The diversification role of fixed income securities and forward-looking implications for asset allocation
Abstract
Investors are concerned about the rising rate environment and the role of bonds in multi-asset portfolios. The primary role of bonds is not to produce high returns, but to act as a shock absorber in times of equity market stress. History suggests that high-quality bonds act as ballast for the portfolio in both high and low interest rate environments. Also, by applying unsupervised learning techniques to periods when rates were low, we show that government bonds have historically acted as intended in an equity-bond portfolio, performing positively when equities have fallen. Although in some periods both equities and bonds fell, this can be considered part of market volatility and distinctly different from recurrent market states. Amid low but rising interest rates in the U.S., investors may benefit from non-U.S. fixed income. This can offer diversification because of imperfect correlations of interest rate movements in other countries. Also, when we use our portfolio construction models to build an optimized portfolio, we find that certain high-yielding assets, such as U.S. high-yield corporates and emerging market bonds, enhance the portfolio’s risk-adjusted return.
Bio
Giulio Renzi-Ricci is head of asset allocation for Europe in the Investment Strategy Group, specializing in multi-asset portfolio construction, single fund solutions and econometric forecasting. His research has covered topics on factor investing, active-passive blending, dynamic portfolio optimization and ESG investing. His research has been published in The Journal of Investing and The Journal of Portfolio Management. Before joining Vanguard, Giulio worked at NERA Economic Consulting where he provided expert analysis on financial derivatives pricing, hedge fund litigation, market efficiency testing and the suitability of trading and investment strategies. Before that, he was a fixed income structuring analyst at Banca IMI in Milan. Giulio holds a MSc in financial economics with distinction from the University of Warwick and a BSc in economics and finance summa cum laude from Bocconi University.
