Is the 60/40 Investment Portfolio Dead?
What is the 60/40 Portfolio?
The 60/40 portfolio refers to an investment strategy that allocates portfolio assets to a split of 60% stocks and 40% bonds. The traditional theory behind this strategy is this asset distribution protects investors against dramatic stock market fluctuations, whilst benefitting from asset growth over time. Stock market investments make up a larger proportion of the portfolio due to a higher average rate of return, whereas the bonds allocation functioned as insurance. The bonds provided steady income, lower volatility, provided the option of liquidity without realizing a loss, and potentially a return profile that is counter to the equity portion of the portfolio. In the past, bonds, particularly government bonds, had tended to rise in price as stock prices fall.
Why is the 60/40 Portfolio No Longer the Best Option?
Simply put, many financial and investment experts believe that the 60/40 portfolio is no longer an investment strategy that generates the best growth profile. In the current financial climate with rising inflation, the equity market has experienced a strong sell off from its previously lofty valuations, consequently weakening the 60% portion of the asset split. Inflation triggered the Federal Reserve to take an aggressive tightening stance on short term rates. These rising rates have also caused the bond market to fall in value, and the future actions of the Fed will continue to erode value for bond investors. This means interim and long-term fixed income will be providing low levels of income at depressed values. Short term income products might provide slightly higher returns than previously but will still have downward pressure on value with future tightening from the Fed. Crucially, the 40% bonds allocation will offer little to no income in nominal terms, and often negative in real terms. They also now no longer have the same diversification potential due to their limited price upsides.
What has the Past Looked Like for the 60/40 Portfolio?
The chart below was compiled by the Chartered Alternative Investment Association to show the historical return and some risk characteristics of a 60/40 portfolio, Alternative investment only portfolio, and a sample “endowment” portfolio. The key take away is the addition of Alternatives increased return and lowered risk over time, even before the events of 2022 where traditional markets were greatly devalued.
| Annualized Returns | Volatility | Max Drawdown | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 1-Year | 5-Year | 10-Year | 15-Year | 10-Year | 15-Year | 10-Year | 15-Year | |||
| Public 60/40 Portfolio | 10.0% | 10.6% | 8.6% | 6.7% | 8.5% | 10.7% | -11.6% | -30.1% | ||
| Alternative Assets Portfolio | 17.2% | 11.2% | 10.2% | 7.9% | 5.8% | 7.7% | -9.3% | -24.4% | ||
| 60% Alternative Assets Portfolio / 40% Public 60/40 Portfolio | 14.3% | 11.0% | 9.5% | 7.5% | 6.6% | 8.5% | -10.2% | -26.7% | ||
Source CAIA. Data is quarterly, annualized returns are computed using arithmetic mean. Data for Private Equity, Private Debt, Real Estate, Natural Resources, and Infrastructure are computed using pooled time-weighted return statistics for funds with vintage years 2000 through 2016 computed using pooled time-weighted return statistics for funds with vintage years 2000 through 2016. *Alternative Assets Portfolio is represented by an equally weighted portfolio of Private Equity, Private Debt, Hedge Funds, and Real Assets (Real Estate, Natural Resources, and Infrastructure). ** Public Data is represented by MSCI ACWI All Cap and Bloomberg US Agg Bond TR .
$1 Million Dollar Portfolio Comparison
The chart below displays the return differences for an investor with a US$1 million dollar portfolio.
This study utilizes certain Alternative indices in the calculations. There are many other potential Alternative investments that could be viable replacements to traditional assets. The key is to identify the investment’s characteristics that will facilitate an enhanced return over traditional fixed income, provide similar diversification parameters, and the option of distributed income.
Replacement for Bonds: Real Estate Included in the Portfolio?
“…core real assets like real estate and infrastructure are seen delivering about twice the yield of global bond aggregate with 40% less volatility than global stocks”
Thus, it is important to consider including exposure to real estate in your portfolio.
There are many options within real estate. Real Estate Investment Trusts (REITs) can be traded on the stock market and have previously provided high dividend yields along with moderate long-term capital appreciation. REITS do offer liquidity but come at a cost of market volatility. Public REITS can have drastic falls in value, as can be seen by the MSCI US REIT index in 2022, down 14.85% as of the end of May.
Private Alternative investments have long existed in real estate and can better match the longer investment horizon character of this asset class. For example, the option that Kirkland Capital Group provides is access to a pool of micro-balance private commercial real estate mortgages through its Kirkland Income Fund I. The Kirkland Income Fund is a principal preservation focused high-yield fixed income fund. The fund delivered over 10% net returns for 2021 and continues strong performance in 2022 while using no leverage.. The Fund has the option for monthly payouts, providing income to investors. The Fund also serves as a diversifying addition to a portfolio as it has shown negative correlation for the period of April 2020 to May 2022 to the S&P500 TR Index (-0.50 correlation), Bloomberg US Aggregate Bond Index (-0.44 correlation), and the MSCI US REIT Index (-0.40 correlation).
As shown below, an investment of $1 million into a split of 60% to the S&P 500 and 40% into the Kirkland Income Fund would have outperformed a 60% S&P 500 / 40% US Aggregate Bond portfolio by over $150,000 since the inception of the fund.
Conclusion: Is the 60/40 Portfolio Dead?
The traditional 60/40 portfolio that allocates 40% to bonds no longer provides the positive historical return and diversification factors. In terms of generating growth whilst simultaneously offering diversification, there are now a variety of Alternative Investments that provide better supplementation to your portfolio. These Alternative Investments, as discussed above, often have additional factors like illiquidity that allow them to capture greater returns than public markets over time. Therefore, all investors should consider the inclusion of a significant proportion of Alternatives when building their investment portfolio for the future.
