Over the course of the past year, a number of high-profile investment firms and banks have pronounced that the traditional 60/40 portfolio is dead. Though these statements inevitably caught headlines, from what we can tell, this notion has yet to have become real for many individual investors.
Here at Halbert Hargrove, we began talking about the death of the 60/40 portfolio several years ago. We published a market view for our clients and used the term “Death of 60/40” simply because we knew it would cause readers to dive in. But we don’t really believe the 60/40 portfolio is dead. To our way of thinking, hibernation is the best way to view what’s going on. Therefore, investors need to consider assets and/or strategies beyond just passive allocations to traditional stocks and bonds for the next few years.
Sobering returns for Treasuries
Before I go much further, let me steal some language defining the 60/40 portfolio from our 2017 mid-year market view. “60/40 is the conventional playbook for asset managers. It refers to the time-honored portfolio allocation of 60% equities/stocks and 40% fixed income/bonds.”
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The COVID-19 pandemic caused central banks globally to lower interest rates to levels we had not seen since the financial crisis of 2008/2009. These interest rate cuts gave bond prices a tailwind, but bond investors should not expect a repeat performance in 2021. At this point they should not be banking on more significant interest rate declines to estimate their expected total future return. They should expect to earn the yield (interest) – and that’s about it.
So here’s the sobering reality, which is why the 60/40 rule is feeling pressure. Around the writing of this piece, we are sitting on U.S. Treasury rates as follows: The 2-year Treasury is yielding 0.13%, the 10-year about 1.10% and the 30-year is at 1.85% (Source: JP Morgan's Weekly Market Recap from Jan. 25, 2021). A common index used to represent the 40% of the portfolio under discussion is the Bloomberg Barclay US Aggregate Index. This index is yielding about 1.19%. Go a little bit further on the risk spectrum and the Barclays Investment Grade Credit Index is yielding around 1.91%.
When you compare investment grade bonds to the U.S. 10-year Treasury yield, you’re getting less than an additional 1% compensation for taking on more credit risk. So think of it this way if you expect the 60/40 to perform the way it has historically: If 40% of your portfolio is hibernating and only expected to earn about 1.9% on the top end for the next few years, the other 60% (stocks) are going to have to work much harder.
Investors still have many options
Saying the 60/40 is dead is fine, but we believe it will come back to life at some point. But whether it’s dead or just hibernating, it’s important to remember that investors have options outside of just moving more money to stocks. Yes, bonds still make sense, especially for risk control and for those who depend on regular distributions from their portfolios. Yes, returns are low, but not every investor can handle the stress of a 100% stock and high-risk portfolio. Many investors are likely to cause themselves more harm switching around positions in stressful times than having part of their portfolio earn 1.9%.
Our suggestion is to still hold some bonds in a balanced risk portfolio – but to hold significantly less than has historically been considered as part of a 60/40.
Before I get a bunch of arguments from active bond managers, the point of this piece is not to trash bonds as a legitimate asset class that still can play an important role. I get that one can make duration and credit bets and beat the benchmark bond indexes. But my point is that passively allocating to bonds right now is likely not going to get investors the returns they have been accustomed to for the past 35 years. Yes, we do believe you can add active credit to bond positions to improve returns.
Considering alternatives to traditional bonds is a prudent move
However, as diversified investors, we’re also looking to other areas beyond active bond management. None of these areas are bulletproof and all carry their own risks, which differ from traditional stocks and bonds. These investment possibilities include:
- Private real estate, which yields rental income.
- Reinsurance is another area where you earn insurance premium income.
- A third area is private direct debt, where one can demand higher rates of return for the risk taken.
There are also transparent low-cost equity strategies that can be employed to shift more of an allocation to stocks, but have protective buffers on the downside. These types of buffered equity strategies are not a free lunch. (Another term frequently used is defined outcome, but I prefer buffered equity. What used to be placed in structured notes can now be done in ETFs where you have stock exposures, but options contracts are then used to protect a certain level of downside.) If you’re protecting stocks beyond a certain level of loss, you should not expect that position to match the returns of stocks if all markets do is go higher in the interim.
Needless to say, we’re not expecting to enter a period similar to the years 1964 to 1981 anytime soon. In case you weren’t around for it back then: Interest rates increased over 10 percentage points, causing a 60/40 portfolio to underperform 3-month U.S. Treasury yields!
We’re also humble enough to recognize the perils of forecasting with confidence. If we stay range-bound with interest rates for the next few years, we do think it’s prudent for investors to consider alternatives to traditional bonds.
Sure, some investors can increase their equity allocations based on their financial situation and ability to add money when corrections occur. But for those who cannot (prudently) take on that risk, we think looking to other alternatives makes sense – while that traditional 60/40 portfolio allocation you used to rely on is hibernating.
The views contained herein are not to be taken as an advice or recommendation to buy or sell any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without previous notice. This material should not be relied upon by you in evaluating the merits of investing in any securities or products mentioned herein. In addition, the Investor should make an independent assessment of the legal, regulatory, tax, credit, and accounting and determine, together with their own professional advisers if any of the investments mentioned herein are suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment.
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