Bonds Don’t Need to Be Negatively Correlated with Equities

Abstract

The current narrative that bonds no longer diversify equities because of low yields and a potential shift in bond-equity correlation fails to consider the relative importance of bond volatility in reducing overall portfolio volatility. Bonds will continue to provide diversification if bond volatility is lower than equity volatility, even if the correlation is positive. While better outcomes can be achieved under negative correlation, this is secondary to the impact of relative volatility.

Key Findings

• ▪ The current narrative that bonds no longer reduce portfolio risk because of low yields and a potential shift in bond-equity correlation fails to consider the relative importance of bond volatility in reducing overall portfolio volatility.

• ▪ The role of bonds in the portfolio is to provide volatility reduction. Bonds will continue to lower portfolio volatility if bond volatility is lower than equity volatility, even if the correlation is positive.

• ▪ While better outcomes can be achieved under negative correlation, this is secondary to the impact of relative volatility.