Long-term investors in diversified portfolios have seen a dramatic rise in the probability of achieving a 7 per cent nominal return, rising from 11 per cent in 2021 to 38 per cent now, new data from Vanguard has shown.
This is due in part to higher interest rates spurring a substantial increase in bond return expectations, according to Vanguard.
Namely, the firm forecasts Australian bonds to return an annualised 4.3 per cent to 5.3 per cent over the next decade, compared with the 1.3 per cent to 2.3 per cent 10-year annualised returns it expected before the rate-hiking cycle began.
Similarly, for global bonds, annualised returns of 4.5 per cent to 5.5 per cent over the next decade are expected, compared with a forecast of 1.6 per cent to 2.6 per cent when policy rates are low or, in some cases, negative.
Noting that 60/40 portfolios have attracted criticism over the last two years, the investment manager said that these new figures may give pause to critics.
Nonetheless, Vanguard said that it would remain cautiously constructive for equities, as higher rates are expected to present near-term headwinds to asset prices, profit margins, and corporate earnings.
“The Australian equity market continues to appear more fairly valued than the US, with less rate relief in the near term than appreciated,” the firm explained.
Speaking on the new findings, Vanguard senior economist Alexis Gray said: “The headlines and industry commentary were plastered with obituaries for the 60/40 in 2022 but the case for the 60/40 portfolio, spurred by higher bond return expectations, is now stronger than it has been in recent times.”
“While volatility in the financial markets are not quite in the rearview mirror, we are nearing the end of this structural shift,” Ms Gray added.
“As we move towards higher interest rates and as markets settle, the permanence of higher interest rates will lay a solid foundation for long-term investors.”
Earlier this year, the rally in equities and bonds markets similarly “silenced” speculation about the “death” of 60/40 portfolios, according to T. Rowe Price.
“Despite correlations between stocks and bonds remaining elevated, noise around the death of the 60/40 portfolio has been silenced as strong returns in both stocks and bonds have led to a more than 5 per cent return for the 60/40 in just the first month of the year,” the group noted in February.
“The rally in both asset classes has been supported by evidence of falling inflation and lower rates. Our analysis has shown that, in historical periods like today when inflation is declining from elevated levels, correlation between stocks and bonds can remain elevated.
“While perhaps still not providing diversification, if the disinflationary trend continues, the two asset classes could perform well, bringing back the 60/40 portfolio from one of its worst years ever.”
