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.
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)
https://jpm.pm-research.com/content/early/2020/09/13/jpm.2020.1.182
