While the 60/40 portfolio has recently been abandoned by asset managers such as BlackRock, suggestions that the traditional investment approach is “dead” have been dismissed by figures in the Australian investment industry.
Jody Fitzgerald, the head of institutional portfolio management and solutions at Morningstar Wealth, told the Morningstar Investment Conference this week that it was necessary to look beyond the “dramatic clickbait” when considering the status of the 60/40 portfolio.
“Fundamentally what that argument is saying is that naive diversification just doesn’t work in some market environments,” she said.
“The 60/40 portfolio assumes that you get naively diversified by having 40 per cent defensive assets. You’ve got your bonds, domestic, international, some cash. Have your equities, and they’ll move in different directions at different points in time.
“Naive diversification works until it doesn’t.”
Prior to the hiking spree embarked on over a year ago, she suggested that central banks had been effectively “rigging” the risk-free rate and deliberately holding it at zero for over a decade.
“When the risk-free rate has no value, that has profound implications for the way risk is then priced across all asset segments,” she explained.
Given the recent period of low interest rates, combined with the amount of liquidity flooding into the market, Ms Fitzgerald said that the outcome was asset price inflation.
“All assets were significantly overvalued. So effectively, when you’re in an environment where you know your assets are overvalued, including your bond portfolio, it is not going to behave the way you need it to when that repricing of risk starts to occur,” she continued.
“So that’s fundamentally the argument behind it being dead. That’s changed.”
Ms Fitzgerald said that Morningstar had previously held very little duration, or sensitivity to interest rates changes, in its portfolio and was making sure it held an appropriate level of alternative assets while also utilising FX as a diversifier.
“Now though, bonds are back. We find you can get a yield from a bond. It will play more of that diversification role than it has in a very long time,” she said.
“So, we are now increasing our exposure to duration and really ramping up knowing that, yes, they’re not necessarily cheap, they’re roughly fair value. However, if you do walk into a recessionary environment, it will play the diversification role it hasn’t had the opportunity to play for some time.”
Mark Delaney, the chief investment officer at AustralianSuper, also told the Morningstar Investment Conference that the 60/40 portfolio does not actually appear to be “dead”.
“We’ve done some work on this and the argument really is that high inflation, or higher inflation, is going to make it harder for bonds to work and more difficult for stocks, and there’s a degree of truth in that,” he stated.
“More than likely, higher inflation, if it manifests itself over the medium term, will result in lower returns in all investment classes, and the absolute total return comes down, but the relative ranking of asset class returns probably won’t change that much.”
Subsequently, Mr Delaney suggested that, when taking a 10-year view, stocks will still do better than bonds, and bonds will still do better than cash.
“It’s just that, instead of getting, like AustralianSuper’s balance plan has done, I think, eight and a quarter [per cent per annum] over the last 20 years. You won’t be getting eight and a quarter, you’ll be getting six and a half,” he predicted.
When announcing its pivot away from the 60/40 portfolio last month, BlackRock admitted that the approach was performing well in 2023 after suffering “the worst year in decades”.
But strategists at the world’s largest asset manager believe that old assumptions no longer apply and have assessed that the new economic regime, in which central banks are hiking interest rates to combat inflation, invites a reconsideration of long-term strategic allocations.
