If the past year has taught us anything, it’s that reading the investment environment can be incredibly difficult even intra-day. Therefore, I’m always wary of rules that could over simplify multi-faceted concepts and considerations of risk, encouraging people down the wrong path.
There are, however, some rules which have stood investors in good stead for decades. One of these is the “classic” investing strategy of splitting your portfolio into 60% stocks and 40% bonds, the former generating greater potential for returns and the latter acting as ballast while also delivering a modest coupon or interest.
This split is an offshoot of Modern Portfolio Theory, the details of which need not detain us but which basically focuses on diversification as a means to bolster overall returns. The results speak for themselves: lest we forget the efficacy of the 60-40 strategy, we should note that a portfolio allocated this way to the S&P 500 and Bloomberg Barclays U.S. Treasury Index would have posted annual returns of almost 10% since the 1980s, and even almost as much for this year too - crisis notwithstanding.
There is still talk of the “death of 60-40” in the industry, and it’s not hard to see why. As with interest rates, bond yields – particularly those issued by highly rated countries - are in the doldrums of rock-bottom or even negative levels. The Fed is holding rates close to zero for the foreseeable and Treasuries are attractive mostly on the basis of being less unattractive than other options. Indeed, several countries, like Switzerland, have been effectively asking buyers of long-term bonds to pay them to hold their money.
Nor have bonds always performed as investors would have liked. March’s simultaneous falls proved equities and bonds are sometimes all too positively correlated, seriously denting fixed income’s famed status as a safety valve in rocky times.
Alternatives for hedging equities risk, and inflation, are now high on the agenda – equity options and other derivatives for the more sophisticated investors, and the exploration of alternatives by almost everyone who isn’t simply retreating into cash. Bitcoin and gold represent two ends of the alternatives spectrum, while others are betting the farm on a commodities super-cycle as fossil fuel’s dying gasp.
Nonetheless, many experts are holding firm on classic asset allocation, upholding bonds’ diversification benefits. Throwing their hats into the debate, Vanguard strategists recently observed that bonds and equities only move down together 29% of the time, for instance.
Their analysis concluded that government bonds do generally act as the shock absorbers investors need, generating positive returns to cushion the effect when equities have fallen by 10% or more peak to trough. What’s more, these diversification benefits get stronger when government bond yields go ultra-low or even negative.
Risk vs reward
Crucially, their analysis of past crises showed that the longer one goes on, the more likely bonds are to act as portfolio stabilisers. Without pouring cold water on all the recent vaccine euphoria, it’s fair to say that the road back to any kind of normality post-COVID could well be long and difficult – and markets correspondingly volatile. There is certainly growth to seek in the stock markets, but the months ahead might give investors great cause to be thankful they have also allocated to some very boring bonds.
It’s certainly been around for a long time, and whether the 60-40 rule will serve investors equally well in the changed world we find ourselves in remains to be seen. I’d argue it isn’t meant to be followed slavishly in any case. Rather, it should be taken to heart as a call to diversify.
Every crisis seems to bring headlines about the “death of 60-40”. But as a starting point for negotiation, and as a prompt to better balance both risk and reward, I’d say there is still plenty of life in this old maxim yet.