Cover story – Investment strategy
president of research at Morningstar. “Once again, they dis- trust 60/40 portfolios because bond yields have become too low and equity price/earnings ratios too high.” On the repeated death of 60/40, James Brooke Turner, invest- ment director at the Nuffield Foundation, a charity seeking to improve social well-being, says it is down to the natural invest- ment search for alpha. “The industry is always looking for new products to place in between pure equity and cash which offer high returns with lower volatility.” Mikulskis says alternatives to 60/40 are often presented as superior and more complex options. “One simple reason is that complexity sells in investment. “We have a big chunk of the industry that is set up to sell more complex solutions,” he adds. “And how do you do that? You find a simple straw man to tear down. 60/40 is a convenient punching bag while putting forward more complex and more expensive solutions.”
Not dead yet
In a similar critique, the death of 60/40 is premature, Mason says. “I can only speak from the perspective of a long term open-ended scheme like the LGPS, but from this view, it may be premature to mourn the death of 60/40 – the brave new world might claim to be funky and directional, while under the bon- net there are a number of familiar looking component parts.” Brooke Turner agrees. “I don’t see that 60/40 is dead,” he says. “But there will be a period of re-adjustment which will be linked to the rate of withdrawal of monetary support for asset prices as much as rising rates.” Mikulskis is even more convinced that 60/40 is not dead given how it has held up this year – despite its overall poor showing. “If anything, this year’s moves have strengthened the case for the approach over the long term,” he says.
“In recent years many commentators have pointed out that going into this year the future prospective returns on the 60/40 portfolio have dwindled far below what has been seen historically,” he adds. “The underlying yields on government bonds just didn’t support it.”
The bond problem Going forward, it looks to be the bond segment that will be the most stretched within the 60/40 framework. “It is government bonds, particularly in a higher inflation environment,” Mikul- skis says. “There are a few simple things you can do to improve bond portfolios including using short-dated corporate bonds as a core holding and allocating to investment grade asset-backed securities.”
Bonds could suffer the most looking ahead, agrees Mitchell. “The likelihood of a higher inflation environment poses poten- tial opportunities but also difficulties, particularly for bond
18 | portfolio institutional | September 2022 | issue 116
60/40 is a convenient punching bag while putting forward more complex and more expensive solutions.
Dan Mikulskis, Lane Clark & Peacock
markets. While the fall in bond prices has been painful for investors holding them, the superior yields they now offer can provide a reasonable income stream again, potentially benefit- ing portfolios constructed of public equity and bonds.” Inevitably the shift from a negative correlation between equity and bonds, which is already apparent, plays a part here, Mitch- ell adds. “The risk though is of a shifting performance correla- tion – bond and equities have been negatively correlated for 20 years, offering a strong diversification factor for investors. Higher inflation might mean a positive correlation returning.”
Market concentration Mitchell notes that with more volatile times ahead, 60/40 faces a different set of challenges, which it is not built for. “We have already seen greater volatility and uncertainty in markets following the pandemic, and there’s an increasingly concen- trated public equity market – the number of listed companies has fallen considerably in recent years,” Mitchell says. The latter point about a decline in company listings is a good one. Although outside the formulae of 60/40, it presents a problem for the approach as the 60% may not now, or in the future, be as wide-ranging and deep in terms of stocks as it has in the past, due to a lack of on-going listings. Working on this theme further, Mitchell adds: “Indexes them- selves are becoming more concentrated into fewer companies, as we have seen with the US tech giants. Both undermine diversification strategies and should encourage investors to seek out new areas to deploy money.”
What next?
One of the key attractions of 60/40 is a strong element of pragmatism, measured as a moderate level of risk in invest-
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