How to prepare for the end of the bond bull market

2 mins. to read
How to prepare for the end of the bond bull market

Traditionally investors have been able to diversify fairly simply by using a mixture of bonds and equities, but with the world’s central banks starting to reduce liquidity there is a good chance that both asset classes will weaken in unison. Many alternatives also look vulnerable, which creates a major challenge for fund investors who want to protect their portfolios.

Bond guru Bill Gross has recently tweeted that the bond bear market has been confirmed by the break of 25-year trendlines in the 5 and 10 year US treasury markets. Other respected bond investors such as Jeffrey Gundlach, CEO of Double Line Capital, believe that the bear market is on the horizon.

The problem is that the policy of low interest rates and Quantitative Easing employed in the US, the UK, Europe and Japan has bolstered asset prices right across the board from equities and bonds, to property and other alternatives. Now that QE is being scaled back and interest rates are on the rise there is a real headwind for all of the major asset classes. This will make life more difficult even if you don’t expect a major correction.

There was an interesting discussion on how to deal with all this published by Hawksmoor fund managers, whose updates are always worth reading. Their Hawksmoor Vanbrugh fund aims to generate positive real returns and preserve capital by investing in a diversified portfolio of investment trusts and open-ended funds, which mirrors the aim of many long-term private investors.

Hawksmoor have taken a series of steps to further diversify their portfolio in recent months. This has included reducing their exposure to highly leveraged investment trusts, investing in gold equity funds and certain absolute return funds, and minimising their holdings in long-dated bond funds that would be the most vulnerable in the event of rising yields.

They also looked at but dismissed buying put options as a form of portfolio insurance because of the high cost and rejected the idea of liquid alternatives funds that use strategies such as merger arbitrage, volatility arbitrage, and relative value long-short positions.

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Instead they decided to open a small position in two managed futures funds: Garraway Financial Trends and Natixis ASG Managed Futures. These sorts of funds aim to identify and profit from price trends across many different asset classes over various time horizons for as long as those trends persist. They use sophisticated computer algorithms to buy into and out of these markets using the associated futures contracts that are cheap to trade and highly liquid.

Hawksmoor point out that at turning points in markets, managed futures funds are likely to perform poorly temporarily and they could be very volatile, but they should perform well during a persistent market correction without costing them much while they wait for better opportunities to come along.

Most private investors would probably feel uncomfortable with this sort of holding so the best way that they can reduce risk would be to follow Hawksmoor’s example and allocate a sufficient weighting to gold funds, short-dated bond funds and absolute return funds. They should also not underestimate the value of cash during periods of heightened market risk despite the negative real return.

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