by Pierre Daillie, AdvisorAnalyst.com
The echoes are uncomfortable. War, energy shocks, supply chain disruptions, and resurgent inflation — 2026 is rhyming loudly with 2022, and for multi-asset investors, that means one haunting question is back on the table: what actually diversifies a portfolio when bonds fail?
In a new paper from Man Group1, Edward Cole, Head of Multi-Strategy, confronts that question directly — and his answer challenges one of the most entrenched assumptions in institutional portfolio construction.
The Stock-Bond Correlation Problem
The 60/40 portfolio has endured as, in Cole's words, "the bedrock of asset allocation for good reason." US Treasuries have historically offered deep liquidity, negligible credit risk, and a tendency to rally during growth shocks. But Cole is explicit that "this diversification benefit is not unconditional."
The data tells the story plainly. When US inflation runs above approximately 2.5% on average, the stock-bond correlation has historically flipped positive — meaning bonds and equities fall together. The inflationary decades of the 1970s, 1980s, and 2020s all produced exactly this dynamic. The great moderation of the 2000s, by contrast — low inflation, benign macro — was when bonds shone as portfolio shock absorbers.
2022 was the live stress test. The MSCI World lost 18% in euro terms. The Global Aggregate Treasuries index lost approximately 13%. Bloomberg's 60/40 index lost nearly 17% — its worst annual return since the Global Financial Crisis.
Cole does acknowledge one structural difference between 2022 and 2026: duration risk is meaningfully lower today. Because bond yields have already repriced sharply higher, "the post-2022 repricing has itself created a cushion — higher starting yields mean lower duration and more coupon income to absorb future shocks." Prospective bond losses in a sustained 2026 inflationary shock would likely be smaller. But smaller losses are not the same as gains, and the more important point stands: bonds may not reliably offset equity drawdowns in the way they once did.
Equity Market Neutral: A More Durable Shock Absorber
Cole's proposed alternative is equity market neutral (EMN) strategies — and the historical case he builds is compelling. Running the same exercise as for bonds (average monthly returns when the S&P 500 falls 3% or more), a simple average of four Fama-French factors — Value, Risk, Quality, and Momentum — demonstrates meaningfully more consistent protection than Treasuries across the same time span.
But Cole goes further, asking what inflation specifically does to EMN returns. The answer is counterintuitive: moderate inflation is actually good for the strategy. Using the HFR Equity Market Neutral index from 1991 through 2026, Cole finds that CPI regimes between 2.5% and 4.0% have been associated with "materially better returns than other environments," both in nominal and real terms.
His working hypothesis is structural. Sustained higher inflation raises the cost of capital, forcing management teams and boards to restructure businesses generating sub-cost-of-capital returns. This improves capital allocation decisions and creates more differentiated corporate outcomes — exactly the fertile ground that stock-selection-based EMN strategies require to generate alpha. Japan, Cole notes, has been the inverse case study: decades of low inflation and depressed cost of capital produced "zombification of the corporate landscape," suppressing exactly the dispersion that EMN strategies feed on.
The conclusion: "so long as inflation does not become runaway, we should continue to think of inflation as a tailwind for the equity market neutral approach."
Implementation: Why Cash Efficiency Is the Decisive Variable
Cole is equally rigorous about how EMN should be accessed. He distinguishes three routes — single manager, fund of funds, and cash-efficient multi-manager — and makes a pointed case for the third.
On single managers: alpha is scarce, capacity is limited, and forecasting manager-level returns is, in Cole's words, "a fruitless process, precisely because the attributes that drive returns are idiosyncratic in nature." Furthermore, "every strategy will incur drawdowns — if an asset manager suggests otherwise, they are being disingenuous."
Diversification across managers improves the portfolio information ratio and reduces the probability of loss in any given year. But traditional fund-of-funds structures sacrifice this advantage through fee layering and cash drag — "100% of capital is invested directly into underlying funds" with no leverage efficiency. A cash-efficient multi-manager construct, using cross-margining and prime broker arrangements, can achieve multiple turns of leverage on the underlying strategies — and Cole's modelling suggests this structural advantage can more than offset a fund-of-funds selector's ability to identify higher-returning managers.
Key Takeaways for Advisors
- Elevated inflation regimes reliably erode the bond diversification benefit. The 60/40 framework requires a rethink, not an abandonment, but the diversifying component needs scrutiny.
- Equity market neutral strategies have historically provided more consistent equity downside protection than Treasuries — and may actually benefit from moderate inflation rather than suffer from it.
- Manager diversification within EMN is essential. Single-manager exposure concentrates drawdown risk unnecessarily.
- Access structure matters as much as strategy selection. Fee-layered, cash-inefficient fund-of-funds wrappers can undermine the very return advantage EMN is meant to deliver.
The inflation regime may not be permanent. But while it persists, the rules of diversification have changed — and Cole's framework offers a disciplined, evidence-based response.
Footnote:
1 Cole, Edward. Man Group. ”The Inflation Diversification Problem | Man Group." 23 April, 2026.
