Ex-Fed Staffers Ran Millions of Models to Revamp 60/40 Portfolio

The key to beating the traditional 60/40 portfolio may lie in doubling down on duration and slashing your equity holdings, according to two former Federal Reserve staffers.

With stocks overly expensive and long-dated Treasuries too cheap, traders ought to buy up the long end of the curve and reduce equities to as little as 20%, Roberto Perli and Benson Durham of Cornerstone Macro LLC wrote in a report.

Portfolios that overweight government bonds will return as much as 20% over the next year, according to Cornerstone. That’s compared with just 3% for a traditional 40%-bond-and-60%-stock mix.

“The S&P 500 still seems stretched,” Perli and Durham concluded after running more than 10 million models against the U.S. equity benchmark. “Longer-dated USTs on the other hand are cheap (yields too high) all along the curve.”

Ex-Fed Staffers Ran Millions of Models to Revamp 60/40 Portfolio

It’s the latest broadside against the 60/40 portfolio blend, a decades-old investment staple designed to balance risk and reward. While many strategists are calling for alternatives to government bonds as yields plumb fresh lows, for Cornerstone “the big source of positive long-only return lies at the back end of the curve.”

An investor looking for the same volatility as a 60/40 portfolio but an additional 10 percentage points in annual returns should hold 20% in stocks, half in two-year Treasuries and most of the rest in 30-year bonds, according to the analysis.

Someone who wants to reduce tracking error to the model portfolio should have 56% in equities with the rest split between two-year, 20-year and 30-year Treasuries, they said. Even that model portfolio beat the 60/40 allocation by 5 percentage points.

The report cites numerous caveats to its findings, including a likely change in fundamentals and the fact that the so-called Fed put “looms large.”

©2020 Bloomberg L.P.

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