While some believe the established portfolio allocation is dead, AGF's David Stonehouse doesn't agree
A portfolio with allocations of 60% to stocks and 40% to bonds is a well-trodden path but some believe that 60/40 has had its day.
However, David Stonehouse, MBA, CFA, head of North American and Speciality Investments at AGF Investments thinks that the death of 60/40 has been greatly exaggerated, although he acknowledges that a rethink may be due.
He notes that last year upended the philosophy that either stocks or bonds will generally be winning at any given time as rising rates set bonds on a negative course while economics and geopolitics stalled the post-pandemic rebound that equity markets were expecting.
“The result: both stocks and bonds took a beating at the same time,” Stonehouse wrote in an article on the firm’s website.
But then came 2023 and an improvement for both asset classes with bond yields seeing a massive reset and stocks gaining from resilient corporate earnings and a lower expectation of recession.
Rethinking allocations
Does this mean the case for 60/40 is now as strong as ever? Stonehouse says it is more nuanced.
“We recognize the apparent signs of a return to “normal;” however, we are far from certain that the conditions conducive to a 60/40 portfolio are that simple. Indeed, while 60/40 clearly does not deserve to be banished to the dustbin of asset allocation history, we believe it might benefit from some tweaking – at least when you consider what may lie ahead for stocks and bonds,” he wrote.
While inflation was easing, it remains above the BoC target and has recently started rising again, largely due to energy and housing costs. The impact on bond yields creates concern that they may not be the cushion against falling stocks that has been frequently seen in the past.
“The market may have already priced a substantial slowdown accompanied by central bank rate cuts, limiting the upside for bonds,” stated Stonehouse.
The sticky inflation is also bad news for equities with valuations perhaps already at their top-end.
Another option?
With the current outlook, Stonehouse conceptualizes a modification that could include 50% stocks, 30% bonds, 10% real assets, and 10% alternatives.
The addition of real assets, including commodities, infrastructure, and real estate, reflects their historical performance where inflation is elevated. While there are risks, at 10% there could be enough growth and diversification wile avoiding too much volatility.
Additionally, alternative investments such as private debt and equity, senior loans and derivatives, help diversify the portfolio.
He highlights that this is not a recommendation as each investor should have a portfolio that meets their circumstances, objectives, and risk tolerance.
Stonehouse’s view is that the 60/40 portfolio is not necessarily the wrong option currently.
“However, the events of the past few years have shown that financial and economic conditions can change quickly, and what worked for portfolio construction yesterday will not necessarily work as well today or tomorrow,” he concluded.
