Does a 60-40 portfolio still represent a sensible allocation?

With no inflation, unlimited QE and the huge flatting of curves across the globe, the allocation towards bonds has been an enormous source of carry and capital appreciation.
Flavio Incoronato

Portfolio Manager

Banca del Sempione SA

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The classical 60% global bonds and 40% global equity portfolio allocation has been an unbeatable in the last 20 years, returning more than 120% in Eur terms (3.9% annualized since the beginning of the century), notwithstanding three big market shocks in between: the dotcom bubble burst, the global financial crisis and the Covid-19 pandemic.

In particular, the bond component (measured by the Bloomberg Global Aggregate Index) has contributed to 2/3 of the overall performance, with a total return of approximately 80%.  

In fact, with no inflation, unlimited QE and the huge flatting of curves across the globe, the allocation towards bonds has been an enormous source of carry and capital appreciation and even more appreciated by risk managers, an incredible shock absorber during volatile equity periods.  However, going forward the question is, how sustainable this trend could be in the next years.

If we take the 10Y US treasury yield as a reference index, the YTM has gone from 6% at the beginning of the ‘2000 to 1.5% today, with inflation running already much higher than that (2.4% according to the 10Y breakeven and over 4% according to the last US CPI print). 

Source: Bloomberg

Here is where alternative UCITS comes to play

Since the Madoff’s scandal, back in ’08, there has been an increasing demand by global investors toward liquid and transparent UCITS hedge fund strategies, in search of uncorrelated source of returns without having the money stuck for long in often dark and unsecured vehicles. 

However, the expectations have been barely met by actual results, often disappointing and highly disperse among managers. The composite as measured by the HFRU Hedge Fund Composite Index has in fact returned approximately 30% since data are available (beginning of 2008 – 1.9% annualized) underperforming both global bonds and the 60-40 allocation.

Source: Bloomberg

So, what’s the point then of including into a global AA these strategies compared to the two simpler, cheaper and better performing etfs like the Global Aggregate and MSCI World?

First and foremost, fund selection is of paramount importance given the huge dispersion in managers’ performance. If the composite performance has been disappointing, the same does not hold true for many active funds; eventually the real challenge is to spot them before they become too big and as a consequence, as it often happens, lose their source of alphas.

Secondly even though those funds are considered “alternatives”, it doesn’t mean that they are all weather strategies suitable in every market environment.

Macro and micro conditions require an active approach in selecting the strategies which offer the best potential in the future. Third, especially in this historical moment with low yield, ultra-expansionary policies and inflation expectations going up, even a small tweak in monetary policies may cause a big correction in bonds indices (which are way too long duration) and more in general in long duration assets (like equity tech names).

Finally, without having the presumption of knowing how equity indices will perform in the next future, in terms of valuations they look at least stretched. 

What solution for allocation do we propose?

Base Multi Asset Capital Appreciation is a Fund of funds which offers a new version of the traditional balanced portfolio, by equally investing in active bonds, equities and alternatives funds, keeping however a flexible approach.

Flexibility means that we are forced to be fully invested in every sub asset class at any point in time: if there is no value left in bonds, for example, why being invested? 

As it is the case nowadays, by not being invested in bonds, we aim to replicate the (old and good) carry components of fixed income by using M&A Strategies, which in this particular moment offer an incredible spread thanks to a myriad of deals.

While for loss absorption, we always keep a moderate portfolio allocation towards long volatility funds in case unpredictable black-swans events happen.  

To conclude, the 33%/33%/33% portfolio allocation offers better risk adjusted returns compared to alternatives and bonds taken individually and potentially might offer a better risk-reward in the future compared to the traditional 60-40 approach for all the considerations made above. 

Source: Bloomberg

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Does a 60-40 portfolio still represent a sensible allocation?