A year ago, many market participants were loudly declaring the death of the classic 60/40 portfolio (60% stocks, 40% bonds). This was not surprising since news cycles typically follow poor performance. Amid the steepest rate hiking cycle in recent history, and the subsequent repricing risk premium due to attractive risk-free rates, both fixed income and equities lost ground in 2022.
The bear case for 60/40 portfolios has been advanced many times. This has been particularly relevant for fixed income in times without a decent risk premium and with extremely low yield levels on government-issued bonds. These conditions make bonds unproductive diversifiers because, starting near 0%, they simply have nowhere to go.
But reports of the balanced style’s death are greatly exaggerated: with global fixed income yields having likely peaked, and the diversification benefits of bonds likely to return, 60/40 portfolios should be well positioned going forward.
Government bond yields at these real-term levels provide solid alternatives to risk assets. These periods can be naturally less good for equity performance as debt and capex become more expensive, and cash becomes a more attractive investment than equities. Sharply higher global interest rates and interesting bond risk premiums further reinforce 60/40 portfolios’ appeal.
This cornerstone investing concept has delivered an annualized return of approximately 8.2% over the last 49 years (up to 2022) with volatility of 10.7%. This translates to a return-to-risk ratio of 0.77.
Bonds have proven strong cushions for portfolio returns when risk assets fall behind. As mega themes such as AI, climate change, geopolitical tensions, rising populism and aging population lead to more uncertainty, the need for diversification and downside protection only increases. With yields now back at higher levels, bonds are again a viable tool for providing hallmark portfolio diversification.
Yet these are not the only scenarios under which 60/40 portfolios outperform. Over the last several months, inflation has continued to tick down, and the labor market has shown signs of loosening up. Major central banks are now close to ending their tightening cycles, and the U.S. Federal Reserve appears to have become more open to the prospect of easing—and at the very least stopping rate hikes.
Expected returns from bonds should be positive going forward, owing to meaningful positive yields in the absence of capital losses resulting from further yields increases.
Continuing economic resilience and a shift toward more accommodative policy should support returns on risky assets. Following recent market moves, yields have fallen more than equities have rallied, leading to an expansion of the so-called “equity risk premium” and improvement in relative valuations of equities versus bonds: equities have become cheaper.
Economic activity levels seem reasonable, consumer spending remains robust, real yields have eased and the upcoming rate-cutting cycle will likely lower the hurdle for companies and consumers to borrow to invest. If the soft-landing scenario materializes, investors can make money in both equities and fixed income; and if a recession happens rates should provide ballast to equity underperformance, with the tail of a sharp re-acceleration of inflation.
Despite all doubts, the 60/40 portfolio showed impressive resilience in 2023, up 16.5%—a year when investors paradoxically worried about both an over-heating economy and a recession, the market narrative then shifting to a debate around the likelihood of soft-landing versus recession.
Nobody has a crystal ball for 2024, but balanced portfolio construction will likely prove fruitful across a wide range of outcomes.
After a decade and a half of very easy monetary conditions, followed by more than a year and a half of aggressive global monetary policy tightening, the balance is back – the 60/40 portfolio from a rates and an equity risk premium perspective is starting at an attractive spot. This widely popular, time-proven, balanced investment strategy should again provide solid risk adjusted returns.
Alexandra Wilson-Elizondo is Co-Chief Investment Officer, Multi-Asset Solutions, Goldman Sachs Asset Management
