HSBC Asset Management’s flagship £11.5bn multi-asset fund range has ditched some of its bond allocation in favour of alternative strategies designed to offer true diversification away from equities, according to Nick McLoughlin, head of UK managed fund solutions and global head of research at the firm.
Bonds have had a wretched run this year and things have gone from bad to worse recently with the UK 10-year gilt yields hitting their highest level since 2008 this week.
The sell-off in bonds has been global, driven by inflation fears, heavy government borrowing and, most recently, renewed conflict between the US and Iran.
For long-term bondholders, that has meant capital losses for an asset that is supposed to be the safe half of a portfolio. The fact that equity markets have started to sell off too raises questions as to whether the asset classes are negatively correlated, the theory that multi-asset 60/40 portfolios have been built upon.
Broadly, for most of history, when equities have fallen central banks have cut rates and bond prices have rallied. This has led to negative correlation and given investors a sense of safety in their portfolios.
However, that relationship broke down in 2022, when inflation became a persistent problem. It was “the perfect storm for 60/40”, said McLoughlin and has yet to be unwound.
“These days, [central banks] can't cut rates because it's either an inflation problem or something else going on,” McLoughlin said.
As such, he has decided to pivot to defensive strategies in an effort to balance out the risk portion of the fund range.
These defensive strategies include a gold position, a currency trade that buys the yen, Swiss franc and dollar against higher-beta currencies such as the Australian and Canadian dollars, an interest rate volatility strategy, an equity volatility strategy, systematic put options and a trend-following strategy that sells equity futures once markets start falling.
“In normal times, it should be quiet and stable,” McLoughlin said of the combined strategy. “But if we enter a period of volatility or equity drawdown, we're hoping that these strategies will produce sufficient convexity to protect the portfolio, in the same way fixed income would have done five, 10, 15 or 20 years ago.”
Gold has a longer-term case going for it as well, independent of its role as a portfolio hedge. The manager expects central banks to keep reducing their reliance on the dollar as a reserve currency over time, which should support the gold price structurally. Over shorter horizons, though, he was more cautious, given how sharply the price has already moved.
“[Gold peaked] at $5,000, went down to $4,000, we're now about $4,500,” he said, referring to the price in dollars per ounce. “Eighteen months ago a client was joking, saying: 'Do you think gold will reach $3,000?'”
The scale of that move, “warrants a bit of caution” over the near term, even if the structural case still holds.
Commodities were the other side of his diversification case, with the team running a basket approach across energy, industrial metals, agriculture and precious metals.
McLoughlin was particularly constructive on energy, which is the most directly tied to the current backdrop: futures curves are in “quite nice backwardation [when the current price of a commodity is higher than its future contract prices],” McLoughlin said, which gives the position a favourable carry profile regardless of whether prices ease if the Iran conflict is resolved.
Industrial metals are being supported by demand from infrastructure building, including AI data centres, while agricultural prices are up due to El Niño-related weather patterns affecting crop yields.
“It's not just an oil story or a gold story,” he said. “The breadth of performance is there in commodities.”
Even more broadly, the World Selection portfolios are tactically steering away from credit and towards equities.
The manager is running a roughly 4% overweight to equities against its neutral allocation, funded by trimming credit: a 2% underweight each to investment grade, high yield and hard-currency emerging market debt, offset by a 2% overweight to local-currency emerging market credit.
“We're quite clear that that's something we've reinforced more recently, reducing our investment grade and high yield exposures, and increasing our equity weight,” McLoughlin said.
The team has also been adding risk within emerging markets (EM) specifically, shifting around 4% of the portfolio across equities, currencies and bonds combined, out of developed markets and into the region.
Within that EM allocation, the moves have skewed towards higher-risk, higher-beta names: the fund holds an overweight to the South African rand against an underweight to the lower-volatility Polish zloty, for instance, a trade McLoughlin frames as adding EM beta rather than simply adding EM exposure.