For many years, a large percentage of financial planners and stockbrokers crafted portfolios for their clients that were composed of 60% equities and 40% bonds or other fixed-income offerings. And these so-called balanced portfolios did rather well throughout the 80s and 90s.
But, a series of bear markets that started in 2000 coupled with historically low-interest rates have eroded the popularity of this basic approach to investing. Some experts are now saying that a well-diversified portfolio must include more asset classes than just stocks and bonds. As we'll see below, these experts feel that a much broader approach must now be taken in order to achieve sustainable long-term growth.
- Once a mainstay of savvy investors, the 60/40 balanced portfolio no longer appears to be keeping up with today's market environment.
- Instead of allocating 60% broadly to stocks and 40% to bonds, many professionals now advocate for different weights and diversifying into even greater asset classes.
- In particular, alternative investments such as hedge funds, commodities, and private equity, as well as inflation-protected assets are some new additions to the well-rounded portfolio.
Bob Rice, the Chief Investment Strategist for boutique investment bank Tangent Capital, spoke at the fifth annual Investment News conference for alternative investments. There, he predicted that a 60/40 portfolio was only projected to grow by a rate of 2.2% per year into the future and that those who wished to become adequately diversified will need to explore other alternatives such as private equity, venture capital, hedge funds, timber, collectibles, and precious metals.
Rice listed several reasons why the traditional 60/40 mix that had worked in past few decades seemed to under-perform: due to high equity valuations; monetary policies that have never previously been used; increased risks in bond funds; and low prices in the commodities markets. Another factor has been the explosion of digital technology that has substantially impacted the growth and operation of industries and economies.
“You cannot invest in one future anymore; you have to invest in multiple futures,” Rice said. “The things that drove 60/40 portfolios to work are broken. The old 60/40 portfolio did the things that clients wanted, but those two asset classes alone cannot provide that anymore. It was convenient, it was easy, and it's over. We don't trust stocks and bonds completely to do the job of providing income, growth, inflation protection, and downside protection anymore.”
Rice went on to cite the endowment fund of Yale University as a prime example of how traditional stocks and bonds were no longer adequate to produce material growth with manageable risk. This fund currently has only 5% of its portfolio allocated to stocks and 6% in mainstream bonds of any kind, and the other 89% is allocated in other alternative sectors and asset classes. While the allocation of a single portfolio cannot, of course, be used to make broad-based predictions, the fact that this is the lowest allocation to stocks and bonds in the fund’s history is significant.
Rice also encouraged advisors to look at a different set of alternative offerings in lieu of bonds, such as master limited partnerships, royalties, debt instruments from emerging markets, and long/short debt and equity funds. Of course, financial advisors would need to put their small and mid-sized clients into these asset classes through mutual funds or exchange-traded funds (ETFs) to stay in compliance and manage risk effectively. But the growing number of professionally or passively-managed instruments that can provide diversification in these areas is making this approach increasingly feasible for clients of any size.
Alex Shahidi, JD, CIMA, CFA, CFP, CLU, ChFC – a Teaching Professor at California Lutheran University and Managing Director of Investments, Institutional Consultant with Merrill Lynch & Co. in Century City, California – published a paper for the IMCA Investment and Wealth Management magazine in 2012. In this paper, Shahidi outlined the shortcomings of the 60/40 mix and how it has not historically performed well in certain economic environments. Shahidi states that this mix is almost exactly as risky as a portfolio composed entirely of equities, using historical return data going back to 1926.
Shahidi also creates an alternative portfolio composed of roughly 30% Treasury bonds, 30% Treasury inflation-protected securities (TIPS), 20% equities and 20% commodities and shows that this portfolio would yield almost exactly the same returns over time but with far less volatility. He illustrates using tables and graphs, exactly how his “e-balanced” portfolio does well in several economic cycles where the traditional mix performs poorly. This is because TIPS and commodities tend to outperform during periods of rising inflation. And two out of the four classes in his portfolio will perform well in each of the four economic cycles of expansion, peak, contraction, and trough, which is why his portfolio can deliver competitive returns with substantially lower volatility.
The Bottom Line
The 60/40 mix of stocks and bonds have yielded superior returns in some markets but has some limitations as well. The turbulence in the markets over the past few decades has led a growing number of researchers and money managers to recommend a broader allocation of assets to achieve long-term growth with a reasonable level of risk.