Is it time to switch gears? (Part 1)

Speaker 1 (00:08): Hi everyone, and thanks for joining us for your Thriving Practice. I'm your host, Dan Corcoran.

Speaker 1 (00:15): Today we're kicking off a new series focusing on the 60/40 portfolio mix. Over the next four episodes, we'll examine the future of this long-revered investment strategy after an especially dismal 2022, how adding an annuity or real estate investment trust to the mix could provide stability. And lastly, will provide suggestions for financial professionals who may be having conversations with their clients, looking for more certainty in their portfolio. There's a lot to get to, so let's jump right in. My guests today are Matt Estes, a managing director and senior product strategist for the Global Allocation Portfolio at BlackRock, a multinational investment company. And Charles Rotblut, who is a vice president at the American Association of Individual Investors, as well as editor of their AAII Journal. Gentlemen, thanks so much for joining me today.

Speaker 2 (01:07): Hey Dan, thank you for having me.

Speaker 1 (01:08): Thanks for having me Dan. So let's examine the recent volatility surrounding 60 40. Up until last year, a traditional portfolio mix of 60% stocks and 40% bonds would satisfy most investors. As we saw equity soar to new heights and interest rates plunge to new lows. However, the tables turned in 2022 and the 60 40 strategy suffered one of its worst years in history. So Matt, why had the 60 40 strategy worked so well for decades and what happened in 2022?

Speaker 2 (01:41): Sure. I think that's a pretty fair assessment of what took place last year. You know, I think what's worth calling out is that balanced or 60/40 portfolios really did serve as an effective kind of foundational portfolio for many clients for a number of years. I think if you went back all the way to 1929, what you find is there were only like three calendar years where bonds didn't go up, when stocks went down. And that was 1931 when Britain was forced to abandon the gold standard, 1941 when the US announced they were entering World War II. So those were pretty unique examples. And then if you look back to kind of 1969, 1970, that's probably more akin to some of the issues that we saw in calendar year 2022. And you know, what I would say was emblematic of then and, and last year in 22 was that you had ultra loose monetary supply, you had a generous amount of fiscal support that was, you know, kind of pumped into the economy and you had some energy supply disruptions.

Speaker 2 (02:44): So I guess a simple way to frame this up is to say that historically bonds have worked as an effective hedge when the risk to the market was some sort of an economic contraction. Bonds generally don't serve so well or are not as an effective hedge when the risk to the market is an overly aggressive Fed. And one of the things my boss likes to say is that the markets can only focus on sort of one risk at a time, or what we say the shark that's closest to the boat and the shark that was closest to the boat last year was really an aggressive Fed. So bonds didn't provide that traditional hedging characteristic like we've seen in the past. But again, I think it was largely predicated on this view that inflation was a lot higher than, than most had expected. And, and the Fed was really aggressive in trying to tamp that down. It's

Speaker 1 (03:32): Really good that you give us that context, that timeline. It's very helpful. Well, let's talk about flexibility for a moment. What makes a portfolio more flexible and nimble?

Speaker 2 (03:42): Yeah, so when we talk about 60/40 portfolios, what I would say is I think that today you want portfolios that number one can be a bit more flexible and more nimble. And number two, what I mean by that is you want an ability to adjust. And if we think back over time, we just went through a really unique period in financial markets, right? It, it's sort of a period that we at BlackRock characterized as the great moderation and it was largely characterized by low levels of volatility, stable growth, and generally low and stable inflation. And what I would tell you is if you look back at the period from post 2008 post global financial crisis up until 2019, a sort of set it and forget it portfolio worked quite well. Meaning you could have simply selected 60% in the S&P 500 and 40% in the Barclays AG and you had a pretty good return.

Speaker 2 (04:38): The reason why I think you want portfolios that can be more flexible and more nimble and an ability to adjust your exposures is because that environment I think is largely behind us, right? The period of central banks coming to the rescue isn't taking place anymore. We're not in an environment where inflation is sitting at 1.7%. You're seeing supply chains that are being redrawn and I think we're facing more elevated levels of geopolitical risk. So all these things warrant portfolios that again, can change the composition of what they're holding and have an ability to do that and react to different market and economic conditions.

