FIVE THINGS YOU SHOULD KNOW
The team at TEN is so happy to have Shelby back with us after her maternity leave, we are excited to welcome her beautiful baby girl Emerson, born March 4, 2021, at 6:10pm weighing 6lbs 13oz!
INSIGHTS for INVESTORS
We’ve been on record for some time now that the traditional 60/40 is in dire trouble (and no, a few token positions in other assets classes won’t save you). And trust me I’ve heard all the counterarguments, but to me they hold no water at all, and invariably amount to nothing more than quoting past performance to justify stale allocations that are somewhere between lazy and cowardly.
The reality is things have changed, even as portfolios haven’t, consider the foundation of the 60/40 which was based on four key foundational pieces that are no longer present:
In short, your old methodology won’t get you there because bonds are arguably not the defensive, uncorrelated asset class they once were and no longer even pay you a yield that can keep up with inflation. Stocks and bonds were both pushed higher on declining rates and liquidity which are likely to abate and now become headwinds for both with greater frequency.
Therefore, not only will your emotions be challenged as you see losses across your portfolio but that reality will also greatly increase the risk to the longevity of your portfolio as your Sequence of Return (https://www.investopedia.com/terms/s/sequence-risk.asp) risk grows and you have to sell assets to pay bills.
The Simple Math of It
Consider the simple math of it.
The 20-year annual average return for the S&P 500 is 6%, which if it comprises 60% of your portfolio gives you a 3.6% return. Current traditional bond yields are around 1.5%, which if 40% of your portfolio gives you a 0.6% return.
So, the likely case is your average total return is around 4%. If you are taking the typical 4-5% distribution your “head is barely above water” and that’s before any volatility, inflation, and/or taxes which will really stack up over a 20 to 30 year retirement and only compound the problem.
At best your plan would likely suffer severe drawdowns as you age and become more risk averse (a bad combination), and at worst your financial plan may be completed busted.
With over 25 years since I began in the industry and seeing what really works for people’s peace of mind, along with extensive modeling of the challenges above, my conviction in making sure investors address this issue couldn’t be higher. That is why we continue to pound the table about this topic and why we created our High Income Strategies to solve for it for our soon-to-be or already retired clients.
If you are already a client of TEN in one of these strategies then you’ve tackled these issues already, but I can tell you after seeing the referrals and new clients that continue to come in, that many of those that you know and care about have not.
My goal, whether people work with us or not, is to honor their hard work and sacrifice and play some role in helping them enjoy their retirements – it’s one of the reasons we put the effort and time into these commentaries and give them away for free.
As to the risk from stale 60/40 allocations that still predominate the industry, you don’t have to just take my word for it, below is a great article with comments from various Chief Investment Officers managing over $5 trillion dollars that are raising the very same concerns.
Have a wonderful weekend,
Tim and the team at TEN Capital
‘It’s reasonably dead’: $5tn CIOs give a grim diagnosis for the 60/40 portfolio
With yields already low, inflation on the rise and equities expensive, the outlook for the traditional balanced portfolio isn’t looking great, according to these CIOs.
Alex Steger by Alex Steger May 2021
The 60/40 portfolio is not quite dead, but its condition appears to be critical.
This was the verdict of five investment chiefs from leading asset managers who took part in Citywire’s CIO Summit.
The Summit brought together CIOs from Amundi, Franklin Templeton, JP Morgan Asset Management, Legal & General Investment Management (LGIM) and T Rowe Price, who between them oversee almost $5tn (R70tn) in assets.
Their pessimistic prognosis for the classic balanced portfolio was based on a dire outlook for bond yields, already pushed low by loose monetary policy and now under pressure from inflation.
And with inflation only expected to rise in the US due to ambitious fiscal programs, increased consumer spending and supply bottlenecks, this will eat further into real yields, raising more questions over the role of bonds in the classic balanced portfolio.
Sonal Desai, CIO of Franklin Templeton Fixed Income, said that it was premature to say 60/40 was dead, but that it was not ideal positioning for the current environment.
Desai said she did not envisage 1970s-style inflation, which ran at an average of 7.1% over the decade, but predicted that price increases would not return to the US Federal Reserve’s target of 2% either and were more likely to be in the range of 3% or higher, which would still leave Treasury investors short.
If the 60/40 portfolio was taking a nap for Desai, it was ‘reasonably dead’ as far as Amundi CIO Pascal Blanqué was concerned, due to bonds failing to be the ‘great diversifier’ they have been historically.
He said the role of bonds in portfolios would need to be reconsidered and that, while bonds could still provide liquidity, additional income would need to be found from other asset classes.
Diversify for income
Blanqué said the fixed income portion of the 60/40 portfolio should be divided in two, with one portion for liquidity and the other forming part of a wider income bucket, which would also include other asset classes and a greater variety of bonds, including securitized debt, emerging market debt and municipal bonds.
‘This is going with the more positive correlation between equities and bonds. It’s on the agenda and it will come,’ he said.
‘So we’ve got the problem of finding diversifiers, new diversifiers, because the great diversifier of bonds versus equities is not dead, actually, but is reasonably dead.’
Sonja Laud, CIO at LGIM, agreed with Blanqué that investors would need to find alternative asset classes to deliver some of the traditional characteristics of bonds in a 60/40 portfolio, namely income, diversification and downside protection.
David Giroux, who runs the $49.1bn T. Rowe Price Capital Appreciation fund, a multi-asset strategy that sits in the Morningstar Allocation 50% to 70% Equity category, said he rarely had 40% exposure to traditional bonds.
Giroux, who is head of investment strategy and CIO for US equity and multi-asset at T. Rowe Price, said other asset classes, such as leveraged loans, and covered calls, could offer better risk-adjusted returns than traditional bonds.
‘We’ve gone from less than 1% of my portfolio a couple of years ago in leveraged loans to more than 10% today. Leveraged loans may be the most attractive part of the market today, on a risk-adjusted basis,’ he said.
‘We’ve gone from 1% back when everybody thought rates were going to go 3% to 4% and we were buying Treasurys at that time, to today, where we’re zero Treasurys and 10% leveraged loans.’
While low bond yields are the primary threat to the efficacy of the 60/40 portfolio, global head of equities at JP Morgan Asset Management, Paul Quinsee, highlighted that the yield on equities was also low due to their high valuations.
He noted how the 60/40 portfolio had traditionally returned 6% per annum over the last 30 years, but that this would not be the case in the future. Credit Suisse has projected it may return as little 2% per annum.
Desai pointed out that a new economic cycle could result in yields going up at some stage, meaning that such dire projections may be too hasty.
‘[If yields] start becoming more attractive again… maybe 60/40 wakes up. It’s probably not dead. That might be premature.’ [TEN Cap editor’s note: Desai’s last point here very well may have some merit for investors allocating their investments in the future when rates are higher, but does not have much merit or applicability for investors already within a classic 60/40 mix as they are already in at these lower bond rates.]