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The old 60-40 formula for stocks and bonds has run into trouble

A pair of ProShares ETFs that short Treasury bonds that mature in 20 years or more posted their best performance in almost two years Wednesday.
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A precipitous slide in Treasury yields is calling into question one of the world’s most popular investment strategies.

The traditional asset mix of 60% stocks and 40% bonds, a starting point for investors since the proliferation of modern portfolio theory in the 1950s, has produced one of the best risk-adjusted returns of the past three decades, outshining debt alone. But with Treasury yields now hovering around zero, and likely to stay there for years, those gains are in doubt.

It’s not the first time that so-called 60/40 portfolios have faced scrutiny; often a target of griping after a surge in stocks leaves investors short-changed, they’ve still eked out a positive return through the volatility of 2020. But it’s the other side of the blend that’s now in focus as yields in the world’s biggest debt market plumb new depths, giving bonds less room to rise and act as a hedge against falling stock prices. That has money managers such as JPMorgan Asset Management and U.S. Bank Wealth Management looking beyond Treasurys to securities that have more potential to rally.

“There’s a strong temptation to reach for yield wherever people can find it,” said Bill Merz, head of fixed-income research at U.S. Bank Wealth Management, which oversees $180 billion from Minneapolis. “On a global scale, more investors are migrating out the risk spectrum because they feel they have no choice.”

Calls for the demise of the 60/40 portfolio resurfaced in August, as U.S.-China trade tensions exacerbated fears of a global economic slowdown. Bank of America and Morgan Stanley warned of sobering returns late last year, but expectations that the Fed will eventually cap yields for some Treasury maturities have given these arguments further traction.

The mix, as measured by the S&P 500 and Bloomberg Barclays U.S. Aggregate Bond Index, produced an annual compounded rate of return of almost 10% from 1983 to 2019, Jan Loeys, a senior adviser of long-term investment strategy at JPMorgan, wrote in a note June 30. Going forward, he sees returns on the 60/40 portfolio dropping to around 3.5% per year over the next decade, but investors could boost their returns to a little over 4% by adopting a portfolio that’s 40% stocks, 20% bonds and 40% invested in securities with some characteristics of both, he wrote.

That could include collateralized loan obligations, commercial mortgage-backed securities, real estate investment trusts or utility stocks.

Making a Move
Investors seem to be on the same page. Conning — an investment manager that oversees $120 billion from Hartford, Connecticut — has looked more closely at structured products such as CLOs over the past three months because it’s an area where prices haven’t been pushed higher by the Fed’s emergency asset purchases, Chief Investment Strategist Rich Sega said. And U.S. Bank Wealth Management increased allocations to investment-grade corporates and municipal credit in June, Merz said.

Convertible bonds, which offer a risk profile between bonds and stocks, have also benefited from greater investor interest. U.S. ETFs tracking this type of debt added more than $300 million in May, and another $427 million in June — the biggest monthly haul in six months, data compiled by Bloomberg show.

“Convertibles are getting the best of all worlds because they have both bond- and equity-like aspects: They are a bond and they are convertible into stocks,” JPMorgan’s Loeys said by phone. “They gain when stocks go up and they gain when bonds rally, as both asset classes have in the last three months.”

The leaders raked in a combined $949 billion over the past decade.
July 7

In Europe, where banks have spent the past decade shoring up balance sheets and deleveraging following the 2008 financial crisis, so-called CoCos — or bonds issued by the lenders that are convertible into stock — have become an appealing bet. They’ve returned more than 6% annually during the five years through June 30, even after accounting for a 9.4% annualized loss in the first half of 2020, according to Daniel Tenengauzer, head of markets strategy at BNY Mellon. CoCos returned double the region’s government bonds over the same period.

Still, some investors aren’t ready to write off 60/40 just yet. Jack McIntyre, who helps oversee more than $60 billion at Brandywine Global Investment Management in Philadelphia, says some of the criticism about this strategy may be unfair.

“No matter what kind of portfolio you have, you need a defensive allocation,” he said. “That 40% serves a role.” — Additional reporting by Sam Potter

Bloomberg News