Speaker 1 (05:16): So with all that being said, where do you see the 60/40 portfolio approach going in the future?

Speaker 2 (05:21): I would say, you know that that ability to be more flexible and adjust your portfolio allocations is gonna be really important. So let me try to paint a simple example. If you're running a portfolio that's 60% in stocks, but let's say the composition of that stocks is largely utilities, REITs and staples, that portfolio is going to behave very differently than one that's comprised of energy, financials, and materials. So you wanna make sure that what you are holding in that say equity allocation is consistent with your view of the market, right? There might be times when you are leaning into value times when you are leaning into growth. There might be other periods where you're maybe trying to express a view on quality or something like GARP (growth at a reasonable price). The other thing I would say is we did go through this period where the S&P 500 had outperformed just about all of your other major equity market indices, again during that period from ’08 to 2019.

Speaker 2 (06:15): And I think that if we move into an environment where the dollar is no longer appreciating at that torrid pace that we saw from 2001 and 2022, if we move into an environment where perhaps the dollar has leveled off, it's no longer appreciating that historically has been a pretty favorable time to hold some non-U.S. asset classes. So I would put that in the camp of both equity and fixed income. And then the last thing I would say is that I think alternatives play an important role on a go forward basis in your 60/40 portfolio. Now I get it, alts can mean a lot of different things to different people, but a few examples might include, think of something like a long/short strategy where you're going long one security and short the other and trying to take advantage of some of that dispersion in the market.

Speaker 2 (07:04): I think volatility is another interesting asset class. You can use trading strategies where maybe you are selling a put generating some income and then taking that premium to buy some longer dated calls and build convex in your portfolio without having to have kind of delta one equity volatility or the ability to use covered call writing as a way to generate income. You know, I would also say systematic strategies I think can play an important role in portfolio construction. There's an awful lot of real-time data that exists today that we didn't have access to a decade or so ago. And then finally, I would say private markets on both private credit and private equity. You know, a lot of traditional financing has dried up and the ability to invest in both private equity and private credit and take advantage of some of that illiquidity premium I think can also play an important role in portfolio construction.

Speaker 1 (08:03): And Charles, we're listening to Matt here, but what are your thoughts on where the 60 40 strategy was, where it is now and where it's headed?

Speaker 3 (08:11): Yeah, as Matt pointed out over the long term, it's worked really well. I always like to use an analogy that's the Subaru of portfolio allocations, meaning that you're not going to necessarily impress anybody at a cocktail party unless maybe you're in a ski area. But it's been very reliable, it works really well and it holds up better than a lot of other portfolio allocations. But we've always thought ai, AI, that people should diversify from simply holding large cap stocks and long-term bonds. And you know, Matt gave some ideas and you know, if you wanna be tactical, I think they're worth listening to you. But if you don't wanna be tactical and you just want to have more of a long-term position, even then I think you do need to think about diversifying both on the bond side and on the stock side. On the stock side.

Speaker 3 (08:57): Certainly when you look at where large caps are valued relative to small caps and where growth is valued relative to value, there's certainly opportunities just to tilt your portfolio. Maybe more small cap include more value in our asset asset allocation models. We do include, uh, international securities as well. I think those do provide diversification for investors. But then on the bond side, you don't have to go long lonely bonds, someone who's individual investor or perhaps you're a larger investor and you know you'll need some cash flows coming out of the portfolio thinking about mixing up that bond allocation. Maybe you, you ladder your bond maturity so they mature different dates. Maybe you hold some intermediate term and shorter term bonds with yields going up. Obviously long-term bonds look a little bit more attractive now than they did a year ago, a year and a half ago when interest rates were so low.

