Experts from Canada's largest ETF providers break down how advisors can adjust their sails to capture tailwinds
Despite the avalanche of headlines declaring its death, Canada’s largest ETF managers agree that the changing trajectory of rates – and consequently, the outlook on bond yields – is breathing new life into the vaunted 60-40 portfolio.
In Wealth Professional’s Advisor Connect webinar last week titled “How ETFs can help you take advantage of market opportunities,” experts from Vanguard Canada, BMO Global Asset Management, BlackRock, and Invesco were unanimous in saying that after a difficult year for both stocks and bonds, the traditional balanced portfolio is alive and well.
“We've been surprised by the number of media stories written in well-respected newspapers, talking about the death of the 60-40,” said Marcus Berry, vice president and ETF specialist at Invesco. “With the opportunities that are now available in the fixed income markets, actually, the 60-40 portfolio makes a lot more sense today, than it has arguably at any time since about 2009.”
2022: A one-off off year?
Sal D’Angelo, head of product for Vanguard Americas, emphasized that 2022 was a rare black mark in the iconic strategy’s record, with study after study proving its ability to deliver solid long-term returns. “If we look back since 1976, there's only really been 1.8% of one-year rolling periods where we've had simultaneous losses in stocks and bonds,” he said. “Zero per cent of the time, there's been simultaneous losses in stocks and bonds over three- and five-year periods.”
According to Alfred Lee, director, portfolio manager and investment strategist at BMO ETFs, the last 10 years have seen the Fed and other central banks engage in substantial quantitative easing and rate cuts. By doing a quick 180 on that in 2022, they disrupted financial markets, causing a deflationary tailspin in asset values that led to both equities and bonds suffering record losses.
“I think whether a 60-40 portfolio is effective from here really depends on the path of interest rates,” Lee said. “If interest rates remain at these levels – restrictively high, as [Federal Reserve Chairman] Powell says – I think the 60-40 portfolio can be very effective.”
A note from BlackRock strategists published last Tuesday caused a stir as headlines from Bloomberg, the Financial Times, and the Wall Street Journal proclaimed the world’s largest asset manager’s abandonment of the 60-40 portfolio. Rachel Siu, director of Fixed Income strategy at BlackRock Canada, pushed back, saying that reporting failed to capture the investing behemoth’s more nuanced view.
“If you dig into it, it’s really looking at each of the components and advocating that investors be more nimble, around how they're allocating to that 60 [per cent in equities], or to that 40 [per cent in bonds] now,” she said.
From headwinds to tailwinds in fixed income
For its critics, fixed income has been the 60-40’s Achilles heel over the past decade. Investors who put 40% of their holdings in bonds yielding 2%, they said, would be unable to harvest much value from their portfolios and left with little buffer against inflation or equity downturns. “Many of our clients in the wealth space did meaningfully go underweight bonds over the past 10, 15 years, when you were getting nothing from your fixed income,” Siu said.
The significant jump in rates over the past year has brought bonds back, Berry said, which means the traditional balanced model makes a lot of sense.
“Breakeven rates on fixed income have increased. … If you’re clipping 5% from your fixed income, you would need rates to go up substantially, almost 75 bps to a full percentage point from here to start having losses on your fixed income,” he said. “Equity valuations are also back roughly in line with their 10-year average.”
ETFs: playing the revival
Vanguard’s 10-year outlook for the 60-40 projects 6% returns – 200 basis points higher than where it ended 2021. Still, Siu said that allocation doesn’t make sense across all people’s investing journeys, and there’s still a case to be made for tweaking those asset class exposures.
“With the opportunities in the market, the 60-40 framework is handy in helping investors think about how much risk do you need to be taking? Do you need as much illiquidity risk? Do you need as much private assets, or even as much equity allocation, given you are extremely underweight bonds?” she said. “Now you don't need to take as much risk to achieve that same yield … you can do it through high-quality, triple A-rated bonds at this point.”’
“We've been a big proponent of things like 50-30-20 models, where you have 20%, allocating it to things like gold, private equity, private debt, and long-short strategies,” Lee said. “I think that's an effective strategy for the last 10 years and potentially [moving forward], depending on where interest rates go from here.”
For those ready to revisit the 60-40 playbook, Lee said the best way to get bond and equity exposure is through index-based ETFs given their cost-effectiveness and potential to outperform active strategies long-term. Asset-allocation ETFs, he added, could provide a good one-stop solution that provides access to professional management and rebalancing.
Vanguard, which played a pioneering role in introducing asset-allocation ETFs to Canada five years ago – today, the category represents $17 billion in AUM – also has a constructive view. “We think the 60-40 will continue to go do well going forward,” D’Angelo said, noting that a balanced ETF with a globally diversified portfolio of 25,000 stocks can be had for a quarter of the price of a typical F class balanced fund.
For Berry, ETFs can be used to potentially reverse-engineer and reinvent the vehicles that have long carried the strategy.
“We’re seeing advisors who own a traditional 60-40 mutual fund, maybe with a high fee,” he said. “They may want to break apart that 60-40 mutual fund and allocate to underlying ETFs instead as a way to be in greater control of the asset allocation and reduce the overall costs.”