According to Wall Street Strategists, the 60/40 portfolio has died, once again. It has been an exceptional run, finishing with a crescendo this year. An blended index of 60% global stocks and 40% bonds has returned over 15% this year through November.
After a choppy summer, global stocks have staged a recovery, adding strong gains so far in Q4. The bond side of this portfolio has also had a stellar year, posting above-historical returns year-to-date.
The death of the 60/40 portfolio has been called many times before, but it has proven to have many lives.
No doubt the 60/40 portfolio has an impressive long-term track record. Global stocks have returned an average of 9.4% per year since 1976. The 60/40 portfolio has returned 8.9% but with only 64% of the volatility of a 100% allocation to global stocks[1]. The fact a 60/40 portfolio has returned nearly all of the returns of stocks with a fraction of the risk is about as close to financial wizardry as it comes.
Strategists say the beef with this portfolio stems primarily from declining interest rates:
Bond yields have fallen over the last 38 years, providing a tailwind to the fixed income component in a balanced portfolio.
Bonds returns are usually good when stock returns are bad and vice versa. This means the bonds have been a great diversifier for stock investors, smoothing out the ups and downs over time.
Because interest rates have now reached a level so low, the thinking is they cannot fall any further. Therefore, the bull market in bonds is dead, and don’t count on them to offset shocks to the stock market in the future either. There isn’t any juice left to squeeze.
The conclusions from such a proclamation usually involve turning to a combination of the following recommendations: buy commodities, real estate, hedge funds, private equity, or even annuities. Each of which is either saddled with fees (look at that yield-to-broker!), fraught with other dangers, or simply misguided.
The reality is these pundits have no clearer a crystal ball than anyone else. The end of the rally in interest rates has been predicted often over the last decade, only for interest rates to continue to fall. The fact bond yields have broken through zero in many places across the world suggests markets can do unpredictable things.
We doubt the diversifying feature of bonds is finished. After all, during market turbulence, investors seek safety – often safety at any cost. During the financial crisis, investors were willing to buy treasury bills with a negative yield, and they are currently willing to do so in Germany and Japan today. When investors are fearful, money will flow to safe-haven assets irrespective of price.
What It All Means
It has been a great year for the balanced portfolio – both stocks and bonds have returned numbers that are above what we believe can be expected going forward. Low interest rates do not necessarily mean the 60/40 will be a less superior portfolio. However, it may ultimately mean that returns may be lower over the next twenty years than they have been over the last twenty. But returns for all portfolios will likely be lower as well – even ones with commodities, private funds and the other more expensive, and less reliable, options.
When planning ahead, especially when it comes to the financial markets, we are forced to make assumptions about the future. Will it be like the past? How will it be different? Don’t bank on history repeating. Today’s market conditions have implications for the future. Investors should carefully incorporate these conditions and lessons from history into a process for a well-crafted long-term plan.
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[1] We use MSCI All-Country World Index back to 2001. Prior to that, we proxy global stocks with the MSCI World Index. Bonds are represented by Bloomberg Barclays US Aggregate. The 60/40 composite is rebalanced annually.