MARKET COMMENTARY

Striking The Right Balance In Your Portfolio

Is the classic 60% equities and 40% fixed income asset mix out of fashion or in need of an update? That’s the question Giles Marshall and Michael Greenberg tackle. See what they say about refining portfolios to thrive in today’s environment.

01.29.2021 - Giles Marshall, Vice President, Portfolio Manager,

For many investors, a portfolio of 60% equities and 40% fixed income has been the right mix for decades— performing well through market drops and surges. Yet, today’s environment is raising questions about this classic approach. Is it truly out of fashion or in need of an update? Giles Marshall and Michael Greenberg take us to the root of the questions and share their views on what lies ahead.

Q: Can you give us some context for this type of portfolio?

Giles Marshall: The theoretical underpinnings of the 60/40 split, commonly referred to as a balanced growth portfolio, date back to academic research done more than 70 years ago. However, for various market and economic reasons, it did not become that common until the mid-1980s and beyond. At that point, bond yields had peaked and the subsequent low to negative correlations between bonds and stocks provided the 60/40 portfolio with strong absolute returns and diversification benefits that have lasted through to 2020.

Q: What is driving the notion this model may be out of date?

Michael Greenberg: We have been reading headlines about the demise of the 60/40 split for almost 10 years. Today, concerns are primarily focused on the fixed income side of the portfolio. In very general terms, bonds generate returns for clients in two ways. First through the coupon, which offers investors certainty, but typically plays the lesser role in the performance equation. Second through capital appreciation, which generally occurs when bond prices rise, triggered by declining interest rates. So, here we are today with bargain-basement interest rates and investors rightfully questioning how their fixed income portfolio is going to generate the additional lift to meet their objectives— whether it is immediate income, saving for retirement, or legacy building.

Giles Marshall: I agree, the key driver is the current level of bond yields and the potential for rising inflation, given the magnitude of global monetary and fiscal stimulus. Right now, 40% of the portfolio faces some headwinds leaving equities to compensate. Going forward, we expect fixed income returns to hover in the low single-digit range.

Q: Is it time to walk away from the 60/40 model?

Giles Marshall: In our view, this is not a take-it-or-leave-it situation for a few reasons. For instance, our readers should appreciate that much of the major media conversation on this topic concentrates on government bond yields, where the outlook is pretty meagre. Government bonds continue to play a role, but have not been a major focus of our fixed income portfolios for some time. We have been actively diversifying fixed income assets to manage risk and add to returns. Franklin Templeton’s considerable expertise in bonds has been further enhanced by its recent acquisition of US-based asset manager, Legg Mason. We will be looking for ways to enrich our fixed income exposure with some new strategies.

Nothing in life stands still, and as active managers, we know the nature of various asset classes and markets changes surprisingly quickly. For instance, the composition of the FTSE Canada Universe Bond and the S&P 500 indices are very different today than 10 or 20 years ago. As the composition of asset classes and markets change, strategies like the 60/40 portfolio, which has served many investors well, need to adapt. We are always evolving along with the changing nature and characteristics of the various asset classes that comprise a balanced portfolio. This process is grounded in discipline and in-depth research and analysis.

We believe risk management should always come first, as we work to generate returns in a low rate environment.

Michael Greenberg: Adding to Giles’ comment on diversifying fixed income assets, we think investors appreciate the defensive and offensive roles bonds play in their portfolios. Times have changed and constructing fixed income portfolios has become more sophisticated and requires a more discerning approach. For instance, looking at government bonds (selected for their defensive properties), those in Canada, Australia and the United States remain positive as compared to Europe and Japan.

Working to gain extra basis points to increase total return, asset managers are looking at different asset classes such as investment grade corporate bonds, asset-backed securities and emerging market debt. With that in mind, it is important to have a strong portfolio construction process to ensure you are truly remaining diversified and not doubling up on risk. Some fixed income assets will move and behave more like equities than one might think. As always, it is important to know what you own.

Q: What about the equities side of the 60/40 equation?

Giles Marshall: There is no question equities and potentially other classes, such as alternative investments, will have to do more of the heavy lifting. For income-oriented balanced portfolios (i.e., 60/40 balanced income portfolios), high-quality dividend stocks will likely play a more important role. Our fundamental approach will be similar to the fixed income side of the equation, adding value through active management and applying tactical steps such as diversification in style and geography.

Q: How do you see balanced portfolios evolving?

Giles Marshall: We see things changing as they have in the past, over time and based on individual conversations with our clients. We are focusing on options that complement existing assets. In the months and years ahead, clients should not be surprised to hear us talk about incorporating alternative assets such as precious metals, infrastructure, commercial real estate and other real return assets or certain hedge fund strategies. Again, it goes back to the client’s situation.

Q: What, in your view, comes under the label alternative investments?

Michael Greenberg: It is a very broad category. We define alternatives as an investment that has a positive expected return and very low or negative correlations to equity markets. Ideally, if you are adding an alternative option, it is not just adding more equity risk. Some of the alternative investment options we see on the market are really equities dressed up in sheep’s clothing. From our perspective, we want to be even more discerning with alternative investments, working to ensure we are adding something that benefits a portfolio’s risk/return profile.

Q: Taking a step back, what do you suggest investors be mindful of?

Michael Greenberg: Look at returns on a bottom-line basis, and as compared to other types of investment options. For instance, expectations for bond performance are down; however, what do similar GICs or savings accounts offer? How can you bolster performance without significantly sacrificing a disciplined approach to managing risk?

We think the 60/40 model, or a derivative of that, remains a viable investment choice for many investors. We are focused on adjusting this performance engine to suit today’s realities. That means taking full advantage of our active management approach and, literally, the world of investment options available to us.

 

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Giles Marshall, Vice President, Portfolio Manager,

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