Unlocking Volatility Hedges for Equity Markets

In an update to a piece that we originally published February 27, we believe strongly that investors should continue to seek out strategies that can capitalize on the negative correlation between equities and fixed income.

As the economic cycle ages, fears of equity market drawdowns and the need for hedges are discussed more often.

Some investors see challenges to hedging, often pointing to bond yields that are negative after inflation and concerns over “expensive” equities.

But we increasingly believe interest rates are going to stay low for longer.

Our Senior Investment Strategy Advisor, Professor Jeremy Siegel, believes bonds have increasingly become the “negative beta” defensive hedge asset of choice.

We see this on days when stocks are volatile: interest rates tend to go down (which means bond prices climb higher).

We tip our hat to the Wall Street Journal’s Daily Shot email, which recently published a chart showing that bonds’ inverse correlation to stocks is about as strong as it’s ever been. We recreated it using index-level data below to illustrate the point.

20-Day Correlation: S&P 500 Index vs. ICE U.S. Treasury 7–10 Index 

For definitions of terms in the chart, please visit our glossary.

A Late-Cycle Solution

In August 2018, we launched the WisdomTree 90/60 U.S. Balanced Fund (NTSX) to capitalize on this phenomenon.

For every $100 invested in NTSX, the fund has $90 of equity exposure and $10 of U.S. dollar-denominated collateral combined, plus $60 of bond futures¹  exposure.

We believe the negative correlation bond trend adds to the total diversification NTSX provides compared to a traditional 100% equity fund.

The roots of this portfolio approach go back a quarter century, when Cliff Asness first wrote about a levered 60/40 offering better diversification and more return potential than a 100% equity position.

While there are decades of historical research on this topic, the 1.5+ year live track record for NTSX shows how the Fund can add value. 

Cumulative Returns of NTSX vs. Stocks & bonds: 8/2/18–3/31/20

For standardized performance of NTSX, please click here.

Have Your Cake, and Eat It Too

Without much in the way of real return, the primary role of bonds is to hedge against stocks. We believe the negative-beta hedging characteristic that bonds offer further strengthens the case for NTSX as a substitute for pure equity beta today.

¹Bond futures refers to a contract that reflects the expected future value of the underlying instrument, which in this case is the price of U.S. Treasuries.