The 60-40 portfolio strategy is a touchstone for the industry, and shorthand for the tried and trusted method of protecting capital from wild market swings. There are endless variations on this theme, largely dependant on client risk tolerance and time horizon, but the navigational starting point of a “balanced” 60% stocks and 40% bonds mix has endured.
This year, however, has seen the strategy come under fierce attack. Sounding the death knell for 60-40 is nothing new but is 2022 different? Alternative investments are more accessible than ever and traditional markets have plummeted. In some ways, analysing the 60-40 approach is like assessing a film from a bygone era – does it still stand up? Is it still appropriate? Are modern takes better?
There is no disputing that this year has been a disaster for traditional portfolios and, by some definitions, the worst year for the stocks-bonds combo. And it wasn’t like 2021 set the world alight, either. Yields on the Bloomberg USAgg Index slid to 1.12%, while the earnings yield on the S&P 500 dropped to 3.25%, one of the lowest readings in the past 40 years.
Let’s not revise history, though. The model has, by and large, done a good job of protecting investors’ hard-earned money. But 2022 has featured a deluge of direct hits. Stocks and bonds have fallen in tandem – the opposite of what the strategy plans for – while central banks are doing whatever it takes to bring down stubbornly high inflation. Throw in global supply chain issues and the escalating Russia-Ukraine conflict and it’s little wonder markets have lost confidence.
A Bloomberg model tracking a portfolio of 60% stocks and 40% fixed-income securities is down 20% this year (as of October 19), which is within touching distance of displacing 2008 as its worst year ever. It’s also only the third down year since Bloomberg started tracking the data in 2007.
An alternative view
While adjusting the sliders within the control panel of fixed income and equities may bring a degree of respite, there is an extensive menu of risk management potential waiting to be unlocked by alternative investments, which are assets that don’t fall into one of the conventional categories like stocks, bonds and cash.
The democratization of these strategies is ongoing, but their attraction is clear. Through liquid alternatives, for example, everybody now has access to a host of investment options. These include the likes of private equity or venture capital, real estate, hedge funds, managed futures, commodities, and even fine wine and cryptocurrencies for the more risk-embracing investor. These options offer the prospect of a different risk-return pattern over time in addition to diversification benefits.
Given fixed income’s travails, and investors’ quest for retirement income, the likes of private debt – when companies sell fixed-income products to investors to obtain the capital they need to grow – is growing in popularity. Once the domain of institutions and the uber rich, it offers higher return potential, mainly because of its illiquidity premium (i.e. it’s not traded daily and pricing is not transparent). Liquid alts, mutual funds or ETFs that attempt to mimic alternative investment strategies also previously exclusive to family offices and pension funds, are symbolic of this new accessibility.
That’s just a flavour of what’s on offer but are they worth it? Why should I bother with the new Top Gun movie when I can just rely on the 1986 classic? But in the same way Tom Cruise’s update proved ideal for the new generation and existing fans, so alternatives are key to adapting to the current economic times.
Do you still trust stocks and bonds alone to provide income, growth, and downside protection given the headwinds of the modern era? As Bob Rice, the Chief Investment Strategist for boutique investment bank Tangent Capital, pointed out1 the endowment funds of Yale University have only 5% of its portfolio allocated to stocks and 6% in mainstream bonds of any kind, while the other 89% is allocated in alternatives.
Verdict
Writing off the 60-40 model may be premature. There is an argument that its recent hammering has been so brutal its valuation is starting to look attractive again. Naturally, there are more buyers for a 4% 10-year bond than there are for 0.3%, while the recent 10-month 22% S&P 500 rout exposed some excessive valuations, with stocks now positioned for a rebound. Vanguard, for example, believes 60-40 will rise again, like a phoenix from the flame2. For some investors, therefore, some version of a stocks-bond mix may be suitable.
But given the number of factors now affecting the markets, portfolios need to be equally multi-faceted. For those investors seeking retirement income, for the younger investor seeking higher returns, or for the risk-adverse wanting a smoother ride, why would you turn your back on strategies that the most sophisticated investors have been using for years?
But just as today’s world is complex, so are alternatives. That’s why a registered Q Wealth portfolio manager can help you understand what investments are most suitable for you and your family, and whether a version of 40-30-30 (stocks, bonds, alternatives) is more suitable to your lifestyle needs.
The 60-40 model shouldn’t be completely thrown out along with your old DVDs – there is obviously growth and capital protection still to be found in stocks and bonds. But it’s time for an upgrade – embracing the likes of real estate investments, private debt, or liquid alts can enhance your portfolio and prepare you for the future. As Tom Cruise proved, sometimes even the classics need a modern take.
2 https://advisors.vanguard.com/insights/article/likethephoenixthe6040portfoliowillriseagain
