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In recent years, particularly in 2022 when stocks and bonds decline in unison, the most common ways of viewing the 60/40 portfolio structure is that it’s alive or dying. Binary, black and white choices to be sure, but options that don’t leave room for a gray area.
That’s understandable because portfolios are judged in binary fashion. Either the construction and securities held get the job done for clients or they don’t. However, 60/40 can be a different ballgame because while tried and true, this way of building portfolios isn’t, nor should it be, linear across an entire client base.
Indeed, 60/40 or slight variations thereof isn’t for everyone. A 40% fixed income allocation is arguably far too high for a 35-year-old client. Likewise, a 60% tilt to stocks could be too aggressive for clients in their 70s.
The point is 60/40 needs new life and accessing that evolution isn’t as cumbersome as some advisors may be led to believe. It is, however, necessary.
Exploring 60/40 Evolution
As noted above, stocks and bonds declined in unison in 2022, dispelling the notion that fixed income provides a buffer against slack equity markets. That scenario is historically rare because equities and bonds usually aren’t highly correlated, but positive correlations between the two asset classes can work in favor of clients after yields ascend as has been the case for nearly two years now.
That speaks to evolution and the need for diversification, both of which can be realized at the asset class level. Yes, that means integrating assets other than stocks and bonds in 60/40 portfolios. There’s good reason to consider such a strategy.
Examining the worst equity drawdowns from the last 50 years, “the 60/40 portfolio mix has tended to fall roughly 50% to 60% less than the corresponding equity decline. The 2022 drawdown does stand out as a notable exception, even when we compare it with earlier inflation-afflicted markets,” according to State Street Global Advisors (SSGA).
Experienced advisors know that 2022, while a rarity, wasn’t a one-off for 60/40 investing. A slightly less worse though still ugly scenario was seen in 2008 and in 1974. In those two cases, the erosion of 60/40 returns was attributable to equity market weakness because there are just three years in the past 97 in which stocks and bonds fell together -- 1931, 1969, and 2022.
Be implementing more alternative assets into 60/40 portfolios, it’s possible that the bad years could have been less worse.
Inflation Matters
As was on full display in 2022, inflation can take a substantial bite out of 60/40 portfolios. However, advisors know that can be ameliorated with select inflation-fighting asset classes.
Those include hybrid assets, such as unique, high-yielding debt, as well as commodities. Neither are guarantees of downside in a 60/40 portfolio, but they can potentially provide buffers.
“We own commodities to help protect against inflation risks and for their diversification properties, which can help to improve overall risk-adjusted returns over time,” adds SSGA. “While we’ve moved away from the traditional 60/40 by holding assets outside of stocks and bonds, we think of commodities as a growth-oriented asset class with great diversification potential. We believe this is especially true for portfolios otherwise dominated by equity risk, and we fund them with assets that otherwise would have been earmarked for stocks.”