Is 50/30/20 the new 60/40 of asset allocation?

The investment world has embraced the 60/40 stock/bond benchmark as a good rule of thumb for building a portfolio. There is nothing wrong with this benchmark and it has served many as an effective  means of risk reduction and diversification. However, it may have to step aside with the revolution of alternative investing.

There is not a strong theoretical foundation for the relevance of the exact 60/40 mix, yet it has served many well as a base reference for any asset allocation. The foundation has seen adjustments through the addition of international stocks and bonds as well as other asset classes. It has been restructured through risk parity, but it has still served as a standard. The historical number look good and it has done well in crises. Many has stated that keeping it simple works, but perhaps times are changing.

There have been assaults on this base mix through the introduction of international stocks, real estate, and commodities, but none have capture the attention of investors like alternatives. Alternative investments have some of the key characteristics that appeal for those who want diversification. First, alternative have lower volatility than equities, so there is an immediate reduction in portfolio volatility from holding these assets. Second, and more importantly, alternative investments often have lower correlations to equities than many of the alternative asset classes. Third, the return  profiles of alternative have more stable than for other asset classes. 

Consequently, there has been a growing movement to take some of the exposure in both equity and fixed income and place it in alternatives. Hence, the new standard mix of 50/30/20. There is no magic in this formula, but it seems to work for a growing number of investors when they start to make basic allocation decision. This is a high level or strategic allocation and easy to discuss. There is nothing about what the allocations within the alternative weight should be, yet it is starting to gain a hold with investors benchmarking.

This impact of adding alternative to a classic stock/bond mix is clearly presented in a simple paper by the Quaker Funds. In the graph, you can see that alternatives provide unique return and risk opportunities. In the table, Quaker Funds shows the return and risk profile of 50/30/20 against the classic 60/40. The return to risk trade-off is compelling. In a low rate, low inflation, high stock price environment, there is a good reason why this new mix is starting to be a standard.