Uncertainty and the correlation conundrum

Beginning with the global financial crisis and ramped up during COVID-19, easy monetary policy coincided with the longest equity bull run in history, aided by the tailwind of low inflation. Bonds played their traditional role of safe haven in dampening volatility, but also provided strong returns.

Since 2022, however, not only have we seen a reversal in the bond/equity relationship, but bonds have also become more volatile relative to their history than equities, as shown in Figure 1. This has meant that strategies that rely heavily on combining these assets have found no safe haven.

Correlations have gone from being generally negative from the early 2000s to becoming neutral or even positive since inflation started rising in 2022. The correlation of asset returns is an important consideration for constructing diversified portfolios, hedging strategies and managing risk, and recent trends have led many commentators to speculate as to whether the era of the 60/40 portfolio has ended.

Figure 2 shows the relationship between inflation and equities/bonds correlation from the 1970s to the 2020s. For simplicity, we focus on the US, specifically correlation between the S&P 500 and ten-year Treasuries. However, this analysis can also be applied to other regions.

We see a clear relationship between correlation and inflation, with inflation typically far higher pre-2000 – and from 2022 onwards – than in the 2000s and 2010s. While most of the pre-2000 period saw positive correlation, 2000-2020 is characterised by negative correlation, which balanced portfolios have become accustomed to.

Rising inflation has a direct negative impact on nominal bonds and potentially equities as both equity and bond prices can be thought of as being determined by a series of discounted future cashflows. Rising inflation against a backdrop of weak economic growth is a particular pain point for investors.

As such, building portfolios that are risk diversified, flexible and able to preserve capital through varying market conditions is more crucial than ever. Increasingly, the answer may not lie in the traditional split of equities and bonds, but a combination of different, resilient strategies – some of which may be less conventional in nature.

The long bull run in equities and bonds caused most non-directional alternative strategies to lag in performance, leading investors to question their viability. However, the current market landscape requires a more considered appraisal of the role of alternatives.

Persistent inflation and policy uncertainty – and the subsequent rise in volatility – come with greater dispersion and opportunities to generate alpha. Accessing return drivers outside of traditional long equity and credit markets can enhance returns as well as provide diversification.

To demonstrate this, we examine the impact of including an allocation to AIMS TR of up to ten per cent in a diversified portfolio of developed and emerging market equities and bonds over multiple time horizons (Figure 3). Over a three-year period, its inclusion provides an uplift of between about 70 and 125 basis points, depending on the level of volatility targeted, which provides an appreciable benefit when considering the impact on compounded returns. This benefit – of around 60-90 basis points annualised – can also be seen over a longer five-year horizon.

Figure 4 breaks down returns within AIMS TR by risk drivers over its three-year investment horizon. The portfolio generated meaningful gains across duration strategies, from both positive and negative duration exposures. In addition, the ability to access non-traditional markets such as volatility contributed positively to performance.

Global macro multi-strategy solutions such as AIMS TR can provide greater risk factor diversification and access to a larger investment universe with more flexibility than simple 60/40 portfolios. Additionally, their broader macroeconomic view drives both idiosyncratic idea generation and portfolio construction. This differs from a traditional strategic asset allocation approach, meaning investors benefit from an additional level of diversification.

Investors can’t always be right. Maximising the probability of achieving excess returns through good times and bad requires a well-diversified and risk-controlled mix of strategies, with robust management of tail risk. This needs expertise in risk factor analysis and quantitative techniques, alongside diligent oversight.

Embedding diversification and resilience is a key area of focus in our AIMS TR investment process. The strategy is generally composed of 15 to 25 diversified strategies that can take both long and short views across the risk drivers shown in Figure 5.

Figure 5: Risk drivers

Source: Aviva Investors, June 2025.

The strategies are categorised into the following three buckets:

• Market return strategies are dynamic allocations to market directional positions, which are expected to perform well in rising markets (e.g., long equities and credit).
• Opportunistic return strategies seek to capitalise on macro and idiosyncratic investment themes that are less dependent on the direction of the broader market (e.g., relative-value market-neutral trades).
• Risk-reducing strategies help stabilise performance through capital preservation positions (e.g., long duration, tail hedging, systematic strategies).

Market Return: Resilient market directional positions

In the current macro environment, simple directional bets carry more risk. Solutions that can move away from static allocations using derivative overlays alongside dynamic scaling and market tilts should be able to mitigate some of those risks and improve their overall return profile. 

