This article is going to cover what I think is the most important question for portfolio diversification today: Are bonds losing their role as the preferred hedging asset and portfolio diversifier that they have held over the past two years? decades?

Based on a 63-day sliding correlation window analysis conducted by Warren Pies, founder of 3Fourteen Research, stock-bond correlation levels have reached levels rarely seen in the past two decades. These increasing correlations – whether they persist or increase even more – would imply that bonds are starting to lose their diversification benefits, and there could be a point in the near future when stocks and bonds decline together.

In the past, we have assumed that on negative days for the stock markets, there would be bids in the US Treasury bond market that would cause bond yields to fall and their prices to rise.

As the market begins to fear the consequences of mounting inflationary pressures – a story voiced by our senior investment strategy advisor Professor Jeremy Siegel of Wharton – it could be high for a number of years to come. .

Rising rates could put some pressure on the stock market and you would lose that property of diversification that bonds have historically provided.

3Fourteen Research emphasizes the importance of real assets such as commodities, gold and oil for their inflation hedging properties. 40% fixed income portfolio executives.

Worst Day Analysis

Evaluating performance on some of the worst trading days for stocks can shed light on the value of diversifiers.

Looking at the 100 worst trading days for stocks since 1998, bonds only returned negative on 17 of them, showing that bonds have served as a productive hedge asset for over 80% of the time.

But if you look back to 1998, that relationship was more precarious. Bonds were more likely to have performed negatively on the down days for stocks as well, as bonds were down on 65 of those worst 100 days for stocks.

Interestingly, commodities have had the opposite experience.

Since 1998, commodity returns have been in line with those of stocks, declining on 84 of the 100 worst trading days for stocks. But before 1998, commodities were only down on 53 of those worst trading days for stocks, being in some ways even better diversifiers than bonds.

Commodities have experienced a brutal bear market for much of the past decade. There was not much inflation, and the structure of the commodity futures market was in contango so that the cost of running futures contracts eroded any gains to be made on spot prices.

Over the past six to seven months, and particularly in 2021 to date, commodity prices have rebounded significantly, with supply constraints and reopening demand creating the perfect mix of upward pressure on commodity prices.

Market dynamics appear to be shifting such that bonds may lose some of their historic dominance as the preferred portfolio diversifier. Commodity and managed futures strategies that rely heavily on commodity exposures are two places where investors can look for new diversifiers in this changing macroeconomic regime. For two possible solutions, consider the WisdomTree Enhanced Commodity Strategy Fund (GCC) and the WisdomTree Managed Futures Strategy Fund (WTMF).

Originally posted by WisdomTree, 6/21/21

Significant risks associated with this article

No level of diversification or non-correlation can ensure profits or guarantee against losses. GCC: There are risks associated with investing, including possible loss of capital. An investment in this Fund is speculative, involves a substantial degree of risk and should not constitute the entire portfolio of an investor. One of the risks associated with the Fund is the complexity of the various factors that contribute to the performance of the Fund. These factors include the use of commodity futures contracts. Derivatives can be volatile and may be less liquid than other securities and more sensitive to the effects of various economic conditions. The value of the shares of the Fund is directly linked to the value of forward contracts and other assets held by the Fund and any fluctuation in the value of these assets could have an adverse effect on an investment in the shares of the Fund. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.

Commodities and futures are generally volatile and not suitable for all investors. Investments in commodities can be affected by global market movements, changes in interest rates, and other factors such as weather conditions, disease, embargoes, and international economic and political developments.

WTMF: There are risks associated with investing, including possible loss of capital. An investment in this Fund is speculative, involves a substantial degree of risk and should not constitute the entire portfolio of an investor. One of the risks associated with the Fund is the complexity of the various factors that contribute to the performance of the Fund, as well as its correlation (or non-correlation) with other asset classes. These factors include the use of long and short positions in commodity futures, forward currency contracts, swaps and other derivatives. Derivatives can be volatile and may be less liquid than other securities and more sensitive to the effects of various economic conditions. The Fund should not be used as a proxy to take only long (or only short) positions in commodities or currencies. The Fund could lose significant value during periods when long indices only rise (or short indices only) fall. The Fund’s investment objective is based on historical price trends. There can be no assurance that these trends will be reflected in future market movements. The Fund generally does not make intra-monthly adjustments and is therefore subject to substantial losses if the market moves relative to the Fund’s established positions on an intra-monthly basis. In markets without sustained price trends or in markets that reverse quickly or “in a gust of wind”, the Fund may experience significant losses. As the Fund is actively managed, the ability of the Fund to achieve its objectives will depend on the efficiency of the portfolio manager. Due to the investment strategy of this Fund, it may make higher capital gains distributions than other ETFs. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.

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Investing involves risks, including possible loss of capital. Foreign investment involves currency, political and economic risks. Funds that focus on a single country, industry and / or funds that focus on investments in smaller companies may experience greater price volatility. Investments in emerging markets, currencies, fixed income securities and alternative investments carry additional risks. Please see the prospectus for a discussion of the risks.

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