The global head of portfolio strategy at Willis Towers Watson, Jeffrey Chee, says the traditional balanced fund’s reference portfolio of 60/40 will need to be rethought in a post-Covid-19 environment.

The 60/40 split has had its best decade in the most recent 10-year period, driven by falling bond yields and rising equities, but “that model is going to be a lot more challenged going forward,” Chee says.

“I don’t think 60/40 is dead. It is still useful as a reference point,” he says. “But investors are going to exploit different levers in order to add value relative to that.”

“From here, it [60/40] is probably not going to get you to your objectives, so investors need to think more generally about how they’re going to add value and why, and the justification for that.”

Augmenting the risk mindset

With markets, including equities and pockets of fixed income, overvalued, Chee says investors need to think about different dimensions, including risk-return.

Covid-19 has highlighted there are a wide variety of triggers of big, sharp drawdowns in equity markets that are difficult to anticipate in advance.

“That highlights the need to augment that traditional risk-return mindset with considerations of the diversity of a portfolio, so fundamentally how exposed are you to different things that drive returns?”

Chee says other important lenses include liquidity, cost and complexity. “To what extent are you able to absorb or deal with uncertainty around assumptions you’re setting?”

Those characteristics can be quantified, Chee describes, which allows investors to rank various characteristics against each other and look at trade offs between liquidity and complexity, costs and diversity, etc. “That is a much better and more holistic way of building a portfolio.”

For example, Chee explains if you want to underweight equities you can test different configurations of strategies brought into a portfolio.

Alternatively, they might increase risk but increase the cost. “You can work out how happy you feel about that. By weighting those different dimensions of portfolio quality in accordance with a particular investor’s beliefs, you can better explain how you got there and make sure the sources of value add and the levers that you pull are in line with your beliefs, your endowments, your competitive advantage, etc.”

Regime changes

When it comes to risk, Chee says that a lot of the traditional models that use historical rolling windows to measure risk will give you potentially quite misleading answers, and investors now need to take a long view of risk.