Investment firm 7IM has warned financial advisers that the traditional split in allocation between equities and bonds “won’t work” for their clients in the next decade.
The 60/40 portfolio “has been around for decades”, the company said, as it was designed to provide balanced investments to investors, by offering income and the relative security of bonds combined with the growth potential of high-risk equities.
But 7IM’s investment team believes such portfolios are becoming “an anachronism which will not serve clients well in this era of record low bond yields”.
Matthew Yeates, head of alternatives and quantitative strategy at the company, believes that the original 60/40 strategy to provide diversification to investors can no longer be achieved.
“The 60/40 portfolio has been a great place to be over the last decade but looking forward, and with an eye on what’s happened in 2020 in particular, we think investors should be looking for more now from their portfolios,” Yeates said. “For a balanced portfolio, we would currently expect to see an allocation of circa 15% in alternatives, a split which will likely only increase over time when you consider where bonds yields and equity markets are currently.
“Be it diversification through proper strategic asset allocation, looking at regions like emerging markets or diversification through alternatives, these should all be differentiating parts of robust multi-asset investing going forward, which should replace the increasingly flawed 60/40 approach.”
Stop building them
He added that a change in strategy is needed because fixed income is now “highly correlated” to equity markets due to the intervention of central banks, meaning that it cannot act as a safety net anymore.
That is why Yeates believes that taking into consideration uncorrelated assets is a more sensible strategy than relying on fixed income when it comes to diversification within portfolios.
For instance, he said, a specific group of alternatives could be incorporated in balanced portfolios to achieve the same diversification bonds were once able to provide.
This would mean using liquid alternatives – such as emerging markets, property and long/short strategies – to create a better overall “risk/reward profile for a balanced portfolio”.
He added: “A genuinely diversified multi-asset portfolio has a much clearer role in today’s prevailing environment of low bond yields, negative debt piles, and returning inflation. Our answer to the problems facing 60/40 portfolios is, therefore, not to build them.”
