Central banks have shifted to a new regime of easy monetary policy, thus reducing expected bond returns. As negative yielding debt increases alongside stock-to-yield valuations1 to all-time highs, gold may become an attractive and more effective diversifier than bonds, justifying a higher portfolio allocation than historical performance suggests.
Re-optimising portfolio structures for lower future expected bond returns2 suggests investors should consider an additional 1%-1.5% gold exposure in diversified portfolios.
High risks and low rates
Investors are facing:
- an environment with flat to inverted yield curves (Chart 1) – often a signal of an impending recession;
- stock valuations at extreme levels, particularly when compared to the level of interest rates (Chart 2), that has historically preceded meaningful stock sell-offs; and
- an increasing set of geopolitical concerns, including trade tensions, Brexit and Middle East turmoil. Within this context we believe that there are clear indicators for higher levels of safe-haven assets like gold.
But portfolio allocation should not be limited to safe-haven concerns, as expected future returns from extremely low or negative yielding bonds (Chart 3) could weigh on the overall performance as well. Our research suggests that lower expected bond returns favour additional gold exposure in well diversified portfolios. As bond yields fall, diversifiers with higher potential returns, like hedge funds, real estate and private equity, carry heavier weights in optimised portfolios. Our analysis also suggests that the historically higher volatility that accompanies these alternative investments, versus other assets such as stocks and bonds, 3 warrants increasing allocations of gold to serve as a ballast in the event of a stock market pullback.