Wary investors struggle to evade market tumult

The S&P 500 has fallen 25% this year, with all three major U.S. stock indexes heading toward their worst annual performances since 2008 (Photo: AP)
The S&P 500 has fallen 25% this year, with all three major U.S. stock indexes heading toward their worst annual performances since 2008 (Photo: AP)


All three major US stock indexes are heading toward their worst annual performances since 2008, and bonds haven’t provided a portfolio ballast

This year’s market tumult has spread across risky assets and havens alike, leaving nervous investors questioning where to hide from further pain.

The S&P 500 has fallen 25% this year, with all three major U.S. stock indexes heading toward their worst annual performances since 2008. Bonds haven’t provided a ballast to portfolios—the Bloomberg U.S. Aggregate bond index is on pace for its worst year on record going back to 1976, down 16%.

“In 50 years we haven’t seen debt and equity markets fall this much in unison," said Rick Rieder, chief investment officer of global fixed income and head of the global allocation team at BlackRock Inc. “I’ve never spoken with clients so much in my life—everyone wants to know when this is going to be over."

The 60/40 model—in which investors put 60% of their money in stocks and 40% in bonds—has faltered because Treasury bonds haven’t risen the way they classically do when stocks fall. Traditional hedges haven’t fared much better. Gold, historically seen as a haven against inflation, is down 8.7% in 2022, sparking three consecutive months of outflows from precious metals funds. Part of those declines are due to the surging dollar.

Monetary tightening by the Federal Reserve has sent yields surging, hurting prices and eliminating the presumed hedge that bonds offer against stocks. The central bank has also signaled it will continue to raise rates until rampant inflation nears historic norms.

Mr. Rieder said the Fed rate increases have presented an opportunity to rotate into highly rated short-duration bonds, which now offer more attractive returns and fall less in price when yields rise. He also noted that corporate balance sheets are in the best financial condition going into an economic downturn that he has seen in his 35-year career.

“We bought a tremendous amount of one-year Treasury bonds at 4%, you’re getting paid to hold cash," said Mr. Rieder. “We love Triple-A-rated credit assets like mortgage-backed securities and collateralized loan obligations that mature in one to two years, which are offering yields between 5%-6%. Then there’s high-yield bonds offering 8%."

“This is nirvana for a fixed-income investor," he added.

Investors have parked $13.5 billion in exchange-traded funds holding Treasury bonds that mature in one to three years. The iShares 1-3 Year Treasury Bond ETF, the largest such fund, shows a more than 3.7% expected return over the next year based on a calculation of its past 30-days of returns, as of Friday.

The flows aren’t just at the short end: Investors have bought $101 billion across Treasury ETFs this year, nearly double the previous annual record, potentially betting on a reversal for bonds.

Those less willing to exit from the stock market have poured billions into equity strategies that promise lower risk, either via holding stocks that are historically less volatile, or those using protective options. Although the majority of those funds have outperformed the broader market, they are still down on the year. For that reason, some investors say those strategies lower risk more than they act as a hedge against stock market declines.

To be sure, the outlook for both stocks and bonds looks better from here, according to Roger Aliaga-Diaz, global head of portfolio construction and chief economist for the Americas at Vanguard Investment Strategy Group.

“The 60/40 portfolio has gone through a very rough time through an abnormal period," he said. “But looking forward, valuations are much more realistic and the outlook for returns has improved."

One haven that has soared while stocks and bonds have tumbled? Managed futures, which follow market trends and systematically bet on them. Such funds—dubbed “crisis alpha" for their ability to outperform during stock market selloffs—are up more than 16% this year on average, on track for the best annual performance since 2014, according to Jon Caplis, chief executive of hedge-fund research firm PivotalPath.

The AQR Managed Futures Strategy, one of the most prominent such funds, with nearly $1.7 billion in assets under management, has returned 41% while a higher-volatility version of the fund is up 62% as of Friday. Together, investors have added $251 million to the funds this year, according to AQR Capital Management.

The few exchange-traded funds offering similar strategies have seen similar interest and outperformance this year. The KFA Mount Lucas Index Strategy ETF, which trades futures in markets besides equities, is up 45% and has seen $213 million in inflows this year. The iMGP DBi Managed Futures Strategy ETF, which seeks to mirror the performance of the largest hedge funds employing the strategy, has gained 32% while taking in $790 million.

According to Yao Hua Ooi, principal and co-head of the macro strategies group at AQR Capital Management, managed futures have benefited from several trends throughout the year, among them a strong dollar, surging commodities, and falling global stock and bond prices. However, performances can vary significantly depending on the manager—while the top one-fourth of hedge funds operating such strategies have returned an average of 23% through August, the worst performers are up only 7.6%, said Mr. Caplis.

Universa Investments founder and Chief Investment Officer Mark Spitznagel—who uses options strategies to protect against statistically improbable crashes—said part of the problem with the seeming lack of havens in this year’s bear market is how the investment industry thinks about risk, and mitigating it, in the first place.

Mr. Spitznagel argues the managed futures’ insurance against the stock market this year hasn’t been enough to offset the premiums investors paid over most of the past decade when stocks soared.

“Across the board in risk mitigation, the cure has been worse than the disease," said Mr. Spitznagel.


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