Is the 60/40 Investment Portfolio Dead?
What is the 60/40 Portfolio?
The 60/40 portfolio refers to an investment portfolio strategy that follows the allocation of all assets into a split of 60% invested into stocks and 40% invested into 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 functions 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. Previously 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 experts now believe that the 60/40 portfolio is no longer an investment strategy that generates the best growth profile. In the current financial climate, the bullish equity market may experience head winds due to current valuation, consequently weakening the 60% portion of the asset split. Furthermore, interest rates are at an all-time low across the board, which hinders the previously reliable, steady income that was provided from the 40% bonds asset split. Crucially, as bonds 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.
Essentially, the central problem with the 60/40 portfolio lies in the 40% asset distribution in bonds. Unfortunately, as yields on bonds have declined, the prospect and creation of governmental policies to boost economic growth simultaneously increases the risk of inflation. Thus, the fixed income return that was generated through bonds now may barely rise above the inflation percentage. Furthermore, as government intervention into markets becomes increasingly common practice, the volatility of bonds has dramatically increased in recent years. It is becoming less shocking to see the government suddenly slash bond interest rates with little to no warning for investors.
What do Future Predictions Indicate for the 60/40 Portfolio?
The entire premise, and ultimate success, of a 60/40 portfolio is based on generating profit growth over long-term timeframes. Therefore, it is important to understand the current estimations for investing in a 60/40 portfolio now. The table below showcases expected returns according to J.P. Morgan, the expected 2021 return for the 60% equity mix/40% fixed-income mix will only be 4.2%.
| Investment | Expected 2021 Return |
|---|---|
| Cash | 1.10% |
| 10 Year T-Bond | 1.60% |
| Investment Grade Corporate | 2.50% |
| High Yield Corporate | 4.80% |
| Emerging Market Debt | 5.20% |
| US Large Cap Equity | 4.10% |
| US Small Cap Equity | 4.60% |
| 60% Equity Mix/40% Fixed Income Mix | 4.20% |
Expected returns sourced from JPAM 2021 Long-Term Capital Market Assumptions September 30, 2020.
The chart below displays a variety of investment frontiers. Key takeaway is a portfolio comprised of traditional long equity and long fixed income allocations will experience a considerable drop in expected returns for 2021. Investors either must take more risk in the portfolio to meet required returns or find investment alternatives that can provide enhanced returns while providing diversification.
What Can Replace Traditional Investments in a 60/40 Portfolio?
Portfolios today should ideally go beyond just stocks and traditional bonds. However, it is important to consider the risk to investing in newer asset classes.
Alternative investments such as hedge funds, real estate, commodities, precious metals, private equity, cryptocurrencies, and inflation-protected assets are potential positive new additions to a contemporary well-balanced portfolio. It is increasingly important to focus on a portfolio that includes several varied asset classes to obtain a higher return or maintain a required return while either lowering risk or preserving a desired level of risk.
Replacement for Bonds: Real Estate Included in the Portfolio?
According to Pulit Sharma (Head of Alternative Investment Strategy at JPAM),
“…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 certain 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 Vanguard Real Estate ETF (VNQ) being down 10.5% in 2020. There are other REITS that focus just on mortgage investing. They generally have higher yields but also suffer large swings due to market dynamics. The iShares Mortgage REIT (REM) had a market price return of -29.52% for 2020.
There are many other potential alternatives that could be viable replacements. 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.
For example, the option that Kirkland Capital Group provides is exposure to a pool of private commercial real estate mortgages through its Kirkland Income Fund I. This income fund has a targeted net return of 8.5% - 9.5% which is far greater than current traditional fixed income investments. The Fund has the option to pay out monthly, providing an income to investors. The Fund is also a diversifying addition to a portfolio as it has shown negative correlation for the period of April 2020 to December 2020 to the S&P500 TR Index (-0.297), Barclays Aggregate Bond Index (-0.636), and the MSCI US REIT Index (-0.155).
Chart based on target annual KIF net returns; past performance does not guarantee future results
Conclusion: Is the 60/40 Portfolio Dead?
The traditional 60/40 portfolio that includes a 40% allocation to bonds is not “dead” but 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 may provide a 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 must be mindful of the inclusion of a significant proportion of alternatives when developing their investment portfolios for the future.
