This is the view of Ed Smith, global strategist and co-head of REMAP at Canaccord Genuity Wealth Management, who says the topic is one that is high on Canaccord’s agenda. While not writing off the diversification properties of bonds entirely, Smith believes that will have a smaller diversification role to play in the near term.
“You can rely on them to do so [be negatively correlated to equities] when equities sell off because of growth concerns, so they still have a place, but it is a much reduced place because there will be equity market sell offs that are driven by an unexpected tightening of monetary policy or an unexpected rise of inflation and in those examples equities and bonds will sell off at the same time.”
In a bid to combat this, Smith says Canaccord has been looking for investments that not only have a low correlation to both equities and bonds, but also generate a positive return regardless of the overall direction of growth assets.
Two examples of this type of investment are infrastructure and currencies.
Infrastructure
Smith says the structural case for infrastructure is built around the significant misallocation of capital that has taken place over the last ten years, particularly in the UK and Europe.
“Governments now need to try and encourage investment in infrastructure which has been woefully under-invested in but, at the same time, they are struggling to rein in their own budgets so they are offering them in public private partnership type models at quite attractive rates of return.”
However, he is quick to caution that from a UK investor perspective many of the vehicles through which one might access this market, for example infrastructure trusts, are now trading at quite large premiums.
“If you already own them it is probably worth hanging on to them, but as an entry point today it is probably less attractive,” he said.
But, an area that the group is investigating at the moment are master limited partnerships that invest in infrastructure in the US.
“These are funds that invest essentially in the so-called 'toll roads' of the US energy revolution and could be quite a good inflation hedge as well, because if there is anything that could kick start the US economy is the ripple effects of this energy boom,” he added.
Currencies
Currency markets can also hold some of the alternative diversifiers, Smith says, but points out that, in such a context these markets are all about relative dynamics rather than absolute direction.
An example of such a trade would be the group’s long US dollar versus Canadian dollar position.
“The Canadian economy is in quite a fragile state in our opinion. The last time the Canadian government tried to raise rates in 2010, 2011 the economy nearly fell over, and they had to back track so the likely path of interest rate differentials means capital is likely to start flowing out of that country in the near future,” he explained.
