KKR's macro team published an update in mid-2025 revisiting their regime-change framework. It is worth reading carefully — not because KKR is always right, but because the structural argument they are making has significant implications for how Australian investors should think about portfolio construction over the next decade.
The regime-change thesis
KKR frames current market conditions around four converging forces they expect to persist:
- Heightened geopolitical competition, particularly between the US and China
- Larger structural fiscal deficits in developed economies
- A messy and expensive energy transition
- Stickier inflation than the post-GFC era produced
These forces, taken together, create a macro environment that looks structurally different from the 2010–2021 period. That period was defined by disinflation, falling interest rates, and a reliable negative correlation between equities and government bonds. When equities fell, bonds rose — and the 60/40 portfolio worked because of that relationship.
Why bonds can no longer absorb portfolio shocks
The central challenge KKR identifies is direct: in the current regime, government bonds will not fulfil their traditional role as portfolio shock absorbers.
The logic is straightforward. Bond yields rise when inflation expectations rise. Equity markets fall when economic growth slows or rates rise. In the old regime, these two forces moved in opposite directions — a flight to safety in bonds was triggered by the same conditions that hurt equities. The negative correlation held.
In a world of structurally higher inflation and large fiscal deficits, the correlation breaks down. Both bonds and equities can fall simultaneously when inflation surprises to the upside or when fiscal sustainability comes into question. The 2022 calendar year was the clearest recent demonstration: Australian and US 60/40 portfolios delivered their worst returns in four decades.
"Government bonds will not be able to fulfill their role as portfolio shock absorbers this cycle." — KKR Global Macro & Asset Allocation, 2025
The diversification implication
If bonds can no longer be relied upon for diversification, something else must fill that role. KKR identifies several candidates:
- Non-US fixed income — international bonds, particularly in markets where fiscal positions are stronger, may provide diversification that domestic bonds no longer reliably deliver
- Private market alternatives — private credit, infrastructure, and real assets have return drivers that are less correlated with listed equity market volatility
- Geographic diversification within equities — KKR specifically notes Japan, India, and Germany as markets with different cyclical exposures to the US
The dollar weakening thesis adds another dimension: for Australian investors with US dollar-denominated assets, a sustained depreciation of the USD against the AUD reduces the return in local currency terms. Currency hedging decisions become more consequential in this environment than they were when the USD was structurally supported.
What this means for our clients
The KKR analysis reinforces the investment philosophy we have held throughout the firm's history. A portfolio constructed on the assumption that bonds and equities will always move in opposite directions is a portfolio built for the previous regime.
The practical response is not to abandon bonds — they remain essential for income, capital stability, and liability matching for clients in or approaching retirement. It is to ensure that the portfolio has genuine diversification across multiple return drivers: real assets that hedge inflation, private credit with contracted cash flows, and geographic equity exposure that is not simply a bet on the US technology sector.
We do not claim to predict where markets go from here. We do claim that the structural forces KKR identifies are real, that they are likely to persist, and that portfolios constructed without reference to them carry risks that are not visible in the headline volatility numbers.