The Iran war has highlighted the relative volatility between shares and bonds, as well as the ability of the latter to endure sudden market shocks and uncertainty, according to a fixed-income investment manager.
FIIG Securities head of research Philip Brown noted the United States-led action against Iran had driven volatility in equity and bond prices and both had moved downward, which ran counter to financial theory, which suggests they should move in opposite directions.
“The sort of shock we are dealing with in the Iran war is something that is more about the total value of the system rather than reapportionment within that system,” Brown said.
“Thanks to the destruction of the oil assets in the Middle East during this war, the total productive capacity of the world has been reduced. This is a global effect because the price of energy is now structurally higher.
“As such, the total value of all assets everywhere falls – though not equally. Bonds and equities both drop in price, but the effects on equities are far more pronounced than on bonds.”
He added the war marked a significant change in global politics and had revealed new lessons that should be heeded by investors, including that the world and investment markets would be more volatile and stay that way.
“The calm, considered growth of the past is no longer likely to continue. That will make for more risk everywhere, including financial markets,” he indicated.
“That suggests that bonds need to be part of investment portfolios since they are far less volatile, but it also means that we ought to be taking care with the particular type of bonds chosen,” he explained, adding floating-rate notes were useful to protect portfolios from duration risk if interest rates changed materially.
Further he suggested investors should be careful of the correlations between assets and take on more diversification than they think they need.
“In large moves, everything tends to move together. For bond market investors, that means having both bonds and equities, but also having different sorts of bonds like fixed, floating and inflation-linked in your portfolio,” he stated.
“Crucially, though, bonds and equities don’t fall by the same proportion. Bonds have been much more stable than equities over the war so far and will very likely continue to be so. As risks rise, diversification into bonds and within bonds becomes even more important to portfolios.”