Investing is a challenging endeavour, but there have been periods, notably from the 1980s to the early 2020s, where success seemed more attainable. This era, often dubbed the golden age of investing, saw the prominence of the classic "60/40" portfolio.
However, with today's world undergoing seismic shifts, this once-reliable strategy faces challenges. This article explores why the 60/40 portfolio thrived in the past and why it may struggle in today's environment, while also presenting alternative approaches to portfolio construction and asset allocation better suited to current challenges.
The 60/40 portfolio, with its 60% allocation to equities and 40% to bonds, was a staple investment strategy during the golden age. In over four decades from 1980 to 2023, it delivered positive performance in 36 of 43 years, with only major shocks disrupting its success. This approach, static in its allocation, capitalised on favourable market conditions characterised by strong equity performance and a robust bond market.
Recent geopolitical and economic events, such as the COVID-19 pandemic and geopolitical tensions, have ushered in a new era marked by uncertainty. Factors like higher inflation and interest rates have led to increased correlation between equities and bonds, challenging the diversification benefits of the 60/40 portfolio. Moreover, bonds, once considered safe havens, have shown vulnerability to market volatility, undermining their role in mitigating downside risk.
The bigger picture
One possible response to what might be seen as a 60/40 portfolio's loss of balance would be to markedly adjust the ratio of equities to bonds. If the latter are not offering enough downside mitigation, for instance, why not move to a 70/30 or even an 80/20 allocation?
In reality, of course, this is easier said than done, as a client's risk tolerances might not permit such a shift. We therefore need to utilise other approaches to asset allocation.
This means we need to think creatively. We need to construct multi-asset portfolios in ways that embed flexibility and can better enable us to navigate uncertain times. In short: we need to consider the bigger picture. Below are some key examples of this thinking.
Geographic diversification
Just as they can benefit from diversifying across asset classes, investors can benefit from diversifying across regions. It may now be especially useful to pay attention to how different regions are valued versus both their own history and other regions. Home bias - the tendency to invest the majority of a portfolio in domestic assets - is still widespread⁵, even though such an approach ignores geographic diversification's potential to help maximise opportunity and minimise risk.
Smaller companies
While many investors' view of the equities universe is limited to large-cap businesses, the small-cap space is home to some of the most promising opportunities to be found anywhere on the market-cap spectrum. Small-caps are often under-researched and under-owned, and they routinely outperform their large-cap counterparts over time - even though they are likely to be more volatile over the short term.
Superior sources of income
Looking further afield and digging deeper can help address the issue of income, too. This is because income can also vary across regions and sectors. This point also applies to fixed income, where assets such as high-yield bonds are gaining more attention - although risk considerations must obviously be taken into account.
Alternative asset classes
We should not forget the investment universe extends beyond equities and bonds. Alternative asset classes include real estate, commodities, hedge funds and private equity. While not every investment is suitable for every investor, it is vital to understand markets are non-homogenous and a healthy blend can therefore help a multi-asset portfolio perform consistently, not least during periods of uncertainty and volatility.
Active management
A traditional 60/40 portfolio is invested passively. Going forward, with greater volatility expected, the role of active managers in attempting to identify likely winners - and, perhaps even more importantly, avoid likely losers - could become more significant. Active management can be particularly helpful when the differential between best-performing and worst-performing sectors becomes unusually stretched, as is the case at present.
Why diversification matters
The chart below may appear daunting, but its message is simple: markets are non-homogenous. The same asset classes rarely lead the way in performance year after year, even when the geo-economic and geopolitical environment is relatively benign. This underscores the value of looking further afield and digging deeper when constructing a multi-asset portfolio.
