The 60/40 portfolio might be the go-to investment choice for those of moderate temperament, but there was nothing moderate about the 20% drop in these portfolios for the year until September 28.
The famous workhorse portfolio has recovered some of its footing this year, and its loss is now only 16.53%. As interest rates rise (and give some relief to bond performance), fans are hoping the recovery will continue, and that 2023 will see this oft-used investment strategy stage a comeback.
Historically, the 60/40 portfolio was often recommended for clients of a certain age—specifically, 100 minus the client’s current age—to determine how much of the portfolio should be in equities. Using this rule of thumb, a 40-year-old client would have 60% in equities and 40% in bonds. This created a nice blend for many a middle-aged and retired American.
But over time, and mostly because increasing longevity puts pressure on a portfolio to last longer, some advisors tinkered with the calculation so that the equity side would stand a better chance of supporting a portfolio for more years. And 110 became the new 100.
For many clients today, though, 70/30 seems aggressive given current equities volatility and the unknowns that lie ahead. Many clients right now are a lot more comfortable with 50/50.
But the key to finding the right blend for a client, industry sources said, is not a prescription at all.
“A 60/40 portfolio is not the be all and end all. It’s just a starting point for a conversation,” said Brian Culpepper, president of James Investment in Cincinnati. “The right allocation depends on a client’s risk and on other things, including what their retirement money is slated for overall.”
In general, his firm focuses on well-balanced portfolio mixes. “Everybody’s excited by stocks if they go up, but if they go down, they cry fast.”
Now that bond yields are providing significant interest rates, selling the bond side of the portfolio to clients is easier than it has been for a while, he said. “Generally, if you see that strategy struggle for a year, it’s usually the case that they do extremely well the following year.”
Anticipating a successful 2023 for fixed income, Culpepper said that some of his clients are at a 50/50 split of stocks and bonds, but about half are at 45% stocks and 55% bonds. And when it comes to portfolio construction, he said he’s starting to build in duration.
“Early on we were pretty short on bond duration, but now we’re starting to skew to more of a barbell approach,” Culpepper said, with short being defined as less than five years and long being more than 20.
His exact mix is somewhere around 60% to 70% short and 30% to 40% long, he said. 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%).
Last month at Schwab’s Impact 2022 conference in Denver, Pramod Atluri, a fixed-income portfolio manager in the Los Angeles office of Capital Group, presented an entire discussion on the benefits of a 60/40 portfolio.
“Earlier this year, 60/40 portfolios really did not deliver on client expectations,” Atluri said. “And that’s because bonds didn’t zig when equities zagged. The negative correlation that bonds have had for quite some time turned into a positive one.”
But he believes there’s sunshine ahead.
“When I look out to 2023, I still think bonds and stocks are going to be more positively correlated than they have been in the past, but I think that actually starts to work in investors’ favor,” he said. “Both legs of the 60/40, instead of working against you, next year are going to start working for you in the second half of the year. Ultimately, two to three years out is where we might see that negative correlation start to reassert itself once inflation is able to come back down.”
In the meantime, Atluri said he was confident that he could construct a portfolio that was even 100% in fixed income and yet would be 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,” he said. “That is going to hit a lot of bogies for a lot of clients and investors.”
George Young, a partner and portfolio manager at New Orleans-based Villere & Co., also lauded the attractive yields that have changed the game for fixed-income investing.
He said it’s important to remember that for a long time the assumptions for annual returns were 10% for stocks and 5% for bonds, putting a 50/50 blend at a 7.5% return.
That changed in 2020, when the assumption on equities was 7% and bonds was 2%, he said. “With Covid, the assumptions for both were brought down,” Young said. “This year, you could say the equities decline was a sucker punch, but we do have attractive bond yields now. A five-year, BBB-rated bond is yielding 5.85%. That’s pretty attractive.”
Young said in addition to corporate bonds, he’s even looking at cash as “a good competitor.”
“You can get 2% without any risk and have that stay liquid,” he said. “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.”