Sovereign bonds preferable to cash as defensive benchmark

The benchmark for the defensive part of an investor’s portfolio should be closely tied to the local sovereign bond rather than to cash, according to Schroders head of fixed income and multi asset Simon Doyle.

Only sovereign bonds will produce a return similar to the real rate of growth in the economy (as a proxy for the preservation of purchasing power) when matched to a medium-term investment horizon, Doyle said.

In addition, he said a sovereign based benchmark makes sense in that it relates purely to the short-term behavioural characteristics of sovereign bonds and risk assets.

“As we saw in 2008, the collapse in risk asset prices coincided with a material rally in government bonds, with returns from sovereign/duration based strategies soaring while returns on short duration strategies with alpha predominately linked to credit collapsed.”

This highlights the critical flaw in the argument for benchmarking the defensive component to cash, Doyle said.

“Not only is cash not risk free for investors with a medium-term investment horizon, it also won’t appreciate when risk assets are declining in price, such as in 2008.

“The cash rate won’t necessarily preserve the real value of the investor’s capital over this timeframe — just look at the close to 0 per cent rates prevailing in large parts of the world today.

“The natural conclusion to this line of argument is that the appropriate benchmark for the fixed income (or defensive) part of the portfolio is one heavily linked to the sovereign yield curve.”