The 60/40 portfolio isn’t dead, but is it evolving, and will look different in the future according to GSFM investment strategist Stephen Miller.
He says it is time to consider a 50/20/30 portfolio, diversified between listed equities / bonds / and ’other’ assets with the ‘other’ including private substitutes for publicly listed equities and publicly traded bonds; namely private equity and private credit.
“Those private assets after all make up increasing proportions of the overall investible pool,” he says.
“The ‘other’ should also include assets ideally uncorrelated with equity and bond returns. This might include precious metals (perhaps a better safe harbour than bonds in the emerging investment environment - a notion given expression by the appreciation in the gold price), liquid alternatives, long/ short strategies in equities and bonds, and macro and quant hedge fund strategies to name a few.
“For some time, it has been the understood wisdom in investing circles – admittedly at a highly simplistic level - that a 60/40 portfolio of equities/ bonds was a reasonable rough and ready approximation of appropriate portfolio diversification.
“The utility of that 60/40 approach was thought to arise from the assumed negative return correlation between equities and bonds.
“Certainly, in the two decades leading up to the COVID-19 pandemic, the logic went that with inflation quiescent central banks could rapidly ease monetary policy to counter episodes of pronounced downdrafts in economic activity and attendant risk aversion that might otherwise have seen a deep(er) recession.
“Central bank easing saw sharp falls in bond yields that cushioned any negative consequence on portfolios of declining equity markets. Moreover, declining bond yields tended to arrest the downdraft in equity markets.”
But he says the negative return correlation doesn’t hold up during large periods of time, impacting true portfolio diversification
“It didn’t hold up so well during the 20th century, including through the high inflation period of the mid-1960s to the early 1990s. Nor has it held up well in the post-pandemic period where developed economies have exhibited more pronounced inflation proclivities.”
He says in the wake of the COVID-19 pandemic a number of developed economies have seen stickier inflation which, by and large, has prevented the previous negative correlation between equity and bond returns from reasserting itself.
“That begs the question whether the 60/40 equity/bond portfolio remains an appropriate rough and ready means of portfolio diversification.
“I think not.
“Inflation continues to exhibit some stickiness. The Trump tariff agenda will exacerbate that in the US, at least in the short-term, and maybe longer if price pressures from tariffs are not quarantined from inflation expectations.
“Retaliation will create similar risks in countries that choose to go down that path.
“Budget deficits are large, particularly (but not uniquely) in the US, and in the absence of meaningful cuts in government spending and / or tax increases, deficits are likely to go higher.
“Not only is this potentially adding to inflation pressures, but the amount of issuance required to fund these deficits may well create episodic indigestion in bond markets keeping bond yields from falling.
“What is certain is that investors need to re-think what appropriate diversification looks like in a multi-asset context in what is likely to be a substantially changed set of global economic arrangements,” Mr Miller says.
