The reported death of 60/40 portfolio, may well be exaggerated, but it certainly is ailing.
As reported by Think Advisor in relation to the 60/40 Portfolio (60% listed equities / 40% fixed income):
“No less than three major firms have issued reports in the last few weeks declaring it dead or ailing: Bank of America Merrill Lynch, Morgan Stanley, and JPMorgan.”
All three firms have similar reasons:
- Low expected returns, particularly from Fixed Income
- Reduced portfolio diversification benefits from Fixed Income
For example, JP Morgan: “Lower returns from bonds create a challenge for investors in navigating the late-cycle economy,” “The days of simply insulating exposure to risk assets with allocation to bonds are over.” (A risk asset example is listed equities.)
With regards to the declining diversification benefits from Fixed Income in a portfolio Bank of America make the following point: Fixed Income (Bonds) have functioned as an offset to equity market loses over the last 20 years, this may not occur in the immediate future.
Technically, fixed income has had a negative correlation to equity markets over the past 20 years, interestingly, this did not prevail in the prior 65 years.
Underpinning these views is the expectation of lower investment returns than experienced over the last 10 years. Access to JP Morgan’s Longer-term Capital Market assumptions are provided in the article.
There is no doubt we are living in challenging times and we are heading into a low return environment. I covered in this in a previous Post: Low Return Environment Forecasted. This Post provides an indication of the level of returns expected over the next 5 – 10 years.
What to do?
JPMorgan strategists are calling for “greater flexibility in portfolio strategy and greater precision in executing that strategy.”
I agree, to my mind, a set and forget approach won’t be appropriate in a low return environment, where higher levels of market volatility are also likely.
Naturally they are calling for a greater level of portfolio diversification and are recommending, Corporate bonds, Emerging market equities and bonds, U.S. real estate, Private equity, and Infrastructure investment. The last three are unlisted investments.
Personally, I think the death of 60/40 Portfolio is occurring for more fundamental reasons. The construction of portfolios has evolved, more advanced approaches are available.
For those interested I covered this in more detail in a recent Post: Evolution within the Wealth Management Industry, the death of the Policy Portfolio. (The Policy Portfolio is the 60/40 Portfolio).
The current market environment might quicken the evolution in portfolio construction.
Modern day Portfolios should reflect the lessons learnt over time, particularly from the Dot Com market collapse and the Global Financial Crisis (GFC or Great Recession).
Understanding the history of Portfolio Diversification is important. Modern Portfolio Theory (MPT) was developed in the 1950s and resulted in the 60/40 portfolio.
Although MPT is still relevant today, the Post on the Short History of Portfolio Diversification highlights much more has been learnt since the 1950s.
Furthermore, we can now more easily, and more cheaply, gain greater portfolio diversification. This includes an increasing allocation to alternative investment strategies and smarter ways to access investment returns.
This in part reflects the disaggregation of investment returns as a result of increased computer power and advancements in investment research.
As a result, Portfolios do not need to be over reliant on equities and fixed income to generate returns. A broad array of risks and return sources should be pursued.
This is particularly important for portfolios that have regular cashflows. High listed equity allocations in these portfolios is a disaster waiting to happen e.g. Charities, Foundations, Endowments.
While those near or just entering retirement are vulnerable to Sequencing Risk and should look to diverse their portfolio’s away from listed equities.
There is still a place for active management, where real skill and truer sources of excess return are worth exploring and accessing. In fact, they complement the above developments.
There are shades of grey in investment returns, as a result the emotive active vs passive debate is out-dated.
I think KiwiSaver Investors are missing out and their portfolios should be more diversified.
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