GMO, a US based value investor, has concluded “now is the time to be moving away from 60/40” Portfolio. Which is a Balanced Portfolio consisting of 60% US equities and 40% US fixed income.
Being a “contrarian investor”, recent market returns and GMO’s outlook for future market returns are driving their conclusions.
The GMO article makes the following key observations to back up their contrarian call:
- The last time they saw such a wide “spread” in expected returns between a traditional 60/40 portfolio and a non-traditional one was back in the late 1990s, this was just prior to the Tech bubble bursting.
- The traditional 60/40 portfolio went on to have a “Lost Decade” in the 2000s making essentially no money, in real terms, for ten years. Starting in late 1999, the 60/40 portfolio delivered a cumulative real return over the next ten years of -3.9%.
As outlined in the GMO chart below, Lost Decades for a Balanced Portfolio have happened with alarming and surprising frequency, all preceded by expensive stocks or expensive bonds.
GMO note that both US equities and fixed income are expensive today. As observed by the high CAPE and negative real yield at the bottom of the Chart.
They are of course not alone with this observation, as highlighted by a recent CFA Institute article. I summarised this article in the Post: Past Decade of strong returns are unlikely to be repeated.
The Balance Portfolio is riskier than you think.
The GMO chart is consistent with the analysis undertaken by Deutsche Bank in 2012, Rethinking Portfolio Construction and Risk Management.
This analysis highlights that the Balanced Portfolio is risker than many think. This is quite evident in the following Table. The Performance period is from 1900 – 2010.
|Compound Annual Return per annum||3.8%|
|Volatility (standard deviation of returns)||9.8%|
|Maximum Drawdown (peak to bottom)||-66%|
|% up years||67%|
|% time negative returns over 10 years||22%|
The Deutsche Bank analysis highlights:
- The, 60/40 Portfolio has generated negative real returns over a rolling 10 year period for almost a quarter of the time (22%).
- In the worst year the Portfolio lost 31%.
- On an annual basis, real negative returns occur 1 in three years, and returns worse than -10% 1 in every six years
- Equities dominate risk of a 60/40 Portfolio, accounting for over 90% of the risk in most countries.
The 4% average return, comes with volatility, much higher than people appreciate, as outlined in the Table above. The losses (drawdowns) can be large and lengthy.
This is evident the following Table of Decade returns, which line up with the GMO Chart above.
|Decade||Per annum return|
We know the 2010s was a great decade for the Balanced Portfolio. A 10 year period in which the US sharemarket did not experience a bear market (a decline of 20% or more). This is the first time in history this has occurred.
Interestingly, Deutsche Bank highlight the 1920s and 1950s where post war gains, while the 1980s and 1990s were wind-full gains.
The best 4 decades returned 11.3% p.a. and the 7 others 0.7% p.a.
As outlined in my last Post, the case for diversifying away from traditional equity and fixed income is arguably stronger than ever before.
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