Is The 60/40 Portfolio Really Dead?

Dissecting some sellside stupidity.

Bank of America has a note out (covered by Marketwatch) saying that the 60/40 portfolio is unlikely to repeat its success of the last 35 or so years because of bond market performance that cannot be repeated. We've made this point here many times. Yields dropped from about 15% on the ten year US treasury to less than 2% now. Even if our ten year goes to a negative yield it can't go negative enough to recreate past returns.

This is not stupid. There is visibility, due to simple math, for 60/40 returns to be less than what they've been, of course equities could make up the difference, I'm saying could, it is possible but I don't know. There are plenty of reasons to expect lower equity market returns for a while but even if that is correct, there will still be some years where equities do fantastically well and lower, long term equity market returns still probably means returns that are better than fixed income returns.

Where the sellside stupidity kicks in is with the idea that if bonds are likely to struggle then you should own more equities, dividend paying equities. The analysis that bonds might struggle could be spot on but the answer is not more equity exposure. The person drawing this conclusion is either inexperienced or not very bright. This idea has of course been floated in past cycles and was just as wrong then as it is now.

Stocks, dividend paying stocks, are never proxies for equities in the sense of helping to mute/manage equity market volatility. The stupidity of the suggestion will become apparent during the next true bear market or even in the next fast decline along the lines of what happened last December.

Just because equities are not replacements for equities doesn't mean replacements don't exist. I've written countless posts about strategies that I believe legitimate, equity replacements. In this context we've talked about merger arbitrage, other forms of long/short equity, managed futures, absolute return and so on. While they might have their flaws, bond have flaws too, but these strategies tend to not look like equities as opposed to dividend-centric equities which, um, look like equities because they're, you know...equities.

Equities are the best performing asset class over long periods of course and while most people should have most of their money allocated to equities, 100% equities creates a volatility profile that is not ideal for a lot of people. Bonds help that volatility profile as do true bond market substitutes.

This won't be the last time a sellside firm comes up with this same stupid idea again but it is that, it's stupid. If a suitable asset allocation for you is 100% equities, then you should already be 100% equities, not switch to it now to chase returns.

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