Home / Analysis / 60/40 alive and well, but don’t stop diversifying there

60/40 alive and well, but don’t stop diversifying there

60/40 isn't dead, but that doesn't mean that investors shouldn't be searching high and low for diversification. Despite what Harry Markowitz once said, it won't necessarily come cheap.
Analysis

Inflation will likely stick around for longer than expected and be higher than expected, and that means volatility will too. And after the brutal market downswings of 2022 some of the world’s largest asset managers believe that the 60/40 equity/bond portfolio is, if not dead, mortally wounded. But Thomas Poullaouec, head of multi-asset solutions for T.Rowe Price in the Asia Pacific, disagrees.

“It’s like that Churchill quote: the reports of my death have been greatly exaggerated,” Poullaouec says. “60/40 isn’t dead. The expected return over the next five years for a 60/40 portfolio has almost doubled from our Capital Market Assumptions last year.”

“We put them now roughly at six or seven per cent in Australian dollar terms and last year it was at three or four per cent. 2022 was the big reset in valuation and that created a lot of issues for the diversification premise upon which 60/40 is built, but that was a year when you also had a big reset in inflation expectations.”

The reason for that more optimistic return outlook is largely down to valuations; while it was painful getting to them, their lower level now provides “a supportive first step for returns over the next five years”. Resilient nominal earnings expectations also provide a basis for increased return expectations, according to the T.Rowe Price CMAs.

“When you have a growth slowdown, which we’re expecting in the next five years, you tend to have good diversification from the 60/40… You can still get good diversification from it in certain economic environments,” Poullaouec says.

That doesn’t mean investors shouldn’t search high and low for diversification. At the equity level, that can come from putting option- or derivative-based tail risk management strategies in place that “attack the equity risk at the core”. The unique features of private assets – like their lack of daily pricing – also makes them attractive for diversification. Of course, both those options have their downsides.

“There’s no free lunch. Within tail risk I’m not suggesting you have a systematic option program; over the long run that tends to be quite expensive – it’s always paying for insurance,” Poullaouec says. But options still play a role on a dynamic and tactical basis where it makes sense to take a position. That can be complemented with volatility targeting strategies… Option-based isn’t the only way for tail risk.”

“(Private asset) valuations also remain a concern, and we can see the ripple effect of the year that just went starting to bite in the crisis we’ve seen in regional banks in the US which are related to some of the issues we have in private equity circumstances. It’s something where if you invest you need to be an expert or delegate to experts who can make the decision for you.”

Lachlan Maddock

  • Lachlan is editor of Investor Strategy News and has extensive experience covering institutional investment.




    Print Article

    Related
    How the Future Fund (and others) think about the total portfolio approach

    TPA is an “uncommon and demanding” approach to running an investment organisation, according to the Future Fund, but a rewarding one – as long as institutions that take it up know that it’s not a transformation that should be embarked upon lightly.

    Lachlan Maddock | 22nd Mar 2024 | More
    How this global giant plans to become a go-to manager for super

    The AUD$660 billion M&G has been a “sleeping beauty” down under, and it wants more than the mandate it already runs for the Future Fund. Thinking like an asset owner is part of the equation.

    Staff Writer | 22nd Mar 2024 | More
    How big investors are getting more bang for their RI buck

    More and more of the global institutional investor set is turning to thematic strategies even as they resist the use of ESG benchmarks amidst questions about the methodologies that underpin them.

    Lachlan Maddock | 13th Mar 2024 | More
    Popular