In the last hundred years, from 1915 to 2014, the classic 60/40 portfolio (60% equities/40% bonds) has generated 8.4% per year. That return can be broken down into 10.3% on equities and 5.6% on bonds. A period of that length obviously has its ups and downs, but despite the myriad crises over the last few decades, the figures for the last 50 and even the last 25 years are better still.
The performance of this simple strategy is not just good; it has also been consistent over time. It is then tempting to conclude that the 60/40 portfolio is both time- and crisis-proof and that investors should stick with it. The recent turbulent period is also concrete evidence of this, with a robust return of 7.2% over the last ten years. Quite an achievement in a decade marred by the global financial crisis, the Great Recession, record unemployment in many countries and sluggish economic growth.
According to Research Affiliates, since 2004 the 60/40 portfolio has beaten 9 of the 16 major asset classes. This implicitly demonstrates that it's not easy to improve the success formula by adding an extra performance-enhancing asset.
“60/40 shows that you do not always have to take drastic steps to achieve attractive returns,” admits Jeroen Blokland, Senior Portfolio Manager of Investment Solutions. “But many of those other assets do not have 100-year track records.” And there is one further observation, of course. “The performance says nothing about the risk-return profile. Adding some other assets to the 60/40 would probably have added little in terms of performance but may well have reduced the level of risk."
Nor is 100 years of history any guarantee for the future. The period between 1965 and 1974 was a difficult one for the 60/40 strategy, which generated a nominal annual return of 2.3%. And after adjusting for inflation the return was actually negative. That poor return was related to the high equity valuations and low bond yields at the beginning of the period. And now, in 2015, equity valuations are even higher and bond yields are even lower than they were in 1965. This could lead to an new era of low returns and Research Affiliates have given a figure for this. According to their models, the expected return for the 60/40 portfolio over the next ten years is a meager 1.2% per year.
More active – or smarter
The decision for investors now is whether to accept this or to actively adjust their portfolios. ‘Actively’ in this context does not just mean searching for 'the new Apple', emphasizes Blokland. “At asset-allocation level, you can shift to a larger weight in equities and less in bonds or to actively managed allocation funds. But within the parameters of the 60/40 strategy you can also search for strategies that have historically outperformed the broader market, without actually departing from the 60/40 split."
According to Blokland, this brings you to factor plays – such as low volatility, value and momentum – that have a track record of generating extra returns and can be applied to both equities and bonds. “Not that this will suddenly turn the 1.2% return into 8%, but it may well help you generate an extra percent without increasing your portfolio's level of risk.”
It is clear that investors who have been able to rely on the good old 60/40 strategy for years will now have to do something to ensure that their capital increases. The era of sitting back, relaxing and generating returns of 8% is coming to an end. Action is required – action in the form of active management.