After a long period of low rates saw investors favour equities over bonds, some saw a permanent trend. Franklin Templeton saw it differently
In 2019, Franklin Templeton released a report that addressed questions about the future of 60-40 portfolios. This traditional split of 60% toward equities and 40% for bonds seemed to be unravelling as the low cost of borrowing sent equities on a tear.
But Franklin Templeton was skeptical. Citing the rise of inflation and the inevitable intervention of central banks, they said although the 60/40 portfolio might be challenged in the shorter term, it wasn’t going anywhere in the long run. They were right.
“Our answer back then was that the 60-40 portfolio wasn’t dead, but probably in need of some help,” says Michael Greenberg, SVP/Portfolio Manager at Franklin Templeton Investment Solutions. “Now, after a tough 2022, we’re seeing an environment that is much more positive. Looking at the next five to 10 years, the prospects for a 60-40 portfolio are much improved.”
Speaking with Wealth Professional in a recent podcast, Greenberg discussed the conditions and trends that are returning markets to more familiar territory. Investors are looking for two key benefits: diversification and yield.
Diversification and yield
Investors, he says, are attracted to safe, developed-market government bonds or high-quality, investment grade credit to offset some of the equity risk in their portfolios.
“The concept there is rather simple,” Greenberg explains. “If the economy is slowing, that's tougher for equities and you have bonds diversifying that equity risk.
The search for yield in fixed income is more complicated, especially as investors are drawn to riskier assets while trying to predict the next move from central banks on interest rates and the impacts on the economy at large.
Fixed-income yield is much more attractive today than it would've been three or four years ago, Greenberg says, particularly “with high-yield bonds and emerging market debt where you're getting as much as high single-digit or even low double-digit yields.
“That being said, I would be careful. We're a little bit more cautious on the economic environment over the next six to 12 months, so we might not jump into higher risk fixed income with both feet just yet. But it's definitely something that looks quite attractive over a five-to-10-year time horizon.”
What comes next?
Looking back (as Franklin Templeton recently did in reviewing their report from 2019) is a lot easier than looking ahead. Asked what he sees over the next year or two, Greenberg is careful with his predictions, citing uncertainty around the impact of higher rates.
“When we pull out the Franklin Templeton crystal ball, it definitely looks foggy. There's a lot of uncertainty in these markets and for us, the glass is a little bit half empty in the sense that the effect of interest rate hikes from the Bank of Canada, the Fed, and even in Europe is probably still yet to be felt fully in the economy.”
Greenberg says reduced lending to small businesses and consumers will be a headwind for economic growth that is “likely to result in a mild recession and bring an end to this rate hike cycle potentially late this year or early next year.”
The prospects for equities will take a while to improve, he adds.
“Profit margins are still fairly elevated. We think there's going to be a little bit of economic weakness, and that could affect risky assets such as stocks and higher risk fixed-income markets.”
“We are a bit more defensively positioned,” Greenberg says. “With the recent rally that we've seen, we've taken the opportunity to take more risk off the table within our portfolios.”
The longer term
Looking further ahead, Greenberg says there are a lot of reasons to be optimistic. The US consumer is resilient, corporations are in good health, and there's a lot of investment required for supply chains, the transition to renewable energy, and the need to boost productivity amid a shortage of workers.
“All of these things could be good for stocks and risky parts of fixed income over the next three to five years,” he says. Conventional energy may also benefit from some tailwinds as demand continues to rise and supply suffers from a lack of investment.
“The supply demand dynamics look fairly bullish for energy over the medium to long term.”
As with other investments, multi-asset portfolios have changed significantly over the years. From simple products and strategies, they have evolved to embrace a wide range of global North American equities, emerging markets, mutual funds, ETFs and derivatives.
Fixed income has changed as well, Greenberg says. “Gone are the days when we would just buy Canadian government bonds or a couple of investment grade corporate bonds.
“With global diversification and access to some very interesting global fixed-income markets, the fixed part of these portfolios has really evolved. And when you put all that diversification together, these portfolios have become a solid choice for investors and a one-stop shop for clients.”
Another development that continues to evolve, Greenberg adds, is the delegation of fund management to experts like those at Franklin Templeton. Sometimes advisors will want to focus on the top 20% of their client base, while delegating the remaining 80%.
“Others will use a managed solution as a core part of the portfolio and then build around it with a couple of their favorite mutual funds, ETFs or even single stocks,” Greenberg says. “These are really important things going forward and I think can be a source of value in the right place at the right time.”
Delegating fund management allows an advisor to focus on key responsibilities including insurance, tax planning, and all the complexities around knowing your customer; while ensuring the portfolio is getting the full attention of experts.
“All we do is manage portfolios,” Greenberg says. “We have the time and resources” to generate attractive returns while managing risk. “It’s a way to delegate some of that investment management to a team like ours, but still have their hand in portfolio creation.”
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