When Bonds Don’t Hedge Stocks

When Bonds Don’t Hedge Stocks

The traditional formula of investing mainly in stocks and hedging with Treasury bonds has finally failed in the face of the 2022 market, contends an article in Morningstar by John Rekenthaler. Both stocks and long bonds have plunged, and the refuge that balanced funds offered isn’t safe anymore. The article offers 3 options of how to readjust your portfolio:

Stay the course. Keep your portfolio as it is and turn off the news to avoid panic selling or changing allocations based on fear. This option could help you weather the storm; since the end of the financial crisis in 2008, the standard 60% stocks/40% bonds portfolio would have brought in returns just as high as a portfolio that switched out bonds for liquid alternatives, as many were advised to do in the wake of that crisis. But there’s no guarantee that this bear market will follow the same path.

Change Your Allocation. Instead of relying on stocks to garner high returns and bonds as a hedge, investors should broaden their portfolios, Morningstar’s Amy Arnott suggests in the article. Allocating a good portion into international stocks and bonds as well as 5% positions in commodities such as gold, high-yield bonds, and REITs would provide better diversification. Of course, it requires more effort than owning just two investments, and probably more money. And if inflation subsides and Treasuries rebound, investors who reallocated could lose some of the gains from that shift.

Get tactical. Shareholders in balanced-funds could temporarily adjust their allocations into commodities and liquid alternatives, which tend to be resistant to inflation, and then switch back to Treasuries when the economy rebounds and inflation subsides. But predicting the precise moment to make that switch is nearly impossible. Out of the 22 funds that promised “tactical allocation” to their investors a decade ago, only 5 still exist. Unless this is a skill you are sure you possess, Rekenthaler writes that he “cannot recommend tactical allocation.”

None of these options are the perfect answer, and long Treasury yields are still unattractively low. But Rekenthaler writes that Arnott’s “advice is perpetually sound” and that adding in some assets to your portfolio could provide a better refuge when both stocks and bonds are stormy.