Speaker 3 (09:49): But you still get pretty similar returns if you do intermediate term, maybe not quite as much yield, but also a little bit less volatility because your duration's a little bit shorter. But then I think at the shorter end, thinking about, you know, getting short term bonds are, are certainly if you wanna be tactical right now, you can lock in two or three month treasury bills for paying literally over four close to 5% interest. So right now, there's certainly an opportunity to lock those in. But I do think people need to be a little creative on both sides and even if they are taking a long-term allocation, realize it's not just the S&P 500, it's not just long-term bonds. You do have a wide range of choices regardless if you're an individual investor or if you're an institutional investor.

Speaker 1 (10:36): And Matt, I see you nodding your head to what Charles is saying.

Speaker 2 (10:39): Yeah, you know, I think Charles makes a great point because there was a period of time for the past few years where people believe that the 60/40 portfolios were, were more or less dead because the 40% of the portfolio wasn't really providing any meaningful income. I think we're getting closer to bonds, again, serving as that more efficient hedge and you're generating a much more attractive level of carry, you know, whether that be in areas like credit, both investment grade, high yield, or even thinking about some pockets of emerging market debt were appropriate for clients.

Speaker 1 (11:11): Okay. So Charles,

Speaker 3 (11:12): What should people consider when they think about long-term versus short-term?

Speaker 3 (11:16): Yeah, I think it really comes down to when do you need to pull cash out of your portfolio. If you're thinking it's really about capital preservation, not exposing the money you need to withdraw to market volatility. But if it's long term, then you really need to think about capital appreciation. And the way we always describe it to people, particularly our members who are individual investors, is over the short term, your big risk is market volatility. But over the long term, your big risk is inflation and you really need your savings to grow faster than the rate of inflation over the long term. And certainly if you have a big goal, say it's retirement or something else, it's not just a matter of having it preserve your purchasing power, meaning your ability to buy goods and services, but also to really just grow in absolute terms.

Speaker 3 (12:04): So you can't have more money to live on than you do. Now, obviously when you put a dollar aside for savings in the future, you want that dollar to be worth more, and that means accepting short-term volatility, not reacting to it, to have that long-term growth. And I think where a lot of people get tripped up is they get overly focused on the short-term with the market movements, not thinking about what is the timing? When do I need this money? Is it money that I'm gonna need in 20 years, 30 years, or is it money? Perhaps I'm looking to pass along? Perhaps if you're an individual, you're thinking endowments, you're thinking charities. Obviously if you're a pension or your endowment, then you obviously don't have an end date and you're thinking about having that money go on really hopefully for decades to come.

Speaker 1 (12:50): Matt, do you agree with Charles's thinking on long term versus short term?

Speaker 2 (12:50): Uh, I do. I think it's important to have maybe a longer term strategic view and then perhaps on the margin you might want to be a little bit more tactical to, again, a adjust to different market conditions. But you know, one of the things that we really try to underscore, it's less about timing the market and really more about time in the market. And, and one of the things that I think serves so many clients, so many individual investors so well, is that if you can embrace strategies that are less volatile and you can smooth out the ride, you can try to overcome some of that investor behavior, that psychological behavior where clients or investors want to capitulate at the market bottom. So again, keeping people on track with perhaps strategies that are less volatile, uh, I think is often the key to success.

Speaker 1 (13:39): Charles your thoughts.

Speaker 3 (13:39): Yeah, it's, I'm actually nodding my head because when I talk about portfolio strategies, one of the first slides I show is that the optimal strategy is always the one you can stick with no matter what the market's doing. And for some people that's full equities, gimme small cap value, I wanna accept the risk, but for other people, they really need to tone down that volatility. And for a lot of individuals, their biggest risk is really behavioral, not the markets that really that sense. I don't like what's going on. I don't like the headlines I'm gonna pull out of the market and wait for things to get better. Unfortunately, when they do that, and we've seen from various studies, they wait for everything to be a lot better and they miss that big rebound. So for a lot of people, if they are nervous, accepting a lower rate of return might actually end up resulting in greater wealth simply because you're able to stick to it.

