Fixed income is no longer a hedge – unless it’s active
April 30, 2025
-
5 min read
First published by The Business Times, Singapore
Investors with exposure to US equities have been richly rewarded in recent years, until recently.
Much of that outperformance, however, had been reliant on a handful of technology stocks: at one point in 2024 the so-called Magnificent Seven – a grouping of the biggest tech companies – accounted for 30 per cent of the S&P 500.
But the wild volatility in markets, in the wake of a new tariff regime announced by US president Donald Trump, has shown just how fragile these rich valuations can be.
Initially it was developments such as the emergence of artificial intelligence challenger DeepSeek that had begun to bring the prospects of US tech stocks into question.
But then came the hammer blow of a tariff-driven trade war, combining with already long-running geopolitical worries to create a potent mix of volatility triggers.
In this environment, fixed income might be thought to offer a source of diversification. But investors looking to add this to their portfolio need to ensure that they are getting true diversification, not simply more of the same.
That’s because the way in which markets behave has changed.
For decades, as rates and yields fell, bond prices rose and the fixed income asset class was a reliable hedge for riskier assets like stocks.
But when inflation returned in the last few years, interest rates and market volatility soared with it. And while rates are now falling, there is little to suggest that the world is about to become much less volatile – whether because of geopolitics, climate change, ageing populations, and now the added chaos of a trade war being waged on multiple fronts. The character of sovereign bonds as safe haven assets is now very much up for debate.
Equities are now feverish. On Apr 8, the Nasdaq Composite closed nearly 21 per cent down from the start of the year, before recovering to about 13 per cent down as at Apr 11.
But this is not just a tech supply chain story. In an indication of how broad the tariff sell-off has been, the S&P500 was down nearly 9 per cent year-to-date as at Apr 11, having closed more than 15 per cent down on Apr 8.
Asian investors have not been spared at home either. As at Apr 11, the Nikkei 225 is down nearly 17 per cent this year, and of the major Asian equity indices, only the Hang Seng is now trading up year-to-date.
In times of stress, fixed income has not always proved to be a reliable hedge. After all, in 2022 the asset class experienced its worst year in more than a century.
And the volatility driven by the current tariff-fuelled trade war has even seen the yields on 10-year US Treasuries gyrate in ways that have worried investors around the world.
In that environment, investors are faced with few obvious safe havens, and they should be in no doubt that the negative correlation of stocks and bonds is no longer assured.
That means fixed income can no longer be relied upon to cushion investors against problems elsewhere. The shock absorber isn’t working.
The rates dynamic
What to do? Wealth investors in Asia have largely been able to ignore inflationary pressures for the last 30 years, but the current still elevated inflationary environment is leading many investors to consider hedging strategies more than in the past.
Those wanting to hedge or diversify might understandably look to fixed income, particularly at a time when there are high yields to capture. But they should consider their approach carefully.
As shown by the recent experience of equity investors, a passive approach may provide unpleasant surprises.
Executed carefully, however, an investment in fixed income now could be a timely move – particularly if buyers adopt a strategy that is anchored in the active management of high-quality fixed income assets, a flexible approach to duration, and low volatility. Done right, fixed income really can be an alpha hedge.
Global investors had already driven record moves into bond funds in 2024, with US$600 billion of inflows as they looked to capture the highest yields seen for years. The ability of central banks to cut rates as inflation fell has provided the prospect of turbocharged returns.
This dynamic may be reaching its natural end. Broadly, economic conditions did not allow as many rate cuts in 2024 as had been expected, and early in 2025 steep cuts had been looking even less likely, making the outlook for duration far from certain.
But trade wars do not leave economies unscathed, and with talk of recession beginning to be heard in markets again, rate cuts may be back on the agenda sooner rather than later. Investors must also be mindful of stagflationary scenarios, in which central bank actions are much more limited.
True diversifier
Either way, current trends suggest that the positive correlation seen between fixed income and equities in recent times may well continue – something that has a big impact on investors hoping for fixed income to be a diversifying hedge against their equity worries. Things may not be so simple.
Today it is not obvious that passive fixed income investment will give you the diversification hedge you are looking for. Active management allows the flexibility to capture opportunities as they emerge, and just as importantly it also allows you to pivot quickly to alternative options when market dynamics shift.
A strategy that focuses on government bonds but with an overlay of additional alpha generators could be an excellent way to generate a cash-plus return in a variety of different conditions.
To be successful, this means managing volatility through the whole cycle. That could, of course, mean sacrificing some upside in the good years, but it also avoids much of the downside of bad years.
Strategies that are particularly liquid will be better placed to capture opportunities, since they can shift positions quickly depending on appetite – the market dislocations at the start of the Covid pandemic showed the value of liquidity.
For fixed income to be of most use as an addition to an investor’s portfolio today, it should be a true diversifier – that means being not only uncorrelated with equities, but also with other major fixed income asset classes.
An active approach to fixed income allows you to intelligently balance the probabilities. Passive investments are more likely to end up with one concentrated view.
That’s one reason why the pivot towards flexible liquid fixed income strategies is playing out across the globe.
Asian investors who have watched nervously as their equity portfolios have suffered would do well to become more active in fixed income.
