Don't write off the 60/40 portfolio just yet: Vanguard

Fund family comes out swinging against balanced portfolio's detractors; bonds still a great hedge

Jan 7, 2013 @ 1:53 pm

By Jason Kephart

Don't start reciting the eulogy for the classic balanced portfolio just yet, warns The Vanguard Group Inc.

Despite the rise of alternative asset classes, the traditional mix of 60% stocks and 40% bonds is still the best asset allocation for the majority of investors, said Fran Kinniry, a principal in Vanguard's Investment Strategy Group.

Advisers have been increasingly turning away from the 60/40 portfolio in favor of less traditional asset allocations, according to a recent survey from Natixis Global Asset Management.

The survey of 163 financial advisers found that half no longer believed a 60/40 mix was the best asset allocation to achieve performance and to manage risk.

Mr. Kinniry said he agrees that the performance of the 60/40 portfolio over the next 10 years isn't going to come anywhere close to what it's been historically, mainly thanks to the record valuations and low yields in bonds today. In fact, he warned it could return as much as 50% less than its historical average of around 8% or 9% a year.

But when it comes to managing risk, the 60/40 portfolio is still an adviser's best bet, Mr. Kinniry said. Chasing after a hot new asset class sets advisers up for failure more often than not, he added. (Click on chart below).

+ Zoom

Managed futures funds, for example, have grown to approximately $9 billion in assets since the financial crisis — thanks primarily to their out performance during that period. Since 2008, however the average managed futures fund has lost money while stocks and bonds have rallied.

“The risks of trying to avoid the risks [of the 60/40 portfolio] are greater than the risks themselves,” Mr. Kinniry said.

The reason he is confident in the classic strategy is that over the past 20 years, nothing has been a better hedge against the downside in equities than investment-grade bonds.

Hedge funds, commodities, and real estate investment trusts are all touted for their diversification benefits, but when equities have been under the most pressure, all those investment classes have fallen along with stocks, albeit in most cases not as far.

“Historical correlations are meaningless,” Mr. Kinniry said. “You need to look at correlations in times of stress. That's the only correlation that matters.”

Treasurys and investment-grade corporate bonds are the only two asset classes that consistently generated a positive return during the worst stock drawdowns since 1988, according to Vanguard.

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