Debating the Traditional 60%/40% Portfolio Amid Market Uncertainty

The “60/40 portfolio” has stood the test of time for a moderate risk investor – a 60% allocation to equities with the intention of providing capital appreciation and a 40% allocation to fixed income to potentially offer income and risk mitigation.   

The strategy has performed extremely well over the past two decades as stock prices have risen in a near-straight line and interest rates have fallen to record lows. It’s been viewed as an asset allocation where financial advisors can rest more comfortably, and clients feel their assets are protected in volatile markets.   

But with equity markets entering a bear market in the first half of the year and interest rates moving sharply higher, many market participants have debated whether the 60%/40% allocation is whistling by the graveyard. The Bloomberg Aggregate Bond Index dropped more than 10% during the same period as the equity markets tumbled, making this the worst environment for the 60/40 split since the 1930s. 

Enter Alternative Investments. For many years, the sector was viewed as risky given their lower liquidity, less regulation, lower transparency, higher fees, and limited and potentially problematic historical risk and return data.  

But more advisors are now diversifying their clients’ assets into Alternatives, whether its private equity, private credit, real estate or venture capital, as a hedge against the recent volatility in the equities and fixed income markets. 

In a recent report by KKR titled “Regime Change: The Benefits of Private Credit in the ‘Traditional’ Portfolio,” co-authored by Henry H. McVey, CIO, the global investment manager of multiple alternative asset classes noted that “in the new macroeconomic regime we have entered, the positive correlation between stocks and bonds will likely be problematic over the long-term for the traditional 60/40 portfolio.” 

The KKR team advocates a “40/30/30” framework of equities, bonds and alternative assets. “Within the 30% ‘alternatives sleeve’ of that portfolio, we now have even higher conviction that allocators of capital can reap benefits by shifting to 10% private credit.” 

Perhaps the case for active management and the need for diversification has never been stronger as it tends to produce lower correlations, lower volatility and historically, if you look at certain periods, higher returns.