As advisors have watched many bond funds suffer unprecedented losses in the first quarter, some see a silver lining at the end of the cycle. Even as they have delivered spectacular returns for clients since the Great Financial Crisis ended, longtime advisors privately acknowledge that generating retirement income for clients was a lot easier between 1990 and 2008, when investment-grade corporate bonds yielded 5% to 7% and the Standard & Poor’s 500 had a dividend payout of 2.5% or 3.0%.
That has prompted some advisors to wonder if an environment where 60/40 portfolios can continue to deliver the desirable benefits they did for decades still exists. As a wave of baby boomers retires, favorable conditions could make advisors’ lives a lot easier, even if equities aren’t going up 15% a year.
Such a scenario is conceivable, but there is no guarantee they should be so lucky. If one looks back at bond market returns over the last 50 years, it’s worth noting that the post-GFC decade of deflationary fears was as big an aberration as the 1970-1982 period of hyper-inflation, noted Fabric Risk co-founder Rick Bookstaber. “The last decade has been one of experiment with QE,” he said.
Risks in the bond market remain elevated. The chance that investors in 10-year Treasury bonds could suffer losses of another 10% or even 20% is real, according to Bookstaber, who served as chief risk officer at Morgan Stanley and the $170 billion University of California endowment and retirement system.
Even sophisticated professional investors are afflicted with short-term rate myopia in Bookstaber’s view. Only one month ago, the smartest professionals in the bond market were predicting yields on 10-year Treasurys might eventually hit 2.5% at some point in 2022. Within weeks, they burst through that threshold.
Inflation is expected to moderate this year, but few anticipate a return to the anemic levels witnessed in the last decade. “We expect inflation will be under control within the next 12 months,” said Michael Hunstad, head of quantitative strategies at Northern Trust Asset Management. That’s “all the more reason for an equity overweight,” he argued.
A day may well come when 60/40 portfolios shine again, Hunstad added, but right now advisors need to remain worried about the risks outlined by Bookstaber. That’s because bonds, the “40% of the portfolio where yield is the driver of returns, [are] as volatile as equities.”
In recent weeks, bond prices have displayed their highest level of volatility ever. Hunstad observed that one could construct a portfolio of high-dividend stocks yielding 2% to 4% and they’d produce a yield equal to or greater than 30-year Treasurys. That equity portfolio would have volatility similar to long-term Treasury bonds with the additional potential for dividend growth and capital appreciation.
Some experienced advisors aren’t buying into the idea that the old 60/40 portfolio will make a comeback as a silver bullet for retirees, even if inflation returns to the 2.75% rate experienced from 1990 to 2008. A 5.0% to 5.5% return on intermediate corporate bonds “sounds pretty good, but after a 20% tax bite and a 2.7% inflation adjustment would be about a 1.35% to 1.7% [return],” said Harold Evensky, founder of Evensky & Katz,/Foldes Financial.
That’s not “very much to count on without factoring in equity returns,” Evensky said. “Even then, if stocks return an optimistic 8%, I estimate the net after tax and inflation return on a 60/40 portfolio would be about 3%. And that doesn’t factor in expenses.”
He expects a difficult, challenging decade ahead for many clients. The solution is "sound planning, not keeping your fingers crossed for better returns."