Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
For much of the past two decades, shares and bonds have performed a neat trick for investors.
Namely, their prices have tended to move in opposite directions from one another. It never happens perfectly but the long-run trend for most of this century so far has been that when one goes up, the other goes down.
That’s very useful for investors because it means they can hedge their holdings to produce a smoother return. Both assets have the potential to produce a positive return in the long term, but the fact their returns are negatively correlated means fewer stomach-churning ups and downs.
It has worked particularly well for those investing regularly and into a balanced portfolio of equities and bonds. For example, imagine were you to invest £100 every month into a balanced fund of half shares and half bonds, with £50 used to buy each type of asset. If one of the asset classes fell in value, next month’s £50 would buy more of it at a lower price than the month before. Conversely, if the value had risen, your £50 would buy fewer assets. With shares and bonds moving in opposite directions you should always be buying more of the thing that’s relatively lower in price - which is a good habit for long-return returns.
The problem is that just recently the trend has been reversed, and both shares and bonds have, at an aggregate level, moved more often in the same direction. That spells more volatility and gives a headache for investors looking to hedge their portfolios.
Some new analysis from Fidelity’s institutional investment team helps to show what’s been going on. It shows the sectors where shares have become more correlated with bonds include technology, consumer discretionary and communication services. Stocks and bonds were negatively correlated in all these sectors over the last five years on average.
The reason is that companies in these sectors are recognised as having strong and predictable earnings which should hold up into the future. This has been prized highly by investors who have been prepared to pay the high-valuations on these companies. That also means, however, that the value of these long-term earnings is sensitive to changes in expectations of inflation, interest rates and the value of risk-free assets like government bonds.
As bonds have fallen in value - thanks to rising inflation and the prospect of higher interest rates - the value of companies in these sectors has fallen too. Because they are so dominant, representing large proportions of the overall stock market, headline market levels have tended to fall as well.
The lesson for investors should be to consider looking beyond just shares and bonds to build a diversified portfolio. Assets like gold, while quite volatile, can provide uncorrelated returns, particularly when most other assets are falling in value. Commercial property, commodities and infrastructure may also provide some hedging benefits.
In the ‘alternatives and other’ category of Fidelity’s Select 50 list of recommended funds you’ll find a range of alternative options, such as the Foresight UK Infrastructure Income Fund, iShares Global Property Securities Equity Index Fund and Ninety One Global Gold Fund.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.
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