The era of diversifying through a 60/40 blend of stocks and bonds is over — at least, that’s what a growing chorus of critics say.
In recent weeks, Bank of America Merrill Lynch, Morgan Stanley and JPMorgan have issued reports that declare the traditional balanced portfolio model dead or ailing.
As reported by ThinkAdvisor, one main criticism comes from the dwindling returns from bonds. Aside from offering lower-than-historical yields, bonds in developed markets have much less potential for capital gains due to already-anemic rates. The 10-year U.S. Treasury is yielding just a little less than 2%, while the 10-year German bund is at -0.25%.
“Lower returns from bonds create a challenge for investors in navigating the late-cycle economy,” said JPMorgan’s David Kelly, John Bilton and Pulkit Sharma. “The days of simply insulating exposure to risk assets with allocation to bonds are over.”
The long-held function of bonds as ballast in a portfolio is also being questioned. As Bank of America Securities strategists Derek Harris and Jared Woodard explained in a new report titled The End of 60/40, the negative correlation between stocks and bonds has persisted over the past 20 years, but policymakers’ attempts to boost growth could throw off that relationship.
Meanwhile, Serena Tang and Andrew Sheets of Morgan Stanley trained their sights on equities, particularly as limited stock-market returns reflect lower income, low inflation expectations, and penalties on both higher-than-average valuations and unsustainable above-trend growth. Based on Sheets’ estimations, a 60/40 portfolio of U.S. stocks and government bonds will see annualized returns of just 4.1% over the next 10 years, close to the lowest expected return over the last two decades.
JPMorgan’s strategists project a 5.4% annual return for a 60/40 portfolio over the next 20 years, though that includes global equities, U.S. corporate bonds, U.S. investment-grade corporate bonds, and high-yield bonds.
With that in mind, JPMorgan strategists recommended “greater flexibility in portfolio strategy and greater precision in executing that strategy.” While corporate bonds “offer a decent return uplift,” particularly in shorter-duration high-yield instruments, they warned of a limited buffer in the credit complex — a risk in case of a wide sharpening in spreads during a period of economic weakness.
On a local-currency basis, they projected that emerging-market stocks would return 300 basis points more than developed-market stocks in the long term; EM bonds were forecast to return 5.9%, compared to 4.9% for EM corporate bonds and 2.4% for 10-year U.S. Treasuries.
The strategists also advised that investors consider allocations to alternative investments. They highlighted U.S. real estate for its low correlation to other assets, stable cash flows, and projected average annual returns of 5.8% over the next 10 to 15 years. They also predicted annual returns of 8.8% for private equity, though they stressed the importance of manager selection.
Follow WP on Facebook, LinkedIn and Twitter