As John F. Kennedy said in his state of the union address in 1962, “The time to repair the roof is when the sun is shining”. With eight years of quantitative easing still compressing yields and inflating valuations, the sun still seems to be shining on pretty much all asset classes. In the first half of the year passive exposure to equities and government bonds returned 7.1%1 and 4.5%2 respectively. But confidence among asset managers in the sustainability of this move in risk assets appears stretched. The recent 20% peak-to-trough decline in the oil price has reopened the cracks in the high yield market, undermining expectations in credit more generally, but the government bond move speaks of a deeper unease. US 2yr notes are close to the highs in yield on the year, while the long end has rallied, flattening the curve by some 50bps since March.
In the very big picture, we believe forward returns on traditional assets simply do not square with the needs of ageing populations, but there are also concerns in the shorter term. A notable and rising proportion of our clients are thinking about ways to help protect against future volatility (the vogue terms are ‘Crisis Risk Offset’, ‘Tail Risk Protection’ or ‘Crisis Alpha’). We believe that this kind of fixing the roof deserves closer attention.