Over the past 18 months, equity and government bond markets have again begun to behave in ways that are confounding professional investors.
Historically there has been an inverse relationship between the two asset classes, but the elevated prices seen in recent years have led some to question the future of that dynamic.
Market activity in September seemingly proved these critics’ point, as both equity and government bond prices fell more or less in tandem.
This has again called into question the traditional 60/40 portfolio of equities and bonds, and whether it is still suited as a building block of the investment process.
A typical 60/40 portfolio containing US equities and government bonds fell 3.5 per cent in September, according to calculations from the Financial Times.
This was the biggest loss faced by these portfolios since a 5 per cent drop in March 2020, according to the FT.
But industry experts are still split on whether this marks the beginning of the end for 60/40 portfolios.
Duncan MacInnes, co-manager of the Ruffer Investment Company, said investors should be asking themselves what to do with the 40 per cent of their portfolios that is invested in bonds and equivalent instruments.
“The reason they should be asking that question is because the bonds or bond proxies guarantee low returns; you know that with certainty from where yields currently are,” he said.
“And then we are also increasingly convinced that they have diminishing protective or diversifying characteristics.
“So low returns that you might not diversify, so what’s the point?”
He added the monetary and fiscal response to the pandemic had “catapulted” investors into a new economic phase.
“That regime is going to be far less friendly to asset owners than the last regime.
“Also, and this is the important bit, cross-asset correlations are going to be different in the new regime to the old regime.
“Therefore, you need a different portfolio from the one that's done so well over the last couple of decades. And you need to think differently about the way that you put those assets together.”
He said this was the biggest portfolio construction challenge faced by the wealth management industry.
Dan Brocklebank, head of the UK business at Orbis Investments, noted static allocation to assets did not provide static return potential and static risk. Given the current state of affairs, that might create problems for passive funds.
“This is because asset valuations are changing all the time. There may well come a time when stock markets and bond markets are attractively valued, and passive might be great.
But at the moment, he added, stock markets and bond markets are very expensive, and credit spreads are near record lows with valuation spreads within stock markets very wide.
“So at the moment it is an unusually dangerous time to be in a passive 60/40 portfolio.”
