Wednesday, October 19, 2022

60/40 allocation disaster - Is it too late to change?

 


You have heard it before - the 60/40 stock/bond portfolio mix is dead. It was the go-to portfolio structure. Start with the 60/40 and make allocation adjustments around it but keep that core mix as a base case. It was hard to beat for a long time, but 2022 is different. The combination is now down 20+% and a good portion of the losses is coming from holding the "safe" bond assets. This bond problem is only exacerbated because the correlation between stocks and bonds has turned positive. Investors were willing to hold low yielding bonds because of the diversification gain. That does not exist.

The best investors can do is increase alternative investment exposures under the low bar that these strategies beat the poor bond performance and offer some lower correlation. Any trend/macro strategy that allows for shorting of assets would have added value to the 60/40 mix. 

However, the past may not reflect the future. As yields increase and the duration of bonds fall, there may be a new appeal for bonds. A decline in inflation or a pause by the Fed may also offer bondholders some advantages. These pro-bond stories, nevertheless, are based on inflation being tamed. If the inflation problem is not controlled, there is no advantage with the classic allocation. The new 60/40 mix will be to hold a high allocation to cash or liquid alternatives.


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