Stock Rebound Raises New Question: How to Hedge With Zero Yields
Stock Rebound Raises New Question: How to Hedge With Zero Yields
(Bloomberg) -- Government bonds proved they still served handsomely as a portfolio hedge earlier this year, when equities plunged into a bear market.
But now that stocks have made their epic comeback, the question of whether the time-honored strategy works in an ultra-low yield environment has returned. It’s made all the more pressing by the slide in U.S. Treasury yields to previously unplumbed levels, with 10-year rates below 1% and two-year ones unlikely to offer inflation compensation for years to come.
So in place of the traditional 60% equity, 40% bond template, Morgan Stanley strategists are promoting a new 60/40 approach. For the 40% part of the basket, they suggest using a screening method known as COVA, or the “correlation-valuation framework.” COVA aims to identify assets with low correlation and low volatility to stocks.
“A 60/40 stocks/COVA portfolio has historically provided better risk-adjusted return (0.5x) when compared to a 100% equity portfolio (0.4x),” Morgan Stanley strategists including Wanting Low and Andrew Sheets wrote in a note June 8.
The approach does better than other common hedges such as long Japanese yen or long equity volatility, the strategists wrote.
The filter currently suggests bets including short positions on emerging-market currencies like the Russian ruble and South African rand. Volatility in euro/dollar, dollar/Korean won and the Euro Stoxx 50 Index also do well, the strategists wrote. Credit stands out as offering reasonable long-term returns, they said, particularly lower-quality.
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