Fair value, Swiss francs and other factors to consider when going defensive

By Mark Preskett, portfolio manager, Morningstar Investment Management Europe

Added 21st June 2016

With sovereign bond yields back down to record lows, it again casts the spotlight on how to invest for a defensive client.

Fair value, Swiss francs and other factors to consider when going defensive

Should advisers be allocating a large proportion of assets into gilts and cash while locking clients into negative real yields in the process? What should be classified as a defensive asset in this low yield world? This is a question we at Morningstar’s investment management group have been wrestling with for some time.

As a result of the low yields on offer, we’ve been running an underweight fixed income stance throughout 2015 and 2016, raising cash levels and favouring alternatives within our discretionary portfolios. However, we’ve stopped short of selling all government bonds and we continue to recommend investing a portion of client assets in fixed income funds. Indeed, for our lower risk clients, bonds still make up the bulk of our recommended allocation. For some asset allocators outside Morningstar though, the answer has been to aggressively move their portfolios out of fixed income markets and into alternatives.


As a general rule, long-term government bonds are negatively correlated to large-cap stocks. There will be periods when the two asset classes move together (such as in the taper tantrum of 2013), but over the long term, they will tend to move in opposite directions.

This is an extremely powerful tool for asset allocators. Combining asset classes with negative correlations can provide investors with superior (risk-adjusted) returns and help dampen the volatility of the overall portfolio.

Even with bond yields at their current low levels, the propensity for bonds to move in opposite directions to equities continues to be demonstrated. Difficult quarters, such as Q3 2015 and Q1 2016, saw equity markets fall and government bond markets appreciate.

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