Risk and Portfolio Construction

Equity/bond correlations - past and future

The most important number you rarely think about

For most of the 21st Century, equity and bond returns have been negatively correlated, allowing multi-asset investors to rely on their complementary behaviour to moderate volatility and drawdown risk. However, history shows that this period of stability is an exception to the rule.

Classic equity valuation models, such as the "Fed model", actually assume a positive correlation between equity and bond yields. For most of the 1800s and 1900s, this was generally true, so the most recent era, from 2000-2016, was highly unusual.  

As the direction of monetary policy changes, how will correlations be affected? Below we list some of the best papers, curated by the Savvy Investor research team, which explore stock-bond correlations in more detail:

Correlation graph

Balanced portfolios: Safer without bonds? (Hermes IM, Jan 2018)
Investors in balanced portfolios have previously been able to rely on the complementary behaviour of stocks and bonds to moderate volatility and drawdown risk. However, this may be the exception to the rule.

Stock/Bond Correlations: Relationship Troubles (UBS AM, Feb 2018)
UBS's Investment Insights document considers the correlation between bonds and equities, its drivers and the possibility that the present day is a new and higher correlation regime.

Do bonds diversify equity risk? (Wellington, Feb 2017)
Due to higher correlations of government bonds to equities, the risk mitigating benefit of holding these assets has diminished. Wellington believes investors should consider using alternative strategies for risk diversification.

Stocks/Bonds: The Fire and Ice Debate (Man Group, March 2017)
There have been negative correlations between bond and stock prices for the last 20 years, yet for the previous 250 years this correlation was consistently positive. Man Group investigates why this is the case.

A Century of Stock-Bond Correlations (RBA, 2014)
This study by the Reserve Bank of Australia examines stock and bond correlations and their drivers in order to draw conclusions about changes in correlation over time.

The equity-bond correlation - the most important number you rarely think about (AON Hewitt, 2014)
The stock-bond correlation is a vital assumption.  AON Hewitt models correlations in this paper dynamically, in order to capture the range of outcomes they can take and their variation over time.

Trends in Stock-Bond Correlations (RIETI, 2015)
This paper discusses long-run trends in co-movements in stock and bond market returns, examining the impact of stock market volatility, interest rates, yield spreads, VIX and flight to quality behaviours upon equity/bond correlations.

Treasuries for the Long Run (Callan, Jan 2018)
With many asset owners considering an allocation to long-term Treasuries, this paper by Callan reviews historical data and concludes that long-term Treasuries have a mixed record of offsetting equity risk.

Science and Art: A Framework to Unlock Multi-Asset Opportunities (AB, 2017)
(For compliance reasons, this paper is only accessible in North America and South America)
Unconstrained, dynamic, integrated multi-asset solutions must be developed to address unwanted risk/return exposures and other asset allocation issues that arise from simple off-the-shelf portfolio combinations.

Two-Dimensional Risk Models Create Full Picture (William Blair blog, Feb 2018)
William Blair uses two proprietary, forward-looking risk models to guide portfolio construction. This article explains how they quantify the present day unusual risk environment.

Inflation and the Stock Market: Understanding the 'Fed Model' (Bekaert and Engstrom, 2008)
In the US, high expected inflation has coincided with higher equity yields. This study shows that countries that frequently experience stagflation often have high correlations between bond yields and equity yields.

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