There are a lot of opinions around on the 60 to 40 percentage mix between equities and bonds that has shaped many investors’ allocation strategies since modern portfolio theory.
Also called the ‘balanced’ portfolio, it was designed to provide “inflation plus” performance and is still widely adopted, but its efficacy has lately come under closer scrutiny.
In a recent analysis by Schroders, it emerged as “unlikely”, based on 30-year assumptions made by Schroders economists and head of multi asset strategy Lesley-Ann Morgan, “that a 60/40 benchmark will deliver inflation +3% per annum in the future”.
It was perhaps for this reason that a survey carried out by Fulcrum Asset Management showed that nearly two-thirds of institutional investors and financial advisers think that 60/40 is no longer fit for purpose for today’s markets; a further 24% believed that the strategy “needs to be reviewed”, while 36% believed it still had a strong future.
The reasons why it might struggle are multiple. Among them, inflation takes the centre stage. The spiralling inflationary costs today mean that the 60/40 portfolio would need a big stretch in performance to keep its target return levels.
Performance targets have therefore been reconsidered in 2021, as inflation started to get out of hand and people preferred to talk about “cash plus” instead of “inflation plus”.
And this isn’t likely to change any time soon. Schroders analysts said several thematic shifts could continue to keep inflation higher, including the energy transition, climate change (higher temperatures could lower productivity), heightened geopolitical tensions (if companies pass on higher costs on to consumers) and ageing populations.
Looking beyond inflation, Aurèle Storno, multi-asset chief investment officer at Lombard Odier Investment Managers, also highlighted the historic connection between the performance of traditional multi-asset portfolios and interest rates.
“Since after the global financial crisis and up until recently, we have had low interest rates. At the same time, balanced allocations have achieved their cash plus target, delivering more than cash plus 3.5%,” he explained.
“In the late 1980s to 2008, when rates were neutral, the balanced strategy was on trend. But before that, in the 1970s and early 1980s, high rates hindered returns, which they could do again today. At this stage we have to rethink allocation strategies and 60/40 principles to better protect capital during drawdowns.”
Another significant detractor to the 60/40 mix is the simultaneous fall of stock and bond markets, as pointed out by Quilter Cheviot’s David Henry on Trustnet.
“If the two main components of your asset allocation are down for the year, then what do you buy?” he asked.
“Commodities have been the standout performer year-to-date – should we be looking to alternatives in the current climate? I have certainly had more emails recently from fund houses landing in my inbox decrying the death of the classic ‘60/40’ equity/bond portfolio than I have in previous years.”
But here is where discipline should kick in, said Henry.
“Increasing enthusiasm about whatever asset class or sector is working at a given point in time means that it can feel like it is going to work forever, both on the way up and down.”
Bonds and equities will not fall contemporarily forever, in fact, “while gilts performed poorly in the third quarter of 2022, the MSCI World index was narrowly positive in sterling terms and therefore we didn’t have another quarter where both asset classes were negative – unlike in the first two quarters.”
“Personally, my view on the 60/40 portfolio has altered very little since August in and I still feel there is a place for it despite those decrying its death,” Henry said.
Nick Cunningham, vice president of strategic advisory solutions at Goldman Sachs Asset Management, did perceive a sense of grief among investors – not for the 60/40 itself, but for the returns we have come to expect from it.
“Investors must first come to terms with the reality that the stellar returns of recent years, when the classic 60/40 portfolio has generated an impressive 11.1% annual return over the past decade, are likely to be more challenged. Once the denial stage is overcome, it’s time to establish a new strategy,” he said.
Traditional types of equities represent an outsized proportion of many portfolios, said Cunningham, noting that the average moderate-risk portfolio has nearly 80% of its risk coming from core equities.
“In our view, this results in an under-representation of other attractive return-generating asset classes,” he said.
As for where investors could be looking, he highlighted options both in the equity market and in fixed income.
“Investors can potentially boost income outside of the most familiar US large caps by considering global real estate, global infrastructure and Master Limited Partnerships (MLPs). On the debt side, corporate and municipal high yield, bank loans, and emerging market debt may help increase income and have historically shown little sensitivity to changes in interest rates.”