This is a feature of the Market Return section of the portfolio via risk-mitigating options structures and quantitative models. We believe this helps us better express macro-driven ideas in sector- or region-specific equity positions during rangebound markets or periods of volatility.

While the strategies may be systematic, there is considerable discretionary oversight as to when they are deployed. Models can isolate a return source from historical data, but qualitative judgement is required to decide whether the source will continue to be rewarded.

We believe the use of systematic models, overlaid with discretionary oversight to inform asset allocation and position management, enables investment views to be expressed more accurately and in a timely manner. This can lead to alpha generation with improved risk-return characteristics. While useful in all market cycles, such tools are particularly useful in an environment where natural risk-reducers are limited.

Opportunistic Return: Widening the investment opportunity set

The Opportunistic Return section focuses on strategies exhibiting a higher degree of market mispricing and/or a lower degree of correlation. AIMS TR goes beyond conventional asset classes to use nonconventional markets and techniques, including investing in volatility as a credit proxy and relative-value trades.

Since mid-2018, considerable enhancements have been made to the AIMS TR investment process that involved investment into 3Ps – people, platform and process (see Survival of the fittest).¹ One of the key focus areas was on improving the performance of, and expanding the investment toolkit within, the Opportunistic Return section.

The steps taken have delivered positive outcomes across different market conditions. As illustrated in Figure 6, since the investment process enhancements were fully embedded at the beginning of 2019, Opportunistic Return strategies in aggregate generated positive returns in 13 out of 18 consecutive quarters, which includes the COVID-induced market turmoil of Q1 2020, as well as the market volatility witnessed in 2022.

Risk-reducing strategies: Diversifying away from traditional safe-havens

Sourcing robust strategies that can preserve capital is critical. Long duration, as many balanced portfolio investors are painfully aware, has not provided much protection recently. In the short to medium term, the path for interest rates remains uncertain as trade disruptions create both inflationary and recessionary pressures. This reduces the likely effectiveness of government bonds.

With the changing correlation environment over the last five years, shorting duration has, at times, proved an effective hedge against uncertain rate moves, a position held within the Opportunistic section during 2022. This is not a stable long-term hedge, however. Should inflation concerns dissipate, we expect long bonds to revert to their traditional safe haven status. However, with uncertainty regarding inflation becoming persistent, our focus within the Risk-reducing section of the portfolio has been to embed tail-risk protection through discretionary options hedging strategies.

Systematic strategies are another area we have explored to improve the Risk-reducing section. Like the systematic value equities position held within the Opportunistic section, the strong balance sheet strategy is constructed as an equity relative-value structure but harnesses the quality factor through long positions in companies with strong balance sheets. This has worked especially well during periods of credit stress and rising defaults.

Currencies have historically offered portfolio protection. However, these require more active position management as varying rate cutting and hiking cycles amongst central banks have broken traditional safe-haven patterns. A prime example is the Bank of Japan, whose yield-curve control policy to suppress interest rates combined with low inflation saw the currency massively underperform the US dollar until 2025.

Portfolio-level resilience

Despite directional Market Return positions being a significant contributor to returns, the strategy’s portfolio construction has helped generate performance with relatively low beta to global equity markets, as demonstrated by the total line in Figure 7. An additional benefit of options implementation is it reduces equity market sensitivity. Therefore, even when the Market Return beta is higher, the actual sensitivity to equity markets is lower due to the convexity embedded in the portfolio.

Another measure to evaluate resilience is the ability to preserve capital through periods of market stress. Figure 8 illustrates the performance of AIMS TR during the ten worst rolling three-month periods of equity declines since the strategy’s inception; AIMS TR fared relatively well during the most difficult periods for equities.²

Investors are facing an uncertain market, macro and policy environment, which is materially impacting the bond/equity correlation.

The diversification implications cannot be overstated. Resilient portfolios now require an ability to source other return drivers and implementation techniques capable of performing during periods of higher rates and equity and bond market volatility. 

AIMS TR, through its unconstrained approach, harnesses expertise from a broad array of investment professionals to access a wide range of ideas and expand potential sources of return and diversification.

We strongly believe its ability to access a much wider range of targeted implementation methods, as well as draw informed views on dynamic position management, is particularly valuable in this market environment. This combination offers resilience to an investor’s overall portfolio in a liquid and cost-effective manner.