility (pre-2010) and lower interest rate volatility (post-2010). The following chart shows eight significant corrections in the Japanese equity market over the past 25 years. Rolling 30 day volatility of 5yr duration JGBs We believe the US and many developed markets will increasingly look like this over time. Volatility has been steadily declining as the absolute level of yields has remained low and the local central bank has continued to increase its ownership of the market. The chart below looks at the volatility of the Japanese Government Bond (JGB) market. This second approach has worked reasonably well for the last 20 years or so, but we believe it is highly unlikely to work as well over the next decade or longer. The second group are those that buy fixed income products because they believe these assets will perform well when there are corrections in their risk assets (mainly listed equities), helping to reduce their overall portfolio volatility. There are a range of products to choose from to target specific objectives and risk tolerance. The first group are those that invest in the products because they want some level of income, modest capital return and capital protection. ![]() ![]() Investors in fixed income products generally fall into two categories. Fixed income investors have been living in a certain world for a long time, but that reality has now changed and investors are facing a tough decision: continue as usual or accept the new normal and learn to navigate a changed landscape. This is a fitting analogy to the world of fixed income investing. Past strategies unlikely to work in future As we all know, Neo chooses the red pill and must face the harsh reality of the world. He is eventually given the opportunity to free himself by taking either a red pill, which will allow him to learn the truth, or a blue pill, which will allow him to stay in his current, computer-simulated reality. In the film The Matrix, the hero of the story, Neo, has been unwittingly living in a dreamworld his entire life. You can download the full original article “Red pill or blue pill? Navigating the matrix of fixed income” here. This article has been modified for Firstlinks. ![]()
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