Is The 60/40 Portfolio Really Dead?
Zerohedge syndicated a post from Guy Haselmann titled The Death Of The 60/40 Portfolio. A 60/40 portfolio is the default starting point for portfolio construction, 60% allocated to equities and 40% to bonds. Over most of the last 38 years, bonds have done fantastically well as interest rates dropped from the mid-teens down to the 1.5%-3% range (as measured by the Ten Year US Treasury Note).
While US rates have gone to very low levels, foreign bonds have even lower yields. There's about $15-$16 trillion in global debt that has a negative yield meaning you, the bond buyer, the lender of the money, are paying for the privilege of loaning the money. Put differently the reward for taking the risk of loaning your money to some government is a guaranteed loss if held to maturity. Where the US is a relatively high yielder among investment grade countries there is visibility for more foreign capital to flow into the US debt market forcing our yields even lower. A low yield from the bond portion of a diversified portfolio is certainly frustrating but no yield, if that's where we're headed, makes an allocation to bonds useless.
Ok, but is that what's happening? No, or maybe not yet. There is still yield available but it is low. As best as I can tell there are three ways to deal with this with one of the three being the worst by far. You can accept lower yields and manage the rest of your portfolio/financial life accordingly, you can allocate your portfolio differently or you can pursue higher yields where they are available. You might also know that last one as chasing yield which means accepting a lot more risk in order to get yield and often people don't realize they are taking more risk which is where people get into trouble.
A couple of poster children for yield chasing over the last 15 years were Seadrill and Nordic American Tanker. Both were very high yielding equities in different segments of the energy sector. They churned out a lot of yield for quite a while and became very popular stocks that were written about constantly in the blogosphere. I wrote about them too but never bought either one. As I have said more times than I can remember, if you're getting a 7% yield in a 2% world, you are taking a lot of risk and it is problematic if you don't understand the risk you're taking. Both Seadrill and Nordic American Tanker blew up. It's not that you shouldn't take that risk, the problem is not understanding the risk your taking which was clearly the case with those two companies.
If bonds now don't provide adequate yield then perhaps time needs to be spent determining a different allocation other than 40% to bonds.
In a related note someone on Twitter asked Jared Dillian what he thought was the optimal all-weather asset allocation and he replied 35% to equities, 55% to bonds, 3% gold, 3% (other) commodities and 4% REITs. I don't have any context for why Jared answered 55% to bonds but the low allocation to equities acknowledges some of the trouble for equities that potentially goes with yields going to unimaginably low levels in terms of a deflationary threat where growth is absent.
There is potential trouble for equities now because of the negative yield threat but there are always threats to equities and yet they keep going up in the same manner they've always done, kind of a three steps forward, one step back routine. I'm not a big fan of portfolio changes based on predictions about when the next bear market will start. This underlies my entire investment process. When the S&P 500 goes under its 200 day moving average (DMA) I slowly initiate defensive portfolio action. That is a reaction to equities exhibiting a demand problem not a guess as to when that demand problem might occur.
But as opposed to allocating based on guessing when the next decline will come, we have interest rates that are very low, that is present tense. One solution is to seek out strategies that can offer bond like returns or what we think of when we think about normal yields. This is ground we have covered before. Short term corporate bonds still have yield, no not 5% but still some yield. I don't just rely on bond funds for this, I also include individual issues for clients. The interest rate risk from 2-3 year paper is pretty low versus longer dated debt. I don't know when or if interest will ever go up a lot but the consequence of that risk would be brutal.
The other day I mentioned client holding the Merger Fund (MERFX) which has the tendency to move higher at a very slow and boring rate, boring is what you probably want out of bonds or bond proxies. Gold is another alternative that I use, however I do not think that it is a bond market proxy. If you want to include alternatives as bond proxies you have to do the work to evaluate the attributes.
Following up from the other day, what about risk parity and the upcoming RPAR Risk Parity ETF? Alex Shahidi, one of the managers of the proposed fund (he works for sub-advisor ARIS) was on ETF IQ on Bloomberg TV today. They laid out an "estimated allocation" as follows; 35% TIPS (TIP), 27% Global Equities (ACWI) 27%, commodities (GUNR) and 35% US treasuries TLT. It adds up to more than 100% because the strategy usually involves leverage. Can that be an answer? I don't know but other variations of the strategy have at times offered bond proxy like attributes.
What about Bitcoin? Can it ever be a stable, haven? Here's one from Simon Constable opining that it failed a haven test last week. It is nowhere near being a haven or even a reliable correlation reducer, it has no correlation to other assets. But that could change. Where bonds are in part a correlation reducer there is room in a diversified portfolio for diversifiers that do not have bond market attributes. Back to gold, which tends to have a negative correlation to equities most of the time even if it is volatile.
Bitcoin is not there but one day could be. There are many studies (search for Bitwise) that show that a small allocation to Bitcoin has done wonders for risk adjusted portfolio results. OK, that's promising but it could easily have one or more 80% swoons in it's future even if it doesn't go to zero. You might not want to endure those sorts of downdrafts.
I don't have answers to just give you, this is the process to undertake if you're concerned that a 40% allocation to bonds might not be a good idea. Asset classes and strategies need to be assessed, understood and properly sized to have the effect you want which I presume is as smooth of a ride for your portfolio that you can possibly create.