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Research Review: Are Long-Duration Treasuries the Best Hedge for Equities?

Echo to this research, Treasuries are a good equity hedge but required active investment discipline. Traditional static allocation through long-duration Treasuries might be hurtful when the curve is flat and during the ultra-low yield era.

First, we should notice that relatively lower inflation expectation in the past 3 decades leads to a positive correlation between Treasury yields and equities. We have seen, during the most stressful market downturns, Treasuries provide a loss cushion, and the protection is more significant with longer-duration bonds during quantitative easings.

Second, while the pre-crisis bond allocation might be more duration-forgiving, this research shows that long-duration bond yield might bounce back faster and higher post-crisis and be hurtful. We have seen the ultra-low yield and flat curve era during COVID-19, and 10-year US Treasury yield hit 1.7% from 0.5~0.7% range within a matter of months. The uplifting trend might keep going, and you don’t want to hold large interest-rate exposure.

Federal Funds Rates 2004/01~2021/04

We can say inflation remains the key factor for bond duration adjustment for hedging. Yet, we believe the curve shape has a strong indication of hedging cost, which we implement into our capital management practice.

Are Long-Duration Treasuries the Best Hedge for Equities?The Journal of Portfolio Management, 47 (6)

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