The long-standing 60/40 split between equities and bonds is becoming an anachronism which will not serve clients well in this era of record low bond yields, according to 7IM’s investment team.
The 60/40 portfolio has been around for decades, designed to provide investors with a balanced investment portfolio which offers the income and relative security of bonds, combined with the growth potential of higher-risk equities.
So well-known is the investment style that many funds and strategies have been named after it. However, Matthew Yeates, Head of Alternatives and Quantitative Strategy within the Investment Team at 7IM, said the very goal of this strategy – namely to provide some diversification to investors – was no longer being achieved.
“The 60/40 portfolio has been a great place to be over the last decade but looking forward, and with an eye on what’s happened in 2020 in particular, we think investors should be looking for more now from their portfolios,” Yeates said.
“For a balanced portfolio, we would currently expect to see an allocation of circa 15% in alternatives, a split which will likely only increase over time when you consider where bonds yields and equity markets are currently,” he said.
“Be it diversification through proper strategic asset allocation, looking at regions like emerging markets or diversification through alternatives, these should all be differentiating parts of robust multi-asset investing going forward, which should replace the increasingly flawed 60/40 approach.”
Last year saw 60/40 portfolios face some major headwinds which are only getting stronger as we move through 2021, according to Yeates.
Firstly, after more than two decades of sliding interest rates which have boosted bond markets, fixed income as an asset class is now starting to sell off heavily as record low rates – whilst not likely to soar – nonetheless start to climb.
More worryingly, this sell-off is coming amid peak equity valuations in many regions. Effectively, just as diversification is most needed, fixed income is now highly correlated to equity markets because of central bank intervention, meaning it is failing to act as a safety net.
Yeates said looking out over the next decade, using uncorrelated assets was therefore a more sensible strategy than relying on fixed income when it comes to diversification.
“A genuinely diversified multi-asset portfolio has a much clearer role in today’s prevailing environment of low bond yields, negative debt piles, and returning inflation,” he said. “Our answer to the problems facing 60/40 portfolios is, therefore, not to build them.”
Instead, Yeates said a specific group of alternatives should be incorporated in balanced portfolios to achieve the diversification that bonds used to provide. This means using liquid alternatives – involving long/short strategies, emerging markets and property, for example – to provide a better overall risk/reward profile for a balanced portfolio.