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Portfolio Adviser ArticleDespite its critics, the fixed income opportunity set has grown significantly since the financial crisis and is likely to continue to play a vital role in any multi-asset portfolio. Fixed income has recently faced an onslaught of disparaging rhetoric. Some commentators have even gone so far as to claim the asset class has no place within a multi-asset portfolio. This view completely underestimates the diversity of the fixed income opportunity, which reaches far beyond corporate and government bonds.

The rhetoric is often most vehemently targeted at the traditional asset allocation model, which suggests it is vital to have a generous allocation to the government bond market in a balanced portfolio. The asset class has historically generated attractive risk-adjusted returns with a negative correlation to risk assets, two characteristics treasured by mean variance optimisers. In this regard, the critics of fixed income have some credibility as the construction of a multi-asset portfolio demands a greater understanding of risk than simply observing historical relationships. Nassim Taleb’s famous story of a turkey’s life encapsulates, albeit rather brutally, the inherent problem of relying on backward- looking models. Imagine a turkey that has been fed for 1,000 days by a friendly farmer until day 1,001, which happens to be two days before Thanksgiving. When the farmer arrives yielding an axe rather than offering food, the turkey’s expectations, shaped by history, are cataclysmically wrong. Investors fall into a similar trap if their outlook is solely shaped by history. The negative correlation between government bonds and risk assets, the foundation of a balanced portfolio, has been dynamic through time and therefore justifiably comes under question by the fixed income naysayers. The correlation of US equities and treasuries during much of the 20th century was positive but has been strongly negative more recently… Read Entire Article >>>

[Source: Portfolio Adviser – Adam Barber – July 15, 2016]


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