News & analysis
STOCK DECLINES SIGNAL END OF 60/40 INVESTMENT STRATEGIES
The fall in stock and bond values presents investors with problems. And more so than first appears, notes Andrew Holt.
The drop in stocks and bonds during the first quarter should not, on the face of it, raise too many concerns. After all, what is one quarter in the wider scheme of institutional investing, which is invariably a long-term pursuit. But you need to look at the returning numbers in more detail. The FTSE All World index slumped 5.1% in the first three months of the year and rising inflation and tighter monetary policy took 6% out of the Bloomberg Global Aggregate Bond index.
The important point here is these two important markets are rarely linked together like this. They usually, and should, counterbalance each other. This quarterly nosedive is the worst cor- responding fall since both bench- marks have been available. The outlook, with rapidly rising inflation and the war in Ukraine, indicate things are hardly going to get better, and most likely get far worse. So, this problematic trend is unlikely to last for one quarter. The noise in the markets is likely to be turned up to maximum vol- ume and is likely to be deafening for some time.
The right balance
This in turn has an impact on the balance of investment portfolios. This trend could well put to bed the 60/40 portfolio model which has been the approach of choice for many investors: where investors allocate 60% to equities for capital growth, and 40% to bonds for income and risk alleviation. This strategy has thrived for decades, as equities reached record highs and interest rates dropped to new lows, boosting bond prices. It generated an 11.1% annual return in the 10 years to 2021, according to Goldman Sachs – an impressive number by any measurement. But as an investment model, it no longer works in the current environment. Posing a major difficulty for investors. “One way to overcome the potential low-to-zero bond return is to expand the toolkit in terms of the types of income-related assets or bonds in the 40% defensive side of the portfolio,”
says Jason Lejonvarn, senior investment strategist at Newton Investment Management. “The other option is to focus on the 60 of the 60/40. To add more of the risky asset: equities, which have a higher expected risk premium,” he adds. This has started a wider argument about portfolio weight- ings. There have been suggestions that 80/20 could be the new 60/40, based on the idea that the 40% is no longer work- ing. So, the passive element is cut in half and put to work in an ETF, while the 80% can be placed in a wider range of equities. Commentators have suggested this would work effectively during the next five years. It is an old idea that has resurfaced under the changing dynamics of the market today. Although it often involves a good deal of regular rebalancing.
Defence and attack Another option that has been put forward is a 50/30/20 port- folio, made up of equities, bonds and alternatives, with an important part played by the latter. “Against the backdrop of inflation, investors must play both offence, with stocks, and defence with a diversifying strategy,” says Dennis Lee, market insights lead at Black- Rock. “In the past, bonds were the main defence – but haven’t done as well during inflation scares. Inves- tors need to consider alternative strategies as a crucial portfolio holding.”
The 20% allocated to alternatives plays an important role, potentially generating a new and uncorrelated source of returns while offering greater diversification. It also sug- gests that investors cannot grow on
a diet of equities and bonds, which underlines all the alterna- tives to 60/40. With a similar message, but over a longer timescale, Lejon- varn said: “Looking to the next 10 years, bonds may create a 60/40 dilemma for investors, where investors will need to expand their investment toolkit from bond substitutes to a modest amount of leverage to long/short investing to alterna- tive asset classes.” Some though have suggested that the death of 60/40 is like that of Mark Twain, much exaggerated, but it is difficult to see how.
The situation for investors seems clear: whatever option they go for, it is no longer enough to stick with what they have always done.
Issue 113 | May 2022 | portfolio institutional | 7
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