Bonds are DEAD! Long live BONDS! 60/40 To Become 45/45/10?

I would like to take a moment and discuss bonds as a part of typical portfolio creation.

Much has been written about how low (US Treasury)rates are and that means they are of little value when hedging overall portfolio risks.

There has been much discussion in financial media lately whether or not the typical ‘diversified’ portfolio (60/40) is, in fact, dead. While NOT ‘proof positive’ the exact OPPOSITE is true, consider that RETURNS of  a typical 60% stocks (S&P) and 40% bonds (Bloomberg Barclays US Treasury Total Return index) averaged .75% since 1991. Last month (August) this portfolio returned 3.87%:

60 / 40 balanced portfolio returns
(CLICK HERE to enlarge image, source: Bloomberg)

A story from was brought to my attention yesterday. This story detaled thoughts from Ben Inker of GMO, one of the storied asset managers of our times. 

GMO Says Treasuries Have Lost Their Appeal in Zero-Rate World. 

Here is the Bloomberg STORY LINK and a couple of excerpts

…“There was a real charm to owning Treasuries bonds,” Inker, the firm’s head of asset allocation, said in an interview. “That insurance payoff in bad times was a pretty valuable thing. If it’s not there, you want to be looking to other parts of the fixed-income universe.”

…Low rates — which are likely to be around for years after the recent Federal Reserve policy change — mean that “taking more credit risk in return for higher yield I think makes sense,” Inker said in the interview.

COMMENT: I’d URGE you to read Inker/GMOs work DIRECTLY before rushing to judgment in the way a headline might suggest. Bonds are not dead but infact, becoming an even bigger part of the pie.

Said another way, perhaps typical 60/40 group think is to become 45/45/10, where both stocks and bonds are equally weighted and 10% kicker is high yield.

READ GMOs Quarterly Letter directly here, via THIS LINK

A couple things jumped out.

…But how about a way to get some income and some depression protection for your portfolio? Somewhat paradoxically, risky bonds might help on both fronts. Today, high yield corporate bonds and emerging country debt are both trading at wider than normal spreads over U.S. Treasuries. Both asset classes clearly have plenty of downside risk in the kind of environment when equities are likely to fall, but they are almost certain to fall significantly less than equities in really bad economic scenarios. Taking 10% out of stocks and moving it into risky debt won’t reduce portfolio downside by that full increment, but if we were to assume the downside for those risky debt assets in the bad scenarios was going to be half as bad as for equities, it is very plausible that a 45% stock/10% risky debt/45% government debt combination would be a better blend than 50% stocks/50% government bonds,15 providing more income and no worse expected returns in a depression scenario

All EMPHASIS mine.

Inker/GMO are not alone in rethinking allocations. The latest from WisdomTree’s Kevin Flanagan offers a similar line of thinking in HIS most recent blog post.

Fed’s Gonna Let the Economy Run ‘Hot, Hot, Hot’

…How Should Fixed Income Investors Position Their Portfolios?

  1. Fixed income investors should consider: a) utilizing short duration strategies within their portfolio; and b) focusing on Treasury floating rate notes (FRNs) instead of TIPS (real yields, aka TIPS yields, can still rise)

  2. Position credit over rates in model portfolios with a more specific focus on core-plus solutions. This would include a high-yield sleeve that focuses on quality, which could potentially benefit from this “new” monetary policy approach.

Again, all EMPHASIS mine. These two are both suggesting the same thing — increasing exposure to RISK in some way that you are comfortable doing.

Most important of all is something ELSE Inker/GMO said.

…So, what should a thoughtful investor do? First, I think it would be an excellent idea to sit down with your fixed income portfolio managers and make sure you and they are on the same page as to what the portfolios they are managing on your behalf are trying to achieve given the new environment and what a realistic return expectation for the portfolio is…

It is with that, as well as LOW RATES for a very long time into the future, in mind, I’d highly recommend a check-in with YOUR Etico advisor! 

Steven J. Feiss

Managing Director, Fixed Income

Etico Partners, LLC

1795 Rout 9 Clifton Park, NY 12065

Office: (732) 683-9222
Mobile: (914) 450-9668

Meet the Author

Financial markets veteran with more than three decades of experience working with high profile, domestic and international asset managers and trading desks, producing customized and actionable solutions for strategic alpha generation and risk mitigation. Author of a unique daily (6x per week) cross-asset macro market commentary (the BondBeat) to inform and assist INSTITUTIONAL FIXED INCOME investors and trading desks.