Great opportunity for long-term investors in 60/40 portfolios: Thomas Digenan
Battered 60/40 portfolios will roar back to life and provide investors with solid returns after the worst performance in nearly 15 years, according to J.P. Morgan Asset Management.
The asset manager said the classic strategy, which allocates 60 per cent to equities and 40 per cent to fixed income, will provide an average annualized return of 7.2 per cent over the next 10 to 15 years starting next year, after a 19 per cent drawdown this year. That compares with a 4.3 per cent long-term return projected from 2022.
Bombed-out stocks and bonds are providing the best entry points since 2010 for long-term investors, said John Bilton, JPMAM's head of global multi-asset strategy, during a presentation of the company's latest Long-Term Capital-Market Assumptions report.
“This breathes a bit of life into the 60/40 portfolio which so many thought was extinct,” said Bilton. “While it's the worst year for 60/40 since 2008, it's important to use this opportunity to rebuild portfolios. This is rightly a year to be in the bunker. But if you stay in the bunker too long, you miss when the dust settles.”
Over the past decade, the likes of pension funds invested trillions in this strategy on the conviction that bonds would reliably keep producing steady income to offset equity losses in any market downturn. It largely worked, with the 60/40 strategy only ending down in two of the past 15 years -- while posting modest volatility to boot. Even in the throes of the financial crisis, when stocks sapped performance, rallying Treasuries softened portfolio losses.
But this year, the worst inflation in decades has become a risk too big to hedge. Both bonds and stocks suffered as the Federal Reserve aggressively raised interest rates to cool price pressure.
It's a challenging year for the 60/40 strategy on many levels. Both U.S. stocks and bonds were expensive to start with and that meant the bar for further gains was high. And bond yields near historic lows at the start of the year provided little protection for the portfolio. S&P 500 Index was down 17 per cent this year while Bloomberg's U.S. Treasury Index dropped 12.4 per cent.
Now things are starting to look brighter. The latest CPI data raised hopes that inflation may have peaked and the Fed can afford to tighten policy at a slower pace. That likely bodes well for both equities and bonds.
While JPMAM's forecast is for average annualized inflation to be above the Fed's target at 2.6 per cent over the next 10 to 15 years, that's much more benign that the 7.7 per cent in the latest reading. Higher bond yields also provides a better buffer for a portfolio, with 10-year yields hovering near 4 per cent from 1.51 per cent at the end of last year.
“With higher yields, bonds are once again a plausible source of income and a potential safe haven,” Bilton said. “At lower valuations, equities are more attractive. The combination of higher yields and lower equity multiples means that markets today offer the best potential long-term returns in more than a decade.”