Saying Goodbye to an Old Friend, the 60/40 Portfolio

Portfolio Construction Must Adapt to New Realities

As each week passes, unlike any point in the modern financial times, Treasury bonds, which have traditionally been the low-risk asset within balanced portfolios, have become a high-risk asset with yields approaching 0%. In this highly informative thought leadership, we asked HP Ventures Group to address the current environment and how as investors we can adapt and find alternative opportunities that can fill in the gap for fixed income in our asset allocation.

Executive Summary

Treasury bonds, which have traditionally been the low-risk asset within balanced portfolios, has become a high-risk asset as yields have approached 0%, because they:

• Generate very little income
• Provide very little diversification because they cannot appreciate during periods of adverse equity performance
• Will probably lose significant value during a period of rising inflation

No other major asset classes can provide diversification during periods of adverse equity performance

In response, asset allocators should adopt strategies by selling bonds that are reaching their maximum price and replace them with investments that:

• Generate cash flows that pay a reliable income stream to investors
• Increase in value during a period of rising inflation

Asset Allocation Must Adapt to New Realities

Financial advisors focus on asset allocation to help clients construct portfolios that balance risk and reward to be consistent with their subjective financial goals. Equities have been the main source of investment return and risk in such a portfolio. Return is generated by the long-term trend of economic growth. Risk is generated during recessions, which are temporary periods of economic downturn that cause significant declines in stock portfolios.

Due to the volatility of equities, asset allocation has traditionally relied upon bond investments to balance the risk of equity portfolios. Bonds are thought to be the less risky part of the portfolio because they generate reliable income and tend to rise in value during periods in which stocks are declining. For this reason, intermediate-term Treasury bonds have been combined with equity investments to create so-called “60/40,” “balanced,” or “target date maturity” portfolios.

The widespread popularity of these three types of portfolios is understandable; they have worked well over the past several decades. During 2020, the most rapid stock market decline in history has been followed by one of the most rapid rises. Yet, as the chart below shows, a balanced portfolio of U.S. stocks and bonds (dark blue line) limited the overall portfolio volatility and the portfolio value has risen to within a few percent of its pre-Covid19 peak.