Is the 60/40 portfolio back and if so, why did it go away? This was a question posed at the Professional Planner 2023 Researcher Forum in Sydney on Monday.
Conexus Financial editor-at-large Simon Hoyle started the discussion off by noting that commentators often describe the 60/40 portfolio, where 60 per cent of a portfolio is allocated to stocks and 40 per cent to bonds, as the “living heart of investing”.
But he added that if you had a 60/40 portfolio, you probably lost money over much of the past two years when both stocks and bonds performed poorly because of soaring inflation and interest rates during the Covid-19 pandemic.
Da Silva Consulting principal Rob da Silva traced the origin of the 60/40 concept to Nobel Prize-winning US economist Harry Markowitz, who developed modern portfolio theory, “which sprouted efficient frontiers, portfolio optimisation and a whole spring of quantitative finance”.
“People were spending a lot of time and effort trying to figure out what the optimal portfolio was,” Da Silva said.
“From that sprang the 60/40 mix as a generally accepted conventional wisdom. I’m not sure there’s any one specific study that nails that number down, but it became the sort of go-to mix.”
Da Silva noted that in the earlier years, a 60/40 mix meant equities and bonds because these were what the US investing public was interested in.
“It’s only over the last decade or two that it’s kind of shifted to defensive versus growth, which I think is a much better way to look at it,” Da Silva said.
“But however you describe it, those numbers seem to have magically held fast. And, if you do all that sort of optimisation stuff, you are going to get close to that, whether it’s 50/50, 60/40 or 70/30.”
However, Da Silva cautioned that the 60/40 mix was not relevant to everybody and the right mix depended on an individual’s circumstances and risk-return tolerance.
Nuveen Natural Capital head of APAC and Africa, Kristina Hermanson, pointed to the direction of her firm’s parent company, US pension fund TIAA (the Teachers Insurance and Annuity Association of America), and how they used Nuveen to diversify with assets outside the equity/bond remit.
“[It’s] always looking beyond on the frontier of what’s beyond that 60/40,” Hermanson said.
“In terms of diversification, what we see from natural capital whether its farmland or timberland, is very low or negative correlation to other asset classes.”
Bonds ‘kind of’ back
DPM Financial Services consultant Dominic McCormick said investors had become used to the negative correlation between bonds and stocks, which didn’t work in 2022 and hasn’t worked in many periods in history.
He said investors had been replacing the traditional bond exposure with other types of assets, taking on additional risks including illiquidity risks.
Da Silva agreed, adding: “Bonds became an unloved asset class. I think now it’s starting to feel a little bit of cuddles, a little bit of love. That will probably grow over time. But the question is, how much love do you want to give it?”
He said bonds were “kind of” back but must be seen in perspective. “You have to think hard about whether inflation is going to get back to 2 per cent so that bonds look good at, say, 4 per cent. “Inflation in Australia is 5.4 per cent and it’s taking its time coming down. That’s not a compelling yield case in itself.”
Changing the mix
Should we think of 60/40 as 60 per cent growth assets and 40 per cent defensive assets and move away from the bonds/equities discussion?
McCormick said this could become a bit problematic, noting that many assets have both defensive and growth characteristics.
That much depended on the sophistication of end investors, da Silva said, and their understanding of the various asset classes and their risk and returns. Also important were their time horizons and their need for or ability to tap liquidity in a portfolio. Plus, there were the costs of the transactions or managing a portfolio to consider.
McCormick said the investment environment had moved on from a world where there was a clear delineation of products considered illiquid. “We now have an increasing number of asset classes that are hybrid or liquid/illiquid products. Unfortunately, they become less liquid or illiquid at times of stress.”
He said the new products in the private equity or private credit space may have their day when they become less liquid at a time when returns were poor. He also queried whether these were the right assets for retirees looking to draw down money and needing flexibility.
Da Silva found the ETF and Listed Investment Companies space interesting in terms of diversification.
“If you look at the US, there’s not a damn thing that you can’t invest in that’s not an ETF somewhere… and I suspect we’re heading in that direction, which will open all of these markets up more to lower down the food chain to wholesale and individual investors.”
