Is the 60/40 Portfolio Dead?

In 2019 we penned a paper titled “Is the 60/40 Portfolio Dead? Our answer was “no”, but that there were potential ailments on the horizon. We had warned that low yields and rising inflation would present a challenging backdrop, pressuring bond returns and diluting any diversification benefit investors hope to receive from the asset class. Fast forward through 2022, and some of our concerns played out. The decline in equity markets got most of the press, but it was a dreadful year for Canadian bond returns as well – the worst in the past 40 years. 

For those who had already proclaimed the end of the 60/40 portfolio, last year’s results, terrible as they were for most assets, must have brought feelings of vindication. But now, the 2022 bond and equity reset may have resurrected the “boringly brilliant” 60/40 allocation.

The end of TINA (There is no alternative - to equities)

Before COVID-19 rates were already low, and then zero-bound after the pandemic began. Investors had little choice but to accept equity risk for appealing returns. But high inflation, unseen for decades, led to extremely aggressive central bank policy and rising yields. Bonds suffered one of their worst years on record in 2022, severely impacting multi-asset portfolios. Looking forward, better equity valuations and higher bond yields make for a better starting point. Our capital market expectations for the next 10 years are more favorable for all major asset classes (see Exhibit 2).  This has improved the longer-term prospects of multi-asset portfolios.

What’s old is new again (why we like fixed income now)

Investors used to depend on their fixed income allocations to provide solid returns; as part of that total return component, bond holders expect consistent, dependable income payments. Furthermore, bond holders hope for relative safety when equities falter. With higher current yields, these benefits have much improved.

1. The income on offer, with higher yields-to-maturities, are much improved compared to recent history. Investors in low-coupon or low-dividend securities often must make sales to generate cash. This introduces timing risk – needing to sell at inopportune times such as market bottoms. Sufficient income production may offset timing risk, and investors may find a trade back into bonds makes sense, given the levels of current yields. Selective positioning is important, as many sub-asset classes pay more, but this comes with significantly higher risk. Many of the best yielding sectors are outside Canada so selective, active management is key to providing acceptable risk-adjusted returns (see Exhibit 3).

2. Defensive characteristics for bonds have now returned. While interest rates could still increase from current levels, we think the aggressive upward moves are behind us. If rates move up marginally, bonds can still buttress portfolios (see Exhibit 4). However, if rates decline, even slightly, then the total return is very attractive over a one-year horizon.  

The 60/40 going forward

At this juncture, we feel it is wise to temper our longer-term optimism with a check on the current environment. Recession is a very real possibility, and risk assets tend to do poorly either leading up to, or during recessions. We expect core inflation and wages to be somewhat persistent, forcing central banks to maintain higher rates for now. This would suggest more defensive overall portfolio positioning is warranted. Higher quality and shorter duration bonds, as well as higher cash balances, could insulate the portfolio from this volatility.

Within the Canadian corporate bond market, we see valuations as somewhat stretched presently and could find better entry points if prices decline on economic weakness. We are not piling into riskier sectors of the credit market just yet despite the more positive view longer-term.

Generally multi-asset portfolios are in a much better position today, mainly due to the better long-term outlook for fixed income, but as always having a more dynamic approach is key.

Comments, opinions, and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment, or strategy.