By Chris Matthews, MarketWatch
MarketWatch photo illustration/iStockphoto
The 60-40 portfolio might not be dead, but some strategists and investors warn that it’s on life support.
It was once a universal rule of thumb that placing 60% of one’s assets in stocks and the other 40% in bonds would offer investors an optimal mix of historically superior equity returns combined with the safe and reliable income of bond investments. But with roughly 25% of government bonds globally yielding negative returns, asset managers and investors rethinking this strategy, while others spring to its defense.
“The 60-40 stock-bond portfolio it’s going to give you protection, but it’s certainly not going to give you the income from the fixed-income component the way it used to do,” John Bilton, head of Global Multi-Asset Strategy at J.P. Morgan Asset Management said last week at an event announcing the release of its 2020 long-term capital market assumptions in New York City. “If we are in a world where we’ve got very little return from bonds, and we get all of our returns from pushing out on the risk spectrum, we’ve got to rethink how we build robustness into our portfolio,” he added.
Bilton advised investors to consider private equity investments, particularly those in so-called “core” real estate funds that own commercial and residential real estate properties, where 75% of the returns come from rental income, rather than asset appreciation, making them bond-like in nature. The downside to such investments is that they typically require high minimum investments and lockup requirements that make these investments less liquid than your typical bond fund.
For investors who can’t meet the investment requirements, or who are looking for more liquidity, they may turn to less-risky equities that pay high dividends. Dividend funds like Integrity Viking Dividend Harvest Fund /zigman2/quotes/205562360/realtime IDIVX -0.86% which selects low volatility equities with a long history of dividend payments also can provide investors with some of the downside protection that bonds typically have done.
Trey Welstad, portfolio manager at Integrity Viking said his clients are “rethinking retirement” by investing in dividend stocks with a low “beta,’ or correlation with the broader stock market, that also have a long history of paying dividends and raising dividends over time. His fund invests in blue-chip firms like AT&T Inc . /zigman2/quotes/203165245/composite T -0.48% , which has a dividend yield of 5.2% — compared with the yield on the 10-year U.S. Treasury note of 1.941% — and which has raised its dividend every year for 30 years.
Since October 1 of last year, IDIVX has earned a total return of 12.4% relative to the S&P 500 /zigman2/quotes/210599714/realtime SPX -1.12% 8.2% return, illustrating the downside protection that low volatility stocks provide during downturns like that seen in the fourth quarter of last year.
However, Mike Loewengart, chief investment officer at E-Trade warned investors not to stray too far from the traditional 60-40 approach. “We don’t have to pen the obituary for the 60-40 approach just yet,” he told MarketWatch. He said that even if investors will be suffering through low bond yields and low expected equity returns in the coming years, the 60-40 portfolio is optimal for helping investors to “stay the course.”
“Low volatility dividend stocks may suffer smaller losses during market downturns, but they are still going to be much more volatile than high-quality fixed income,” Loewengart. said.
The most important reason to stick with the standard portfolio construction is that bonds — even if they won’t provide the income they once did — still provide investors the protection from market downturns that is a key psychological tool for helping an investor remain in the market for the long haul.
“If you adhere to a 60-40 portfolio, that will enable you to see through the ups and downs of the markets,” he said. “You may give up some return when the equity markets are really rallying, but over time the moderate returns you do earn will exceed those from ill-timed attempt to game the market.”
Instead of dumping high-quality bonds for illiquid alternative assets or dividend paying stocks, Loewengart said investors instead should look to better diversify the equity side of their portfolio, which he sees as often overly skewed to U.S. stocks, to the detriment of international equities.
“Within the 60-40 construct their are opportunities to diversify into international and small and mid-cap stocks,” he said. “Many investors have shied away from these in favor of the more recognizable S&P 500 names.”