27 Jul Is the 60/40 portfolio dead?
Image by andrewtuffyplus from Pixabay
In the past few years, obituaries for a traditional ‘balanced’ portfolio of, say, 60% equity and 40% bonds have been written by quite a number of journalists and fund managers. We think that this type of portfolio continues to be alive and kicking.
Good investing is grounded in three things:
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- Using investment logic to think clearly about what one puts into a portfolio;
- Using empirical insights to inform us of general longer-term characteristics of assets, how they work together in a portfolio and the shorter-term exceptions to these generalities; and
- Having the fortitude to stick with a sensible portfolio strategy through these shorter-term, trying periods.
A portfolio mix of bonds and equities balances the potentially severe downside falls in equity markets by owning far less volatile, good quality bonds that will not fall as far, if they do fall at all. There is a general expectation that at times of severe equity market trauma, scared money will move into high quality bonds. This pushes yields down and bond prices up (there is a see-saw effect between yields and prices). That is often, but not always, as 2022 and 1994 demonstrated, the case.
Figure 1: Annualised rolling real (after inflation) returns for different investment horizons
Source: Dimensional Returns Web – 60/40 portfolio[1]
It is certainly fair to say that the past five-year period has been tough for 60/40 balanced portfolios, given that it included the global pandemic, the war in Ukraine, a rapid end to the era of low nominal and negative real interest rates, the highest inflation in 40 years in the UK and a downturn in global equity markets in 2022. Even so, it delivered a return that more-or-less matched inflation over this period, which should be regarded as a good outcome. The longer one stays invested, the more consistent annualised returns should become.
Other five-year periods have resulted in low after-inflation returns for a 60/40 balanced portfolio and in some periods only a return that barely matched inflation. Yet investors who stuck with it during these periods ended up with positive real returns after 10, 15 and 20 years, increasing their purchasing power over time. Meanwhile holders of cash would have seen their purchasing power decline.
Investing is a long-term game. On average, from 1987 to 2022 the 60/40 balanced structure has provided investors with an after inflation return of around 5% over rolling 15-year periods.
Press articles are often influenced by recency bias, which encourages, even if unintentionally, investors to make portfolio decisions based on recent events. For example, the spectacular return of commodity futures in 2021-22 hides their material underperformance compared to global equity assets over the longer term and to include them in a portfolio after a run of strong short-term performance fails the investment logic and empirical evidence tests.
Investment logic still suggests that shorter-dated high quality bonds will remain a useful balance to extreme equity markets, if and when they occur, providing strong downside protection. At market extremes, scared money will still flow to these assets. Bonds are now paying substantially higher yields than they did 18 months ago, providing more return and a greater buffer against any future yield rises. Empirical evidence suggests that bonds are often, but not always, negatively correlated to equities (i.e. they move in the opposite direction). It also suggests that markets work pretty well and that trying to guess which asset class will do well this or next year is well-nigh impossible. As such, having the patience to stick with an investment strategy over the longer term is really important.
The last five years may not have been spectacular but protecting investors’ purchasing power from inflation over this difficult and inflationary period suggests that it is alive and well, despite the headwinds it faced.
In our opinion, claims of the death of balanced portfolios are greatly exaggerated.
This blog is intended for information purposes only and no action should be taken or refrained from being taken as a consequence without consulting a suitably qualified and regulated person. Your capital is at risk when investing. Past performance is not a reliable indicator of future results and forecasts are not a reliable indicator of future performance.
[1] Real (CPI-adjusted) returns since 1987 for global equities & global short-dated bonds (details available on application)