The correction in late spring wiped out all of the gains from a buoyant first half of the year. From the height of the market on 22 May to its bottom on 24 June, the MSCI World index lost 10.31 per cent. In such markets, convention would have it that bonds would post gains, yet the iBoxx Sterling Gilts All Maturities index fell 3.93 per cent.
Performance of indices
Source: FE Analytics
Although the stock market has recovered from its June lows, the question remains – is there any way to protect a portfolio from market falls?
Nangle (pictured) says the answer is no – in the short-term at least. "May and June is when you saw things correlate to a level you wouldn’t expect," he said.
"The only things that didn’t fall in June were Japanese equities and cash. That was it."
"Bond yields will be rising as QE ends. The idea of a portfolio that holds bonds and equities as automatic diversifiers – that case is weaker. We cannot take for granted the strong negative correlation between bonds and equities from here."
He adds that another knock against the diversification model was the US Federal Reserve’s announcement that it would taper quantitative easing towards the end of this year.
"The prospect of getting this [inverse] relationship [between bonds and equities] to continue is challenged," he said.
However, Nangle believes that much like the credit collapse of 2008, this phenomenon is the exception rather than the rule.
"It can be quite hard to escape a pickup in correlation over the short-term, but over the longer term we think we will see less correlation and volatility. To get true diversification, we are trying to find things that aren’t directly correlated that can drive returns."
"Active management is an absolute pre-requisite to managing that sort of environment," he added.
Nangle says "dynamic" asset allocation is needed to capture the strongest returns possible while keeping a lid on the volatility that has become a mainstay in the markets.
Mark Burgess, chief investment officer at Threadneedle, says the firm has been consistently more cautious than the majority of asset managers, but that it is beginning to see signs of life in the wider economy.
It is particularly bullish on the US, especially on its housing market, the collapse of which was the catalyst for the global economic crisis five years ago.
However, he says a resurgence in property will mean a boost for the US jobs market, which can continue to drive consumer spending.
Burgess admits rising bond yields could derail the housing recovery, although he doesn’t expect that to be too much of an issue. He says Threadneedle has added to its property exposure for the first time in five years, and not in obvious areas either.
"We’re very underweight central London," he said. "It’s expensive and bought up by foreign money. We think all that will come to an end."
The firm’s property exposure is driven by a need for income, so the team is looking for yields of 7.5 per cent – higher than the market average of 6.5 per cent.
"Property has been underperforming for quite a long time. But the distress signals from the banking sector are coming to an end because they have recapitalised themselves," he said.
"We’ve increased our weighting to UK domestic property because with yields at 6.5 per cent, given interest rates and bond yields, it’s quite interesting."
"We had been underweight for five years, but property has changed quite significantly. It’s already difficult to get money in because a lot of people are trying to do the same thing."
In other asset classes, Nangle points out the market is still waiting for the impact of QE to follow through.
He says that after the first round of quantitative easing, there was a huge rebound in equity multiples, the second round caused a rebound in earnings per share and the third round, combined with measures from the European Central Bank, led to a large move higher in multiples.
Now, Nangle says, a rebound in wage growth should be the final piece of the puzzle.
"We’re now looking for earnings to come through," he continued. "They won’t be double digits, except in Japan, but we are confident they will come through."
"We expect to have not seen a big boost to earnings from QE2 and QE3, but expect earnings to grow in all major markets."
