In June 2016, Forbes published an article entitled “The 60/40 Portfolio Is Dead, and It’s Not Coming Back.” In October 2017, Bloomberg followed suit with an opinion piece called “The Balanced Portfolio Has Had Its Time.” We disagree with the ominous tone and finality of such titles, but we do believe that expectations for balanced portfolios should be tempered in today’s environment.
A longer-term view of stock/bond correlations
Over the last two decades, investors have had the luxury of holding portfolios containing stocks and bonds with the assumption that those two asset classes would provide a correlation benefit. When stocks experienced periods of negative returns, such as 2008, bonds delivered a positive return, which helped mitigate the pain in a diversified portfolio. Over the last 30 years, core bonds and stocks have never experienced a negative annual return in the same year. However, this negative correlation between stocks and bonds is not the norm. Going back to the 1930s, stocks and bonds have had a positive correlation (i.e., they have moved broadly in the same direction) 73% of the time over five-year rolling periods.
A longer-term view of expected returns
The magnitude of returns is another consideration for investors with balanced portfolios. It’s no secret that bonds have benefited from a generational bull market as the yield on the 10-year Treasury bond declined from the mid-teens in the early 1980s to the current level of just under 3%. With the Bloomberg Barclays U.S. Aggregate Bond Index now yielding a little over 3%, we expect low-single-digit returns for bonds over the coming years. While this represents some improvement after a long period of extremely low interest rates following the financial crisis, it is still noticeably lower than the 6.4% annual return provided by core bonds over the past 30 years. In stocks, the S&P 500 has returned just under 11% over the same period, boosted by the productivity boom during the internet revolution of the 1990s and the aforementioned decline in yields. Assuming slightly lower equity returns versus recent history, this means that a traditional 60% large cap equity and 40% core bond portfolio should expect a return somewhere in the mid-single digits, with higher volatility than recent years. This return would be closer to the pre-1980s average as compared to the elevated returns experienced during the more recent bull market in bonds.
Not dead, just different: Adapting a balanced portfolio to new expectations
So what is an investor to do? First, expectations must be calibrated to the reality that future returns may seem underwhelming relative to recent experience. Investors should focus on their goals, maintain discipline and resist the temptation to undertake undue risk in search of short-term gains. Second, as multi-asset investors with a global perspective, we believe adding other asset classes to a strategic allocation can help boost returns and dampen volatility. Lastly, we believe tactical asset allocation can add value in this period of shifting correlations and lower absolute returns.