The 60/40 Portfolio Isn't Dead. But Is It Enough?

For many years, the 60/40 portfolio has been an investment strategy that many clients followed for a balanced, diversified asset allocation. If not the gold standard, the combination of 60% stocks and 40% bonds was considered to be a solid starting point for a balance of risk and return.

Whether 60/40 or some other mix of stocks and bonds, some advisors and analysts have expressed concern that an allocation featuring only stocks and bonds may not provide the diversification that investors need in today’s market environment.

Changing Benefit of Bonds

During down periods in the stock market in the first 20 years of this century, bonds generally performed as expected. Those periods include the tech bubble and the ensuing downturn; the Sept. 11, 2001, attacks; and the significant drop in 2008 surrounding the financial crisis.

The relationship has seemed to change in recent years, however. In 2022, the S&P 500 dropped over 18% for the year while the Bloomberg U.S. Aggregate bond index declined over 13% for the year. This positive correlation held true in 2023 with both indexes recording gains for the full year.

To many, it looks like this trend of higher correlation may continue in 2024, with the Federal Reserve’s cut of 50 basis points and stocks having another good year.

Using Alternatives to Diversify

Advisors to ultra-high-net-worth clients and institutions have been using alternatives in their clients’ portfolios for some time, especially with the advent of liquid alt options in recent years.

The reasons and methodologies vary among advisors, but alternatives offer a level of portfolio diversification beyond simply balancing the allocation of stocks and bonds. A 2023 survey by Mercer indicated that 62% of the advisors surveyed were allocating between 6% and 25% of their clients’ portfolios to alternative assets of at least one type.

Here are highlights of some of the popular alternatives being used by advisors.

• Private equity investments offer opportunities to invest in companies outside the public equities market. This can allow investors to get in on up-and-coming companies during their initial growth stage and before going public.
• Private credit offers the opportunity for higher returns than the traditional fixed income markets. Private borrowers may be riskier on an individual basis, but this risk can be mitigated by investing through a fund.
• Real estate and some other types of real assets offer the opportunity for growth and protection from inflation.
• Digital assets including cryptocurrencies offer the potential for growth and inflation protection to investors willing to speculate in this class.
• Commodities offer protection against inflation and diversification relative to equities and bonds.

What Alternatives Offer

Alternatives offer several types of portfolio enhancement opportunities.

Diversification: Some alternatives offer relatively low correlations to other assets in the portfolio. These alternatives will help to counteract down periods for stocks and bonds and smooth out returns over time.

Some alternatives offer solid returns that may outperform equities over time. But these high potential returns may come with a high correlation to equities so they don’t offer a high level of diversification. A better option might be to look for alternatives that offer decent returns with a lower correlation to equities, bonds or both.

Durable and consistent returns: Like any investment strategy, an alternative investment should have a consistent and durable record of returns. It’s important to have a good understanding of how this investment is going to perform in different market and economic environments. The fewer surprises the better.

Defensive: Many alternatives act as a defensive component of a client’s portfolio. This is often through relatively low correlation to stocks, bonds or both. The timing of returns from the alternative will often differ from that of stocks or bonds, thus providing a more consistent level of overall portfolio returns.

Alternative ETFs and Mutual Funds

Investing in alternatives has become easier for advisors whose clients are not accredited investors or qualified purchasers. The rise of mutual funds and exchange-traded funds that invest in alternative assets and strategies has made investing in alternatives accessible for more average investors.

An example is the introduction of spot bitcoin ETFs in early 2024. These ETFs offer a convenient, low-cost and liquid way to invest in bitcoin.

Mutual funds and ETFs investing in alternatives are known as liquid alts. On the one hand, the availability of liquid alts allows advisors and their clients greater access to many more alternative investments.

On the other hand, advisors need to look at how these liquid alts might differ from investing into these alternatives in a more direct way, including whether the added liquidity diminishes the performance or diversification value of the underlying alternative. Liquid alt funds often have higher expense ratios compared with other types of mutual funds and ETFs.

Wither the 60/40 Portfolio?

This is in no way to suggest that the 60/40 or other iterations of a balanced portfolio focused on stocks and bonds is dead. Rather, the use of alternatives serves to enhance the allocation in most cases.

The addition of alternatives may act as a part of the stock or bond allocation. Or perhaps the 60/40 might become a 55/35/10 allocation or something similar. Advisors who want to harvest the potential upside of a balanced portfolio while mitigating the downside will often use alternatives to enhance the portfolio and to give their clients a better shot at achieving the original objectives of the balanced portfolio.