She says the realisation from policy makers that QE does not work as intended has led to an increased focus on higher growth and higher spending from governments, and that as a result inflation will be higher.
Sunil Krishnan, multi-asset investor at Aviva Investors, says bonds will behave as a diversifier in most economic conditions, and so “will always have a role in portfolios."
He says: “In a scenario where growth disappoints a bit, and so the expectation is that monetary policy will be looser, it is hard to imagine a better diversifier than government bonds, and that scenario happens reasonably frequently.
"The thing is, you don’t need to have something that is completely uncorrelated to equities to be a diversifier, it just needs to not be totally correlated, and government bonds are not totally correlated.”
Alain Forclaz, deputy chief investment officer for multi-asset at Lombard Odier, says that while bond yields have risen in recent months, they are actually only about where they were at the start of 2020, and were much lower in the initial months of the pandemic, showing that bonds still do act as a diversifier, with prices rising at times of maximum economic stress and then selling off when economic conditions improve.
But he says that, at the present time, with risks around inflation being much higher than growth, a scenario many call stagflation, government-bond holdings will perform poorly, and that as this is only one of a range of possible outcomes, it is prudent to continue to own bonds as a hedge against the other outcomes.
In terms of the diversification options in a stagflationary world, Krishnan says absolute return funds can replace some of the bond allocation.
James De Bunsen, who runs the Janus Henderson Diversified Alternatives fund, says that if we do get a profound and long-lasting change in how markets perform, investors should be pretty confident that the assets that have done well over the past decade, across multiple asset classes, will not be the ones that perform well in future.
He says the assets that have performed well over the past decade can be grouped together as “long duration”, and such assets perform best when interest rates are low. If rates are rising from here, this should imply that shorter-duration assets – those that are more cyclical – will perform better in the coming years.
This implies that assets such as banks and mining companies would do well.