Investors Risk Making a Classic Portfolio Mistake – ValueWalk Premium
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Investors Risk Making a Classic Portfolio Mistake

BlackRock Inc., the world’s largest asset manager, suggests investors should abandon portfolios made up of 60% stocks and 40% bonds, a mix that has been a standard for six decades. This comes after the worst year for so-called 60/40 portfolios on an inflation-adjusted performance since the Great Depression. Moreover, in only one of the seven years since 2015 did either of the two asset classes offset losses in the other, and that was in the upside-down year of 2020 when a global pandemic struck.

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There are a lot of moving parts in asset allocation, so it’s important to be clear about the issue. It’s not the precise numbers 60 and 40, as many investors use 50/50, 70/30 or other ratios. The point is to use fixed long-term allocations for stocks and bonds as benchmarks. That doesn’t mean other asset classes cannot be used for diversification, but they will be evaluated based on their correlation with 60/40, and their allocations will change depending on market conditions. And investors need not be wedded to the core allocation, as tactical adjustments might be made to the proportions. But performance will be judged relative to the 60/40 benchmark.

There are two main alternatives to 60/40. One is to use equities as a benchmark and treat bonds as just another asset class for diversification — like commodities, real estate, venture capital, alternative strategies and private investments. The other is to jettison the idea of a core portfolio and allocate assets based on some other principle, such as risk parity, Black-Litterman or Markowitz optimization.

A major flaw in the BlackRock analysis is to ignore valuation. Based on cyclically adjusted price-to-earnings, or CAPE, ratios for stocks, and interest rates for bonds, the attractiveness of 60/40 has been falling steadily since 2008. At the beginning of 2022, 60/40 investors were facing an exceptionally high 38.3 CAPE for the S&P 500 Index and a low 1.4% yield for 10-year Treasury notes. Actual inflation was 7%, but the market was pricing in future inflation of just 2.5%. When you buy expensive stocks and low-yielding bonds in a high-inflation environment, you can’t be completely surprised by a bad result.

Today, CAPE has fallen to a more moderate level of 28 and the 10-year Treasury yield is up to 3.5%. Inflation has slowed only slightly, to 6.5%, but the Federal Reserve seems much more determined to get it under control than in the beginning of 2022. Investors who flee 60/40 based on a bad 2022 may be making the classic mistake of selling at the bottom. It’s still less attractive than historically, but it’s expected real return is considerably higher than it was for 2022.

Read the full article here by  , Advisor Perspectives.

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