Making a 60/40 portfolio work when bond yields are low

Advisers get creative with alternatives to traditional fixed income, but say portfolios still need ballast

Nov 13, 2019 @ 1:43 pm

By Jeff Benjamin

Historically low interest rates, including negative sovereign bond yields in large swaths of the globe, have sparked conversations among market strategists about the death of the traditional portfolio asset allocation of 60% stocks and 40% bonds.

But financial advisers who operate in the trenches of real-life portfolios and real-life consequences say the situation is much more nuanced than just scrapping bonds because yields are low.

"We are always looking for different types of bonds, but you kind of want that 40% allocation because it acts as a ballast of safety for the rest of the portfolio," said Kenneth Nuttall, director of financial planning at BlackDiamond Wealth Management.

"We remind clients that the bond yield is not the big driver of a 60-40 portfolio and that the bonds are there for protection," he said.

Weighing an alternative to bonds that includes shifting bond allocations into stocks, Mr. Nuttall said he reminds clients of the additional risk that such a strategy would introduce.

"Most of our clients are in 60-40 portfolios, and the second most is 70-30," he said. "The lower bond yields make it harder for people who are in or near retirement, but we're at the top for stocks and when the market starts falling, the stocks are going to fall the most."

But even as advisers recognize and preach the value of fixed-income allocations as part of a diversified portfolio, it is impossible to ignore the shadow cast by the $12.5 trillion worth of global bonds currently offering negative yields.

Even if the U.S. holds firm in positive yield territory, as is expected, the global thirst for yield will continue to be one of the factors driving down bond yields here.

"We still believe in the 60-40 blend, but we have augmented it to add in higher-yielding investments like BDCs, REITs and structured notes to try and enhance the yield without taking too much risk, because you don't want to be just indexing bonds in this environment," said Robert DeHollander, managing principal at DeHollander & Janse Financial Group.

"Nothing is perfect, but we've found that by introducing some of those asset classes, it reduces risk and enhances yield," he said.

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Matthew Chancy, wealth manager at ClaraPhi Advisory Network, is also leaning on alternatives to traditional fixed income while still counting that allocation weighting as technically income.

"For some clients that skew more conservatively, we would consider using fixed indexed annuities as bond alternatives," he said. "And if they're accredited, we'd look to pure illiquids in the alternatives space, where you can exchange liquidity for higher potential yield."

Examples of pure alternatives include private real estate, loans against private real estate and mezzanine lending strategies.

"Absolutely, we are adjusting to lower bond yields," Mr. Chancey added. "The chase for yield is extremely challenging, because you either increase the credit risk or you increase maturities. There's risk all around with such a low-yielding environment."

Dennis Nolte, vice president of Seacoast Investment Services, said the 60-40 model will always have value if risk management is important.

"You still need to manage risk and you can't put too much in equities, but you have to manage client expectations for returns if the bond portfolio is getting 2% annually," he said. "You gotta tell clients if inflation is an issue, bond returns could be lower or even zero, and if they're not okay with that, you have to do something different."

In Mr. Nolte's case, something different often involves allocations to Treasury inflation-protected securities, commodities and dividend-producing stocks.

"The 60-40 portfolio isn't dead, just like diversification isn't dead," he said. "I remember them saying the same thing in 2008 when diversification didn't work."

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