KEVIN COUSINS | Safe havens are changing — is your portfolio keeping up?

Recent IMF research highlights that global bonds have become less effective in mitigating volatility since the start of the Covid-19 pandemic. Traditionally, bonds have been seen as a key diversifier in the traditional 60-40 portfolio (60% equities, 40% bonds), with bond gains offsetting equity declines. However, more recently, as bonds have moved more in line with stocks, global bonds are no longer effective equity hedges. Our research in 2021 and early 2022 reached similar conclusions, making us rethink the nature of safe-haven assets in our global portfolios.

This may prove anathema to a whole generation of investors who have grown up in a world in which US long bonds are the exemplary safe-haven asset. However, a bit of historical perspective is helpful. The popularity of US long bonds as a portfolio diversifier was cemented over the 40 years from 1981 to 2021, when US bond yields trended downwards. The annualised total return over this period was about 9%, compared with CPI averaging 2.8% a year, resulting in strong real returns. Since the equity market crash in 1987, bonds have also displayed strongly uncorrelated performance when risk assets are sold off. This is driven by the “Greenspan put”, as investors anticipate monetary policy easing by the US Federal Reserve in response to economic or market stress. When investors fear a looming recession, large purchases of bonds take place as portfolios load up on “insurance”.

Most investors believed that the negative correlation between equities and bonds was just how markets worked, perhaps because it was the only environment they had experienced. Taking a longer-term view, there clearly have been long periods of positive correlation as markets are in a “supply-side” regime. This is when growth declines are driven by supply-side shocks (such as rising energy prices, tariffs and trade wars or wage pressures) rather than demand-side shocks. Supply-side shocks are much more difficult for policymakers to deal with (they can’t just cut rates to solve the growth problem without triggering inflation), so bonds and equities can drop together.

Given poor US fiscal discipline, continued reliance on debt issuance, inflation exceeding the Fed’s 2% target rate and the weaponisation of the dollar — some of the key pillars supporting US long bonds’ safe-haven asset status — have started to erode. This was evident in 2022 when, as equity markets sold off, developed market long bonds, including US treasuries, delivered their worst performance yet. Yet, the thinking that entrenches bonds as safe-haven assets is treated as foundational in the financial industry and is seldom questioned.

The breakdown in correlations generally has some material implications for investors. Most standard risk-management practices in finance rely on historical average correlations to construct well-diversified and optimised portfolios. The underlying assumption is that historical average correlations between assets correctly describe future correlations. However, in reality, correlations tend to rise sharply during market turmoil. This wreaks havoc in multi-asset portfolios that have been quantitatively optimised based on historical average correlations.

The following quirks of the financial services industry amplify the effect of this reliance on historical data and tend to erode the efficacy of traditional safe-haven assets:

• The industry uses similar quantitative risk models drawing on similar historical data, and they are all searching for “idiosyncratic” positions to enhance portfolio resilience. Markets are dynamic, and future returns are hugely influenced by position crowding and starting valuations. This means an asset that acted as a good hedge historically may no longer behave in an uncorrelated fashion during the next big market event if it is widely owned and expensively valued.
• Many investment strategies carry significant leverage. The hedge fund industry provides one good example, with leverage near record highs. This, with client redemptions, increases the need for market participants to de-gear and sell holdings during market declines. If they have big exposure to the popular “safe havens”, these assets will correlate with the collapsing market rather than act as a hedge.
• In an increasingly fragmented world, in which inflation is likely to remain elevated, the importance of constructing resilient portfolios cannot be underestimated. However, the approaches that served investors well in the past look increasingly unlikely to work in the future. US long bonds may not serve as reliable portfolio diversifiers, and historical quantitative measures of price volatility calibrated during the secular stagnation period may be poor guides to future price behaviour. We believe constructing our portfolios with securities that are uncrowded and cheap relative to their histories is a good starting point when building resilience. In addition, the use of portfolio hedging plays an important role in ensuring we can carry enough risk assets to meet our clients’ long-term return objectives and still weather periods of market turmoil.
• The energy and gold sectors (despite the latter’s strong run in 2024 and 2025) have embedded optionality to the price spikes that typify geopolitical upheavals. Recent events provide an important reminder of the crucial role thoughtful portfolio construction and diversification are likely to play in future portfolios.

• Cousins is head of research at PSG Asset Management.