Does the 60/40 split have a future?
Mixed asset allocators have traditionally relied on a 60/40 split to equities and bonds or other fixed income products, however, this level of diversification has struggled to live up the current economic environment.
According to FE Analytics, within the Australian Core Strategies universe, the cautious mixed asset sector was the best performing of the mixed asset sectors with a return of 0.48% over the last 12 months to 31 October, 2020.
This was followed by moderate (0.08%), flexible (-1.43%), growth (-3.09%) and aggressive (-3.42%).
The balanced sector, which contained mixed asset funds that adhered to the 60/40 split the closest, lost 1.78%.
Anthony Doyle, Fidelity International cross-asset specialist, said with Australian bond and equity valuations close to all-time highs, the traditional 60/40 portfolio was unlikely to generate the types of returns that investors had become accustomed to.
“Since 1986, the average calendar year return of an Australian 60/40 portfolio was 10.3%; this year, returns are -4.4%,” Doyle said.
“We estimate that going forward, the same portfolio will generate returns of around 4% per annum.
“The powerful force that drove returns over the last 30 years – a falling cash rate – has now reached a point where it is unlikely to fall much further, if at all. Consequently, Australian government bonds are now all fixed and no income.”
Simon Doyle, Schroders head of fixed income and multi-asset, said the problem with the 60/40 split was it being dominated by the behaviour of equity markets.
“No one should really be surprised that it didn’t work well during COVID-19 crisis given the big falls in equity markets,” Doyle said.
“The compounding problem going forward is that the ‘40%’ is supposed to diversify and smooth out returns; however, with yields on cash and government bonds at or near zero, it offers limited returns and a reduced ability to mitigate falls in equity markets.”
However, David Bassanese, BetaShares chief economist, said it was not fair to say bonds did not provide any downside protection during the equity sell-off.
“After all, over the few weeks in which Australian equities fell by more than 30%, the local bond benchmark was broadly flat,” Bassanese said.
“The yield on short-term government bonds did fall, but yields on longer-term bonds and especially corporate bonds spiked higher, due to a massive dash for cash that resulted in sell-downs in both investor holdings of equities and some bonds.
“The bigger concern is that bond yields are now so low that the ‘opportunity cost’ in terms of holding bonds for diversification purposes has really increased.”
Stuart Fechner, Bennelong Funds Management research relationships director, said it was not about bonds as the defensive asset class providing a super high level of return, but about providing a better return than equities when equity returns are in deep negative territory.
“In the first quarter of 2020 equities were hit hard, with the S&P/ASX 300 Accumulation index falling 23.4% and global equities (measured by the MSCI World ex-Australia Index, in $A terms/unhedged) returning a negative 9.33%,” Fechner said.
“Fixed income on the other hand did hold sway over this period and played the diversifying and balancing act role quite well.”
Stephen Miller, GSFM investment strategy adviser, said gold could be the answer to providing a defensive safe haven instead bonds, as well as a hedge against inflation.
“Even in the event that bond yields stay low then the opportunity cost of holding gold remains diminished, increasing its attraction,” Miller said.
“Gold is not adversely influenced by the complexities and attendant challenges for central banks that attach to ‘exit strategies’ from the current extraordinarily accommodating global monetary policy settings.
“And it provides safety in the event of any escalation of geo-political concerns, of which there is no shortage.”
Performance of mixed asset sectors over 12 months to 31 October 2020
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