Why low bond yields may mean you need to rethink your portfolio construction.

The future looks even more uncertain than usual. Normally uncertainty translates into lower asset prices. But not this time. And with the prices of all assets buoyed by abundant liquidity, we fear a traditional ‘diversified’ portfolio is not going to be much protection in the next market convulsion.

In particular, we believe that conventional bonds will provide neither acceptable returns in good times, nor much protection in a downturn.

This will be a shocking contrast to the last 40 years. Interest and inflation rates have been falling steadily since 1981 (according to Bloomberg data). The result has been that an investor combining equities and bonds has received excellent returns from both. Better still, when the equities fell, the automatic response of central banks has been to cut interest rates. This conveniently boosted the bonds just when the equities were suffering. The result was that the risk-adjusted returns, the returns adjusted for sleepless nights, from a traditional portfolio containing both assets was particularly attractive.