Low Rates Lead Investors to Look Beyond the Classic 60/40 Mix

It’s an investing strategy that many trace back almost a century, when a young accountant named Walter Morgan started to become alarmed at the rampant speculation in the booming 1920s stock market.

His solution was what became known as the Wellington Fund, the first “balanced” mutual fund that invested in both stocks and bonds. In the early 1950s, economist Harry Markowitz laid out the math that showed mixing stocks and bonds delivered ideal diversified portfolios for those worried as much about risk as much as return. Eventually the blend of 60% stocks and 40% bonds became close to gospel in the industry, with a wide variety of regular savers and professional investors anchoring retirement plans somewhere around “60/40,” or at least using it as a benchmark against which to compare other strategies.

And it’s had a heck of a run, even in a year as crazy as 2020. A basic 60/40 strategy is up about 8% so far this year, and was down much less than the stock market at the depths of the pandemic-induced sell-off in March. That’s after earning an annual compounded rate of return of almost 10% since the 1980s.

Yet many on Wall Street are trying to send this time-tested retirement scheme into retirement itself. The reason is that with bond yields so low and equity valuations so high, the strategy’s reputation for solid, steady returns is in serious doubt. Investors in this type of market environment will need to get more adventurous, or so the oft-repeated advice goes.

The research arm of BlackRock Inc., the world’s largest money manager, told clients in an August report that “resilient portfolios” required moving beyond simple asset-class diversification. Investors seeking healthy returns and protection against volatility should embrace companies that emphasize sustainability, diversify into different countries and sectors, and look to enter the private markets, according to the BlackRock Investment Institute. “The real economy is undergoing dramatic transformations,” says Mike Pyle of the BlackRock Investment Institute, who sees a policy revolution that will keep rates low for years.

For the pros with large sums of money to put to work, the options beyond the 60/40 framework are bountiful—from private equity to venture capital to exotic securities backed by a wide variety of debt. It’s a different story for individuals trying to include those options in their own path to retirement. For one thing, investors may have to pay a premium in fees, and those costs can erode returns. Products available for investing in alternative assets, as well as “go anywhere” funds that aren’t locked into specific regions of the world or tied to a fixed mix of stocks and bonds, often come with higher yearly fees—say 2.5% to 3% of assets, compared with mutual and exchange-traded funds that track stock and bond indexes and charge fees measured in the tenths of 1% or less.

“We have gone around and around with these through the years looking at different options out there,” says John Ritter, managing partner of Ritter Daniher Financial Advisory LLC, based in Cincinnati. The firm manages about $450 million, has about 325 mostly retail clients, and runs one 401(k) plan. “We have really found, for the retail investors, there aren’t a lot of good alternative investment options for them.”

Still, the expansion of ETFs into the alternative space is a big reason why there’s a growing array of cheaper options, including funds that invest in real estate and commercial mortgage-backed securities or that track leveraged loans. With inflation-adjusted Treasury yields below zero, investors are on the hunt for alternative sources of income, such as real estate and leveraged loans, according to Daniel Tenengauzer, head of markets strategy at Bank of New York Mellon Corp.

Of course, branching out often comes with a greater risk of losses. “We do see individuals and clients who have memories of yields being higher, and they will push for higher yield,” says Robert Williams, vice president of financial planning at Charles Schwab Corp. “With Treasuries too low, they want a corporate bond or a junk bond or a limited partnership oil pipeline because it’s going to get them a 6% or 7% yield. But that’s not a free lunch. The yield is there because the risk is there.”

Some managers don’t advise abandoning the 60/40 framework entirely. Instead, they suggest investors be more creative when deciding what goes into their stock and bond buckets. Sixty-forty “isn’t necessarily broken,” says Brandon Pizzurro, a portfolio manager at GuideStone Financial Resources. “There’s still a lot you can do with how things are allocated within bonds and stocks,” he says, such as switching up geographies, sectors, and the size of companies considered.

To Kerrie Debbs, a certified financial planner at Main Street Financial Solutions, who has about 53 clients and manages about $70 million, the new environment involves doing something she’s never done before: recommending clients consider Treasury inflation-protected securities, known as TIPS, whose principal rises with consumer prices. “I had a while ago decided I wasn’t going to use TIPS, given they are more complicated than many think,” she says. “But I’ve come to a point where I think it is good to add them to a slice of a portfolio.” For those in the 60/40 camp, she advises making TIPS about a quarter of their bond holdings. “All the printing of money has now gotten beyond academically inflationary, so these securities are likely good to buy.”

This year’s drama in markets has led many individual investors to reassess their approach to investing. Financial planning discussions with clients at Fidelity Investments were up 24% in the second quarter compared with the previous year, says Jennifer Kruger, a CFP who’s branch leader of Fidelity’s Bryant Park Investor Center in New York. Fidelity clients showed a tendency to buy the dip in stocks during the bear market earlier this year, with buy orders outnumbering sell orders by a ratio of 1.7 to 1 from February to April and peaking at 2.3 on April 21. The historical average is about 1.2.

The holdings of all clients at Fidelity skew a little more aggressively than 60/40. About 65% of their assets are in equities, either individual stocks or ETFs, while 15% is in fixed income and 20% is in cash, according to Kruger.

Since leaning more heavily on equities for returns will likely be the route many investors take in an environment where the safest bonds pay next to nothing, extra care may be needed when crafting the stocks portion of any portfolio—at least for investors with an appetite for trying to beat passive index-tracking funds.

Vineer Bhansali has some advice that’s easy for an individual investor. He’s the founder of LongTail Alpha, based in Newport Beach, Calif., a fund designed to thrive in times of increased volatility, such as in March when it gained tenfold as the S&P 500 slid 12.5%. An ideal way to diversify equity exposure is through the stocks themselves, he says; investors can hedge lofty technology-driven gains in the Nasdaq and S&P 500 indexes with purchases of mid- to small-cap shares in the Russell 2000.

Debbs has an even simpler, though not necessarily easy-to-follow, tip that most individual investors would be wise to heed in all kinds of markets. “You really also have to save more,” she says.
 
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