Investors might reconsider how they diversify their holdings beyond the traditional portfolio of 60% stocks and 40% bonds, as technological advances and other factors shift correlations between the two asset classes, Morgan Stanley suggested in a recent commentary.
The longstanding allocation strategy has been challenged since the COVID-19 pandemic, when bonds' low correlation to stocks, low volatility and steady returns reversed, limiting their ability to diversify portfolios, the firm noted. It cited a new split at the time between economic growth and inflation.
Meanwhile, the spread of generative artificial intelligence, renewable energy adoption and a geographically "multipolar world" continue to shift the correlation between bonds and stocks, forcing investors to rethink how to diversify their holdings, Morgan Stanley said.
"Concerns about the widely-used 60/40 strategy aren't unfounded, but they may be exaggerated," Serena Tang, Morgan Stanley's chief global cross-asset strategist, suggested in the piece. "That said, exactly how one thinks about the right mix of equities and bonds to achieve diversification with stability and good returns may need to change."
Factors supporting the 60/40 strategy stayed in place for decades before COVID prompted monetary policy responses, notably aggressive interest rate increases followed by rate hikes, that rocked longstanding correlations, the firm noted.
With the Federal Reserve expected to start cutting interest rates this year, the historic correlations between growth and inflation, and between stocks and bonds, will likely return, which might revive the 60-40 strategy for a while, according to Morgan Stanley.
"In the short term, the traditionally balanced portfolio of equities and bonds may make sense for investors," Tang said. "As long as bonds are less risky than stocks — and there's little in the data to suggest they won't be — bonds should continue to be good diversifiers in a portfolio mixing equities and fixed-income."
