The euphoric peaks andabyssal precipices of global markets in calendar year 2025 have no doubtensured this year will enter the annals of the history books.  

As this rollercoaster yeardraws near its close, global markets remain at crossroads, making portfolioconstruction and asset allocation a perplexing endeavour for investorseverywhere at present. 

One-time existentialquestions around global trade, geopolitics and economic cycles earlier in theyear have progressively resolved with the effluxion of time, only to raiseseveral more dilemmas for investors. 

Slowing disinflation, de-anchoredinflation expectations, flagging economic activity with weakening labourmarkets and mixed signals from fiscal and monetary policy makers all add up toa wariness that strife may be lurking around the corner and it could be prudentto take some chips off the table. 

It is always instructive intimes like these to recall one of the foundational principles of investmentmanagement - asset allocation is the main catalyst for the performance ofinvestment portfolios. 

As such, investors need tounderstand their tolerance for withstanding risk and volatility (most of usthink of this in terms of portfolio drawdown scenarios).

As valuations across assetclasses, such as shares, credit, property and fixed income have swung violently(think liberation day versus today), investor sentiment has been suspended asit were, oscillating mercilessly between the elation of euphoric valuations andthe fear of impending crises (none of which have yet eventuated, ofcourse). 

Against this backdrop, theremarkable resilience of risky asset classes in the face of trade andgeopolitical turmoil, policy ineptitude and the vicissitudes of outrageousfortune, may have prompted a degree of complacency amongst many marketparticipants. 

This has desensitised manymarket participants to key investment risks. 

Specifically, givenastonishing returns across many securities, sectors and markets, considerationsrelating to investment risk in all of its variegated forms, (including thevolatility of returns, correlations between returns, and tail events defined inthe broadest possible way) have seemingly taken a back seat, as investors chaseunprecedented performance. 

Some assets, including governmentbonds, are often overlooked during times like these. They have historicallyprovided consistent, low volatility and largely uncorrelated return streamsalmost every year during the past three decades including multiple financialcrises, bonds continue to serve as the ballast for well-constructedportfolios. 

Notwithstandingthe secular and cyclical headwinds described above, Australia offers one of thehighest yielding, best in breed (AAA rated) and now deeply liquid government bondmarkets. We do not need to worry about huge fiscal largesse and decaying creditquality seen in many western bond markets, and with our own domestic economyoutperforming that of many anemic western peers, who continue to suffer fromlow or scant growth, we have a marketplace that has now priced RBA rate hikesinto 2026.

Whileour own economy is solid, it still remains subject to shocks. Regardless of differingviews around the probabilities of interest rate hikes occurring, there isgeneral agreement that if the RBA does need to tweak rates to cool inflation,it will be a very mild hiking cycle given the fragility of macroecomiclandscapes. Markets will start pricing the probability that such a move willadd to domestic unemployment and recessionary risks, with bond markets likelyto rally in the expectation of another pivot in policy direction and adjustmentin risk profiles.

Withmany Australian Federal Government bonds now yielding close to 5.00%, and somehigh quality State Government bonds yielding close to 6.00%, they can help toplay a stabilising role in a portfolio facing uncertainty. These assets offergovernment-backed income, strong liquidity and downside protection in extrememarket conditions.

Whiletheir defensive qualities may rarely be called upon, similar to an insurancepolicy, they can provide a reliable income stream while serving as a safeguardduring periods of market stress, particularly within a diversified portfoliothat includes higher-risk assets.

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