The best-known names in asset management and investment banking are taking opposite sides in the debate over the classic way of building a portfolio—60% stocks and 40% bonds—after a disastrous performance for the 60/40 model last year.
says the losses—the worst in nominal terms for a 60/40 portfolio since the financial crisis of 2008-9 and the worst in real terms in a calendar year since the Great Depression—show that the structure is outdated. Goldman demurs, arguing that the odd big loss is inevitable in any strategy and that 60/40 remains a valid basic approach. Strategists and fund managers at other large money managers and banks have been piling in on both sides.
Investors should be paying close attention after decades of 60/40’s being accepted at a minimum as a reasonable base on which to construct a portfolio. Abandon it, and investments once considered exotic—BlackRock likes private debt and equity, commodities, infrastructure and inflation-linked bonds—join stocks and bonds as building blocks. Stick with it and they amount to small add-ons to the stock/bond core.
There are decent arguments for and against the 60/40 split as a sensible starting point for a portfolio.
Before getting into them, it is worth considering why 60/40 became the standard (some prefer 50/50 for a bit more caution, or 70/30 for a bit more aggressiveness). It gives an investor decent exposure to growth through the stock element, steady income from the bonds, and a cushion during recessions when stocks often fall hard and bond yields usually fall too, increasing bond prices. Plus, it is easy.
Last year, stocks were down big, and bonds lost money too. The Dow Jones U.S. Total Stock Market index lost 19.5% including dividends, while the ICE BofA U.S. Treasury index lost 12.9%. A 60/40 U.S. portfolio had one of its worst years ever, because the bonds didn’t do what they were supposed to do. The question, then, is whether 2022 was an exception and bonds will now resume normal service.
The best argument for sticking with 60/40, at least as a base, is that it is a decent neutral portfolio when we don’t have any idea about how the future will work out. Bonds have sometimes lost money at the same time as stocks for extended periods in the past, but not often.
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“It’s happened [losses on both] in the past—it will happen in the future,” says Sharmin Mossavar-Rahmani, head of the investment strategy group in the
investment division and chief investment officer of wealth management. “But it’s rare.”
Goldman calculates that U.S. stocks and bonds both lost money over a 12-month period just 2% of the time since 1926. You might reasonably be upset that your investments were caught up in such an unusual loss, but you should make radical portfolio changes only if you think this is the start of something new.
BlackRock argues exactly this. “This is a different regime. The great moderation is over,” says Vivek Paul, head of portfolio research at BlackRock Investment Institute.
After 10-year Treasury yields peaked at 15.8% in 1981, they fell for four decades to a low of 0.5% in 2020, offering surprise long-term capital gains to bondholders on top of the guaranteed income. Better still, from 2000 onward they offered fairly good day-to-day protection against losses on stocks, as the pattern of price moves flipped so bonds and stocks went in opposite directions. (Put another way, stocks tended to rise when bond yields went up, and fell when yields fell). The protection offered by bonds didn’t come at the cost of sacrificing returns.
For sure, 10-year yields can’t drop more than 15 percentage points in the next 40 years, because they currently yield only about 3.5%. The bond-equity link also seems to have returned to the pattern of higher bond yields being bad for stocks, and vice versa, as investors focus on inflationary pressure instead of economic growth. It is reasonable to think this might last given the long-term upward pressure on inflation from deglobalization, demographics and spending to combat climate change.
In a sense this is the active-passive argument played out again. If you, like me, think we’re probably heading for a more inflationary future, it makes sense to hold less in the way of ordinary bonds. But if you aren’t really sure—Ms. Mossavar-Rahmani says the outlook is clouded by “heavy fog,” and she’s not wrong—60/40 is a decent place to start.
A further argument for 60/40 is that many of the things put forward as an alternative portfolio cushion to bonds also had a terrible year last year. You might think Treasury inflation-protected securities would protect against inflation. But rising real yields meant that since the start of last year, TIPS lost almost exactly the same amount as ordinary Treasurys.
Private markets aren’t immune. Being private could mean the fund manager doesn’t tell you that you’ve lost money, but the value of a loan or a company has gone down as interest rates have risen, no matter whether the company is private or listed. And fees are far higher.
Commodities felt like a no-brainer last year, when everyone was obsessed with rising energy prices, metals shortages and inflation. Yet, the spot prices of crude oil, U.S. natural gas, gold and copper are very close to where they started 2022. It wasn’t a buy-and-hold market.
The fundamental problem is that last year the Everything Bubble deflated. Stocks and bonds started out very expensive, as did TIPS and private assets, because they were priced on the assumption of very low interest rates. Once the Federal Reserve recognized reality, the assumption went out the window and prices plunged. With valuations back in the range of reasonable for both stocks and bonds, a 60/40 equity/bond split is a decent starting point for building a portfolio—even if those who worry more about long-run inflation, as I do, might add a little more inflation protection than comes as standard.
Write to James Mackintosh at firstname.lastname@example.org
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