2Q 2020 GMO Quarterly Letter

Do they have anything left to give?
By Ben Inker

Executive Summary

The recent fall in cash and bond yields for those developed countries that still had positive yields has left government bonds in a position where they cannot provide two of the basic investment services they have traditionally provided in portfolios – meaningful income and a hedge against an economic disaster. This leaves almost all investment portfolios with both a lower expected return and more risk in the event of a depression-like event than they used to have. There is no obvious simple replacement for government bonds that provides those valuable investment services. As a result, investors would be well advised to think critically about not only what their fixed income portfolios can feasibly achieve going forward but also what the implications are for the amount of risk they can afford to take across the rest of their portfolios.

By Matt Kadnar

Executive Summary

Today’s low bond yields, which are without precedent in U.S. history, create several challenges for investors. Three crucial ones for investors to contemplate are: how can we replace the income that bonds used to supply; how can we adapt portfolios for the loss of depression protection that comes from bond yields having little or no room to fall; and how can we protect our portfolios from the risk of rising inflation and rising interest rates? Each of these challenges is unique and requires a different playbook than what we have used over the last 30 years. They will also require more dynamic allocation between the opportunity sets. We will take you through each of these issues and propose portfolio solutions to help adapt portfolios to today’s anemic interest rate environment.