Opinion  

Does the 60/40 asset allocation still work?

Giulio Renzi-Ricci

Giulio Renzi-Ricci

It has been a difficult year for equity and bond markets.

With inflation at record highs, sharp reversals in monetary policy and a perfect storm of events driving down prices, it is understandable that investors want to be sure their investment strategy is appropriate for the times. 

Indeed, it is particularly in times of volatility that advisers can help investors consider the bigger picture and retain focus on their long-term goals. We believe the evidence is clear that a well-established approach to asset allocation – in which a balanced, risk-adjusted portfolio of equities and bonds is held for the long term at a low cost – continues to serve investors well. 

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Share-bond diversification in historical context

Some investors have been unnerved by equities and bond prices declining in lockstep over the course of the year. In fact, brief, simultaneous declines in shares and bonds are not unusual, as our chart shows.

Viewed monthly since early 1995, in GBP terms, the nominal total returns of both global shares and investment-grade bonds have been negative around 13 per cent of the time. That is a month of joint declines a little over every seven months or so, on average. 

Historically, once the market has had time to adjust, the negative correlation between bonds and equities has re-established itself within a matter of months. Our analysis of recent prolonged market downturns suggests the longer a crisis drags on, the more likely bonds are to play a stabilising role. 

Bonds as ballast

This is particularly important, as the primary role of bonds in an investment portfolio is not to drive returns but to act as a stabiliser. We are cautious of proposed alternatives to investment grade bonds as the main counterweight to equities in a balanced portfolio.

Asset classes such as real estate introduce cost and liquidity concerns. Sectors such as commodities and high-yield debt can help with hedging unexpected inflation but exhibit equity-like behaviours.

Hedging strategies such as put options introduce complexity, while still being exposed to considerable drawdowns. This is not to say there is not an investment case for these approaches in particular circumstances. Rather, there is not a compelling substitute to the benefits high-quality fixed income provides with regard to diversification, transparency, relative simplicity and cost. 

Equally, it is unlikely that long-term investors will be able to preserve returns simply by coming out of the market. Short-term market timing is extremely difficult even for professional investors and, we believe, doomed to fail as a portfolio strategy.

Markets are incredibly efficient at quickly pricing unexpected news and shocks, such as the invasion of Ukraine or the accelerated and synchronised central bank response to global inflation. Chasing performance and reacting to headlines tend not to work in the long term since it often amounts to buying high and selling low.

What might the future hold? 

It is also important to remember that, with the painful market adjustments year-to-date, the return outlook for the 60/40 portfolio has improved.