This time last year, the financial commentariat was happily murdering one of its former heroes.
The 60/40 portfolio was widely declared dead after failing its faithful in spectacular fashion, ending its six-decade run as a mainstay of retirement planning for rank-and-file investors.
And yet, the same investing prototype is up by double-digits this year, by most measures. This revival is proving, once again, the incredible durability of the 60/40 portfolio, though it may need to be tweaked for a such a peculiar economic era.
Since its conception in the early 1960s, the model of building a portfolio with roughly 60 per cent in stocks and 40 per cent in bonds has served investors very well.
Estimates based on U.S. data peg the average annual return of the typical 60/40 model at around 8 or 9 per cent, with less volatility than in either the stock or the bond market.
The basic idea is that the stock component provides the bulk of your returns, while the bond portion acts as a stabilizer when some sort of shock throws financial markets into a panic.
Every once in a while, the whole concept breaks down. It’s in these moments that investors start to look askance at the old-school 60/40.
Take last year, when runaway inflation shifted the axis of the financial world. The stock market bubble popped, taking U.S. stock benchmarks down by 20 per cent to 30 per cent.
But the big problem for investors aligned to the 60/40 style was what happened in the bond market. In short, it was the worst year ever. That’s not hyperbole. The longest-dated U.S. Treasuries declined by nearly 40 per cent in 2022, which is unprecedented in 250 years of bond market history, according to data compiled by Edward McQuarrie of Santa Clara University.
Rapid-fire rate hikes brought on a bond bear market for the ages. The iShares 20+ Year Treasury Bond ETF is now down by 43 per cent, wiping out a decade of investment returns. That is a seismic move by bond market standards.
With stocks and bonds in unified freefall, there was little to protect investors with supposedly balanced, conservative portfolios. The Bloomberg US 60:40 Index declined by about 17 per cent last year. That’s not supposed to happen.
Attitudes toward the 60/40 soured pretty quickly. “Is the 60/40 portfolio dead? I would say probably,” Mark Wiedman, BlackRock’s head of international and corporate strategy, told The Globe and Mail last September.
Investors yanked money from balanced funds at a record pace. In Canada, the category had $30-billion in net redemptions last year, according to The Investment Funds Institute of Canada.
“It certainly looked like the 60/40 didn’t work last year,” said Sadiq Adatia, chief investment officer at BMO Global Asset Management. “But that’s because nothing worked last year. It was a one-in-50-year event.”
Last year left the reputation of the 60/40 portfolio in tatters. But there are three important takeaways. First, no single year’s return should matter to longer-term investors. The performance of diversified portfolios tend to smooth out the longer the time frame. Already this year, The Bloomberg US 60:40 Index is up by 11 per cent this year, erasing the bulk of last year’s losses.
Second, the risk of a major bond market drawdown is not the same as it was in early 2022. Central banks can’t push rates from 0 to 5 per cent again.
Lastly, bond yields can do much more heavy lifting today than they have for several years. About 80 per cent of all fixed income is now yielding more than 4 per cent, BlackRock president Robert Kapito said in the company’s last earnings call.
“We’re calling this a once-in-a-generation opportunity,” Mr. Kapito said. “You can actually earn attractive yields without taking much duration or credit risk.”
While there is life in the 60/40, the relationship between stocks and bonds has undergone some important changes. Persistent inflation may mean that higher rates are here for longer than expected, which could limit the upside for bonds, even if the stock market falls on hard times.
As a result, David Stonehouse, head of North American and specialty investments at AGF Investments, suggests some modifications to the 60/40. Keep the core stock-bond split, but take 10 per cent from each to allocate to real assets, like commodities and real estate, as well as alternatives, like private debt and derivatives, he said in a note.
“While 60/40 clearly does not deserve to be banished to the dustbin of asset allocation history, we believe it might benefit from some tweaking,” he wrote.