60-40 Portfolio may need a 'fundamental evolution' – GIC and MSCI

Collaboration by two firms presents an innovative framework for asset allocations

60-40 Portfolio may need a 'fundamental evolution' – GIC and MSCI

With Asset owners still trying to decide on an adequate replacement for the 60-40 portfolio, Singapore's government wealth fund GIC and MSCI have put out one potential resolution.

Investors from GIC in collaboration have collaborated with an MSCI researcher to develop a new paradigm for asset allocation that tries to include macroeconomic factors in portfolio development, reported Institutional Investor.

They think their approach to measuring risk might take the place of the once popular investment strategy, which allocated 40% to bonds and 60% to stocks.

“We are witnessing the rise of private assets to the core of many asset allocations from a peripheral ‘alternative,’ and we have entered a new period of heightened macro uncertainty,” according to a paper published by the two organizations in October. “Both could require a fundamental evolution of the asset-allocation process.” 

Read more: A strong alternative to the traditional 60/40 portfolio

As a result, a macro framework is produced that links the cash flows and discount rates of an investment to a variety of potential outcomes, including shocks to demand, supply, productivity, policy, and real rates.

The report claims that during the past 20 years, demand shocks have dominated as the macroeconomic environment's primary driver. In this setting, declining economic demand pushed down growth, inflation, and real rates.

According to the report, this made it possible for stocks and bonds to serve as hedges against one another.

“Bonds have typically moved down together with equity in response to supply shocks when the threat of inflation superseded the central bank’s aim of fighting recession,” the paper said. “Further, the low volatility and correlations of private assets are largely artifacts of their smooth valuations, rather than reflecting a lack of systematic risk.” 

Supply-driven inflation, a less trustworthy central bank, rising real rates, and sluggish productivity development, according to GIC and MSCI, might "significantly" alter market direction in the years to come.

Read more: Has Fed made a 'public mess' of interest-rate policy?

GIC and MSCI advise employing a "macro-resilient efficient frontier" model, which compares expected return with long-term macro risk to establish the best portfolio.

The article recommends modeling the sensitivity of asset classes to discount rates and cash flow after taking the results of the five macroeconomic settings into account.

The two firms propose that these models should equalize private and public asset classes in addition to adopting distinct risk criteria.

GIC and MSCI demonstrate that asset allocations that are in line with the efficient frontier using macro considerations generally substitute TIPs and infrastructure assets that resemble bonds for Treasury securities.

Private assets, infrastructure that functions like equity, and real estate also make excellent allocations to equity.