Investment strategy – Cover story
END OF AN ERA?
For decades many institutional investors have employed a 60% equities, 40% bonds investment allocation as the bedrock of their portfolio. Yet several challenges are converging, leading some to question if the 60/40 strategy is still viable. The increased correlation between bonds and equities is one factor while monetary tightening is another. The rise in infla- tion is also proving to be influential. Indeed, the increase in the cost of goods and services poses an exceptional challenge to the traditional stock-bond portfolio that we have not seen since the 1970s.
The case for 60/40 has traditionally been that the inverse cor- relation between bonds and equities offers portfolio diversifi- cation. The 60% allocation to equities offers growth, while the 40% held in bonds protects against downturns. The assump- tion being that when stock markets fall, bonds tend to per- form better.
Indeed, investors employing such a strategy received higher returns in every three-year period between mid-2009 and December 2021, relative to those with more complex strategies, according to Arnott, an investment manager. But this year things have gone south, and dramatically. The performance of the average 60/40 portfolio was down 16.9% in the first half of the year, according to Arnott. Such negative numbers question the validity of the strategy as a successful form of investment in the face of the economic environment resulting from the Covid pandemic. If that continues, such a performance would rank among the worst historical scenarios, only behind the depression-era downturns in 1931 and 1937, which saw losses top 20%, accord- ing to Ben Carlson, the director of institutional asset manage- ment at New York-based Ritholtz Wealth Management. Reflecting on this, Neil Mason, assistant director and LGPS senior officer at the Surrey Pension Fund, says: “In the LGPS, 60/40 has echoes of the old man on the cart in the movie Monty Python and the Holy Grail, shouting: ‘I’m not dead’. “Many LGPS funds still essentially have this mix, but the tradi-
tional 60/40 has been ‘pimped’ with a variety of more versatile fixed income/inflation protecting assets. Infrastructure, multi- asset credit and private debt making up the fixed income 40% and private equity adding to the 60% equity mix,” he adds. This suggests a subtle but important move away from the for- mulaic 60/40 profile.
The bigger picture
What drives the increasingly positive correlation between equi- ties and bonds? Inflation, monetary tightening and the war in Ukraine are factors behind this trend. But Dan Mikulskis, a partner at Lane Clark & Peacock, a con- sultancy, says we should pause for a moment on the recent fall in 60/40 portfolios, which should be looked at in an his- torical context. “If you zoom out a little the picture is differ- ent,” he says.
“Over the last five years the global 60/40 portfolio has risen by 4% to 5% per year, depending on composition and currency, and would have doubled your money during the past 10 years. This year’s falls need to be seen in the longer-term context,” he adds. Craig Mitchell, an economist at workplace pension scheme Nest, presents a different narrative, one in which the 60/40 approach has proved successful thanks to market conditions. “Over the past decade, we have experienced excellent invest- ment conditions. Buoyant markets in equities and bonds made it relatively straightforward to achieve good returns in more traditional portfolio constructions,” he adds. “The biggest risk was missing out on such good times.”
The sceptics
The death of 60/40 is a reoccurring theme in investment. More than 10 years ago, the fund manager guru of the time, Pimco founder Bill Gross, claimed he had laid the strategy to rest. “The underlying logic of the 60/40 sceptics has not much changed over the past decade,” says John Rekenthaler, vice
Issue 116 | September 2022 | portfolio institutional | 17
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