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Mayank Goradia: I'm Mayank Goradia, Head of Integrated Portfolio Construction at Fidelity Investments. And I'm on a quest. A quest to help advisors profitably grow their book through the art and science of portfolio construction. With expert insights and groundbreaking research, we'll embark on a journey where wisdom meets innovation and every choice counts. So join me on The Search for the Next Great Portfolio.
In this episode, we dive deep into a topic that has been a cornerstone of investment strategy for decades, the 60/40 portfolio. Once hailed as the golden rule for balanced investing, the classic mix of 60% stock and 40% bonds is now facing unprecedented scrutiny. Is the 60/40 portfolio dead?
[Art Card: Is 60/40 dead?]
Paul Ma: The 60/40 portfolio came about from the realization that it is as important to manage the investor as much as the investment. Behaviorally speaking, investors tend to have bouts of panic during a market downturn, such that some of them tend to sell at the very bottom, at the worst possible time.
Historically, we observed that stocks tend to zig when investment-grade bonds zag. By putting them together in a 60/40 portfolio, you could potentially smooth out that ride and help investors stay invested. Which, we believe, is the key to achieving their wealth goals.
[Art Card: Is 60/40 still the gold standard?]
Matthew Miskin: Modern portfolio theory isn't that modern. It was made in 1952. We’ve had a massive amount of innovation and advancement and thinking about how to run portfolios, options within portfolios. And we do think that there's more to just a 60/40 portfolio.
At the end of the day, that's a decent starting point, but whether it's alternatives, commodities, other parts of markets, the problem, as you know, is that sometimes the diversification between those two things doesn’t always work out.
We do think income is important, we do think equity capital appreciation is important, but there's other options that have evolved in this industry, and we think it's really important to know those, be able to understand them and where they fit in a broader portfolio beyond just the 60/40.
Mayank: Can you tell a little bit about it as to how this drumbeat started getting louder?
Paul: 60/40 just could not achieve certain goals. By incorporating asset class-like alternatives, investors can achieve goals that's beyond what 60/40 can achieve. For example, investors who want to have potentially more diverse asset class than bonds, they can use, perhaps, a hedge fund that historically was designed to have lower correlation with stocks.
If a client wants to have potentially higher returns than stocks, certain private equity categories have shown historically potential upsides to that.
And finally, some investors want to have higher income streams, for example. They can consider private credit in that category.
[Art Card: Can an advisor go too far adjusting a 60/40 portfolio?]
David Lebovitz: I think that there are a couple of things I would mention. One is more of a risk, and I think that risk is of over-diversification. Sometimes what we see is that advisors put a little bit here, a little bit here, a little bit here. And they spread their chips so thin that the portfolio never really generates any meaningful outperformance. And so over-diversification is a risk. I do think that, again, in the current environment, publicly traded stocks and bonds are going to be able to get you two-thirds of the way there. What we worry more about is what happens over the course of, say, a business cycle, right? And we think the opportunity in fixed income may dissipate. The opportunity in equities may begin to look a little bit softer. And so including alternatives is going to be of the utmost importance. But, you know, when we're talking about alternatives—and we've talked a lot about private alternatives today, things like private equity and private credit—there are also more liquid solutions. Things like covered call strategies, strategic income strategies, absolute return strategies, advisors really need to do is understand their clients' investment objectives and understand their clients' liquidity needs. And effectively the intersection of the two will tell you quite a bit about what should or should not be in your investment portfolio.
Mayank: An average advisor has a lot of options today. You think about factor investing, you think about private markets, dynamic asset allocation that takes advantage of where we are in the business cycle. From an advisor's perspective, how do you see—or what are you hearing advisors use to implement that asset allocation down within their portfolios?
Paul: Our research has shown that quality factor actually works pretty well in outperforming S&P in late-cycle and recession, historically speaking. And that is a characteristic that we show advisor when they decide to do the value growth tilt, when value is shown to outperform late cycle but growth outperforming recession. So that's really hard to call if you know exactly where in late-cycle recession, but quality outperform in both late cycle and recession. So using that data, one can link to our quality factors and take advantage of those historical behavior.
[Art Card: Should an advisor adjust the 60 or the 40?]
Matthew: So the way we do it is we start with the risk, not the return. And we map over—so bond volatility over the longer term has been relatively low. And so you want to think about alternatives that have lower volatility. And a lot of times these have more targeted volatility profiles. So within the bond side, maybe it's merger arbitrage, maybe it's market-neutral, maybe it's absolute return. Those are things that typically have lower volatility. On the equity side, you know, there's global macro, there's long-short. There's other alternative options—commodities—that can actually keep that volatility, and at the end of the day, you don't see return often unless you take risk. And that's, again, why equities probably long term, have better capital appreciation. But even in the alternative space you've got to take some risk to find return.
[Art Card: What does the future hold for the 60/40 portfolio?]
David: I think it's a function of today versus tomorrow. And, yes, when the 2-year Treasury is paying you 5% and projected forward returns from US large-cap equities start with a 6%, sure, you can get away with a 60/40 portfolio today. That's not going to be a problem. But again, assuming today is your starting point. Let's fast forward 12 to 18 months. My guess is that growth is going to be slower, rates are going to be lower, and the outlook for equity returns may be a bit more muted. And so I do think that the opportunity that we're looking at in the current environment may be somewhat fleeting. And so we're having a lot of conversations with our clients not only about diversifying within public assets, within equities, and within fixed income to try to ensure that they generate sufficient rates of return over time, but we're also continuing to have conversations about including less traditional and alternative assets into the mix in order to hit that return target that they've set.
Mayank: Today, we learned the importance of diversifying beyond traditional assets, aligning the right investment wrapper to a client's account, and embracing these trends to better serve the clients and grow your business. Thanks for joining us. Until next time, keep evolving and stay ahead.
Next time on The Search for the Next Great Portfolio
Mayank: What are the challenges, typically, these advisors face?
Anand Sekhar: The number one challenge that we're seeing right now is growth.
Jordan Burgess: The need for advisors to scale their business while delivering for greater levels of personalization and customization has never been higher.
Amanda Robinson: If a client comes in their office and they read a headline on crypto, an advisor needs a point of view on that.
Phillip Orlando: So I think understanding this tsunami is coming and taking some proactive steps to better prepare I think is critically important.
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