“The 60/40 is not the typical, exciting investment people talk about,” admits Todd Jablonski, the chief investment officer and head of asset allocation at Principal Asset Management in Seattle. “In fact, for a long time, people picked on it to make whatever other thing they were selling look good.”
But like a maligned, underperforming teammate who suddenly looks ready to shine as circumstances change, the traditional portfolio of 60% equities and 40% bonds has recently won new respect. Serious respect. “If you go back a year, the number of articles on the death of the 60/40 was overwhelming,” says Jablonski, who specializes in these portfolios. “But I think I might be in a pretty good place right now.”
Fixed income, an asset class that enjoys buoyancy amid rising interest rates, was one of the few bright lights at the end of 2022. And given the economic forecasts for the next year or two, investors will likely be drawn once again to the stable returns and muted risk of balanced asset allocations.
The first glimmer that the 60/40 portfolio was ready to dust itself off and get back in the game came last October when Scott Opsal, research director at Minneapolis-based Leuthold Group, published an analysis called “The 60/40’s Annus Horribilis.” He looked at the portfolio’s returns through the decades since 1976, surmised that the worst was behind it and predicted that going forward the allocation should earn a very respectable 6.9% with only moderate risk.
At the time, though, the 60/40 portfolio was scraping the bottom with the best of ’em and had lost 20% for the year through September. A little recovery at the end of 2022 put the annual loss at 16.1%. “This was the second worst year since 1977,” Opsal said in an email, noting that the 60/40 mix lost 20.1% in 2008. In the last 45 years, he said, 2022 was the only year in which stocks and bonds were each down more than 10%.
Stocks have risen a bit since he published his article, while bond yields have fallen a tad. He said Leuthold’s actively managed balanced portfolios are in a slightly defensive posture for 2023, but the long-term outlook is positive. “Long-term expectations in a range of 6% to 8% seem very reasonable,” he said.
In November, J.P. Morgan Asset Management forecast a 7.2% return for the 60/40 portfolio in 2023. Given that the 60/40 portfolio’s historic performance is a 7.8% annual return, this seems like nothing to complain about. Yet for portfolio managers willing to take on a little more risk on the fixed-income side, that might be just a starting point.
Last November at Schwab’s Impact 2022 conference in Denver, Pramod Atluri, a fixed-income portfolio manager in the Los Angeles office of Capital Group, said he was confident he could construct a portfolio that was 100% fixed income and be very competitive with any stock-bond blend. “With investment-grade yields getting close to 6% and high-yield yields at 10%, 11%, maybe 12% pretty soon, we could construct a portfolio achieving 7% to 8% total yields with half to a third the volatility of equities,” Atluri said. “That is going to hit a lot of bogeys for a lot of clients and investors.”
The big hurdle for investors weighing the 60/40 portfolio, however, isn’t the returns that are possible. It’s that one of the key features of this allocation—the negative correlation of bonds with stocks—evaporated last year and left a lot of investor pain in its wake. “Bonds didn’t zig when equities zagged,” as Atluri put it.
What has to happen, these experts agree, is that the negative correlation has to return. When that will happen is anyone’s guess, but advisors think it will be sooner rather than later.
Atluri said it will happen when inflation starts drifting down—about two to three years out. Many economists expect inflation to downshift in 2023’s first half.
Jablonski is a little more optimistic. “We’ll be out of this soon,” he says. “We might see a negative correlation in 2023. And that’s when this pattern of behavior will return as a value-added element as opposed to a risk element.”
How one invests a 60/40 portfolio depends on the advisor or manager. If one looks under the hood of Jablonski’s funds for more detail, they’ll see he is divvying up his equity allocation into a 36% U.S. stocks position (where he’s overweight in mid-cap and small-cap names) and 24% international equities (in the developed markets).
Brian Culpepper, president of James Investment in Cincinnati, uses 60/40 portfolios as a mere conversation starter with his clients. “The right allocation depends on a client’s risk and on other things, including what their retirement money is slated for overall,” he says.
In general, his firm focuses on well-balanced portfolio mixes because “everybody’s excited by stocks if they go up, but if they go down, they cry fast.” The dates of his bond maturities have recently changed, since he wasn’t quite ready for long-term holdings in the middle of last year.
“We were pretty short on bond duration, but now we’re starting to skew to more of a barbell approach,” Culpepper says. (He defines short as less than five years and long as more than 20.)
His exact fixed-income mix is somewhere around 60% to 70% short and 30% to 40% long, he says. And all of those picks are in U.S. Treasurys, which he calls the right place to be right now. “I think we’re kind of in a recession now, a rolling recession. And with the high-yield bonds, the risk/reward is not there.”
On the equities side, Culpepper’s betting on defensive large-cap stocks (60%), with mid-cap and small cap splitting the remainder (40%).
George Young, a partner and portfolio manager at New Orleans-based Villere & Co., also lauds the attractive yields that have changed the game for fixed-income investing. “Suddenly, we’re getting real returns,” he says, adding that he’s been laddering five-year corporate bond maturities. And he’s even looking at cash as “a good competitor.”
“You can get 2% without any risk and have that stay liquid,” he says. “For those who can’t sleep at night, you can have some cash and have it not be a drag on the portfolio. A year ago, you couldn’t say that.” (At press time, a host of money market accounts were offering 3.3% annual yields.)
While fine-tuning allocations is exciting to financial advisors, it might be nothing more than sausage-making to the average client. In fact, Jablonski says there’s been a little bit of a disconnect between clients and their allocations, thanks to the proliferation of target-date funds. These offer a simpler way to discuss risk with clients and put them in appropriate vehicles, but they might mask what a client’s tolerance actually is.
“‘What’s your risk tolerance?’ is a hard question for people to answer,” he says. “‘When are you going to retire?’ is a lot easier.”