Rethinking the 60/40 Portfolio

Nic Millikan CFA, CAIA

The simplicity and time-tested effectiveness of the 60% equity/40% fixed-income portfolio allocation mix have been key reasons for its endurance. But times change. With market conditions in the foreseeable future unlikely to produce results that made the mix so successful in the past, this may be the right time to consider a modified approach to portfolio allocation. To look at new ways to reach clients’ investment goals, InvestmentNews Create recently sat down with Nic Millikan, Managing Director and Head of Investment Strategy at CAIS, the alternative investments platform. The discussion, edited for length and clarity, follows.

InvestmentNews Create: Before we discuss why revisiting the traditional 60/40 asset allocation mix may make sense, explain why it has proven popular and useful for so long.

Nic Millikan: The short answer is that, for much of the population it has worked. From March 2009 through the start of the recent stock market volatility, a 60/40 portfolio has returned 11.1% a year, on average, with a standard deviation of 8.4% and a Sharpe ratio of 1.27%. That can be really attractive on a risk adjusted basis, so it’s no wonder that the performance and relative simplicity of the 60/40 portfolio has helped endear it to investors. But the recent past has offered an almost perfect set of conditions in that equities were rising at the same time that bond prices were rising. So investors not only benefitted from bonds providing a safety cushion, they also provided a boost to performance. But interest rates now have gone as low as they can hypothetically go and equities appear to be fully priced, so the party that has lasted for 13 years has likely ended. Unfortunately, many investors may not realize that.

InvestmentNews Create: How should investors and their advisors adjust their thinking?

Nic Millikan: First, it’s important to recognize that changing one’s approach isn’t easy, especially since equities loom so large on the minds of investors. They see news and commentary about stocks on TV and talk about stocks with friends. And since we’ve been in a strong bull market, despite dips, for 13 years, many investors have greater confidence in their own stock-picking ability; others have concluded that professional active management provides little added value. As for bonds, the inverse relationship of yield and price may confuse investors.

Despite the challenge of investors’ current mindset, it’s important to note that banks and asset managers have lowered their assumptions about future equity returns and foresee slightly higher interest rates as well. That translates into an investment environment that is likely to be different in coming years, meaning this is a good time to reassess the 60/40 portfolio and look into the use of alternative investments, whose performance is not typically dependent on the direction of markets.

InvestmentNews Create: Why should an advisor consider adjusting an asset allocation strategy to include alternative investments?

Nic Millikan: Alternatives provide an opportunity to look at a wider opportunity set. The investments that come under the alternatives umbrella have varied characteristics and are actively managed, which may help overcome headwinds. What’s more, some alternative strategies and vehicles — like long-short investing or venture capital, for example — don’t need equity markets to go higher in order to be successful. They can often zig when the market zags.

InvestmentNews Create: What are some of the key considerations when investing in alternatives?

Nic Millikan: The biggest issue is suitability; do alternatives fit an investor’s profile? The degree to which an investor is willing to forego some liquidity for the potential of higher returns is likely to be a consideration since some alternative investments, such as private equity, have holding periods that may be eight to ten years in length, while others, such as hedge funds, may require only a one- to two-year commitment. In addition, performance dispersion among alternative asset managers is generally several times greater than among managers of traditional mutual funds for example. Manager selection, therefore, can be very important, and since there tends to be some persistence of return among alternatives managers, due diligence to identify the skills that persist is very important.

InvestmentNews Create: How should advisors frame the conversation about alternative investments with their clients?

Nic Millikan: I would start by saying that allocations that worked in past may not work in the future, and ultimately may turn out to have been riskier than adjusting a portfolio to contain assets where performance is not correlated to the movement of markets. Fortunately, because of technological developments, there are now new tools that advisors can use to access a wide range of alternative asset classes and strategies. What’s more, these alternative choices have become democratized in recent years as a result of innovation and are more accessible to a wider range of investors than ever before.

InvestmentNews Create: How can advisors find the tools they need to support their clients in exploring an alternatives strategy?

Nic Millikan: Advisors need an easy-to-access resource. At CAIS, we specialize in providing advisors with the resources, tools and education they can use to help their clients maximize the value of alternative investing. Knowing what to say and how to say it, advisors can have the confidence they need to prepare their clients for the different market environment that lies ahead.

The post Rethinking the 60/40 Portfolio appeared first on InvestmentNews.

Andrew is half-human, half-gamer. He’s also a science fiction author writing for BleeBot.

Andrew Vincent
Andrew is half-human, half-gamer. He's also a science fiction author writing for BleeBot.
%d bloggers like this: