Breathing new life into old-school 60/40 models
As more advisers and pundits lean toward heavier allocations to stocks over bonds, there are still ways and reasons to benefit from fixed income.
Amid all the arguments being made for reducing fixed-income exposure in exchange for the much more exhilarating journey across the high-flying equity markets, Thomas Lee, chief investment officer at Parametric, offers a counter perspective.
While Lee acknowledges the rationale against allocating to bonds, which in many cases are producing negative real yields, he also reminds financial advisers why the traditional model of 60% stocks and 40% bonds has stood the test of time.
“I concede that rates are low and expectations for fixed are muted, but you don’t want to take a whole asset class that has served us so well and just throw it out,” he said. “There are still reasons to hold fixed income.”
Lee’s perspective, which he detailed in a blog asking, “Why does everyone keep trying to kill the 60/40 portfolio?,” stands out as a contrarian position given the increasingly popular trend of riding the wave of the equity markets for as long as it lasts. And there’s no getting around the strength of the argument supporting more equity and less fixed-income exposure.
Steven Skancke, chief economic adviser at Keel Point and former member of the White House National Security Council and U.S. Treasury staffs, boils it down to risk management.
Citing the Federal Reserve’s March 2020 one-two punch of dropping interest rates to zero while pushing $120 billion a month into the bond markets, Skancke said savers have been punished while risk takers have been rewarded.
“The complementary $5.5 trillion fiscal support healed consumer balance sheets and further fueled investing in homes and other risk assets,” he said. “None of this was a surprise or unintended, and a 70/30 stock/bond investment portfolio was an easy, comfortable consequence.”
In essence, we’re all risk-takers now, whether it’s fixed income or equity. Thus, more investors and financial advisers are justifying the equity market performance over the bond market.
In a report earlier this week, Ritholtz Wealth Management Chief Executive Josh Brown pushes the 70/30 model up to 80/20.
Citing the fact that the S&P 500 Index doubled in value off its March 2020 bottom in record time, Brown said the changing investment landscape justifies more risk-taking.
Parametric’s Lee doesn’t dispute any of the arguments for increased equity allocations, but he offers financial advisers and their clients some rationale for not jumping headlong into lopsided portfolio models.
“We were just trying to add our voice to not throwing away the portfolio construction that has been useful for so long,” he said.
As Lee explains, for all of its recent shortcomings, fixed income is still the best form of portfolio ballast.
“Assuming we don’t migrate into a high-inflation environment, high-quality fixed income will continue to dampen the volatility of portfolios heavily oriented toward growth assets,” he said. “For investors nearing retirement, minimizing the potential for steep portfolio drawdowns is critical.”
Lee also believes talk about low and negative bond yields misses the point that many fixed-income allocations are laddered in a way that provides incremental income even in the lowest yield cycles.
“Managers who implement an equally weighted laddered fixed-income portfolio can enhance the yield through active selection and roll down, depending on the steepness of the yield curve,” he said. “A general rule of thumb for investors to keep in mind is, as long as their time horizon is longer than the portfolio’s duration, rising rates will be beneficial to returns.”
Then there’s the matter of alternatives to traditional fixed-income allocations, which is where Lee believes financial advisers can introduce added fees and tax consequences.
“Fixed-income portfolios can be structured in a tax-aware manner to minimize tax liability, and investors can achieve this outcome for a modest fee,” he said. “Private investments like real estate and infrastructure are often less tax-aware and come with substantially higher fees. Taxable investors, in particular, need to consider carefully what they expect to earn after realizing all taxes and fees.”
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