Speaker 3 (14:32): And a great analogy is that if you try to diet and you fall a diet that's really too strict, you're gonna abandon that diet. But if you have a diet that perhaps allow you to have that, you know, nice ice cream sundae, you know, once in a while you probably will be better able to stick to that diet because you have that little bit of ability to channel your emotions or at least a little leeway to sin a little bit, but not so much that you're abandoning your long-term strategy or in this case your diet. To stick with the analogy,

Speaker 1 (15:01): Charles, given what happened last year, if we were talking to you two years ago, would you have said that 60 40 is fine as it is?

Speaker 3 (15:09): Yeah, I would've, and I actually, my position on it has not changed yet. Two year, three years ago I was talking about the, the same things I am now. It's a good strategy. It's actually held up better than most allocation strategies are the strategies that have outperformed it. Absolutely. But when you look by and large, it's been a very simple but very good strategy. But even then I was telling people, diversifying both sides, diversifying the equity side, diversifying the bond side. You don't have to have it just be two simple asset classes, long-term bonds and large cap stocks. You could diversify in both sides. And I still think that continues to apply. And I think too often people view asset allocation strategies based on their short term performance without realizing that asset allocation strategies are meant to be work over the long term and they're meant to be measured over the long term. I mean, and that doesn't matter and it doesn't change if you're following a very buy and whole type strategy. If you're following a tactical strategy at any given year, on any given month, any strategy can really be terrible. But over long-term you start to see that performance and it comes down to really that long-term investing as a marathon, not a sprint. And you need to realize that some miles are gonna be really tough and other miles are gonna go by pretty quickly.

Speaker 1 (16:26): Matt, what do you think?

Speaker 2 (16:27): Yeah, I might have a little bit of a different view here. You know, I would tell you the, the portfolios that I work on, you know, two years ago I would tell you we were, we were more comfortable being a little bit overweight stock, so we were actually carrying a little bit more than the traditional 60%. And I'll be honest, we were very underweight bonds. Again, back to my point about real yields were negative throughout many of the world's sovereign bond markets, we just felt like we were carrying a, a higher balance in cash. The other thing I would say is we were really trying to minimize duration in our portfolio. And in fact, at some points we were actually short duration. The other thing I would say is two years ago we were carrying a pretty large overweight to the U.S. dollar. I'd say our view has probably changed there and, and we'd prefer to be underweight the USD, so you know, by and large, yeah, we still believe in the overall portfolio construct, but I think there's probably some tweaks and, and some expressions that have evolved over the last two years given the massive rate hiking cycle that we've been going through.

Speaker 1 (17:28): So Matt, how should a financial professional advise somebody who is still a bit nervous about their 60/40 allocation and wants to add some stability?

Speaker 2 (17:37): Yeah, well, you know, again, I do think calendar year 2022 was fairly unusual. Again, we did go through a very rapid rate hiking cycle. Our base case is that that's not the environment that we're like to experience over the next few years. We're, we're sort of the mindset that we're probably at the last dead rate hike, at least for this cycle. I mean, look, there's always a chance you could get more, but the base case is we're probably coming to the end of that cycle. And to the extent that we move into an environment where at some point the Fed will start cutting rates again, I wouldn't anticipate a backdrop like we saw in calendar year 2022. So again, bottom line, I think bonds every day are getting closer to returning back to that traditional role that they've provided as being a hedge in portfolios. And look, I get it the last time we saw that dislocation between stocks and bonds where they both moved in the same direction, it was almost 50 years ago. So for a lot of people that did feel very unusual, but I don't think that history necessarily repeats itself in the short to intermediate term. So I do think 60/40 is still a very viable allocation for many clients. And I would say that, you know, don't be too focused on the sort of the, the near-term history and let that influence your longer-term goals. So,

Speaker 1 (18:53): Charles was last year just a blip in terms of the viability of 60

Speaker 3 (18:56): 40? You know, I think it was a blip. It doesn't mean that we can't see another blip in the future either. Uh, you know, the market has a way of rhyming history. It doesn't necessarily repeat, but obviously there are scenarios where you could see something's happening involving war, commodity shortages, storms that could suddenly cause a spike in an inflation. But I do think overall, when you look at long-term history, you do have those blips in 60/40. And what we saw last year, it was a little unusual. As I said, probably as Matt alluded to earlier, what we saw in the late sixties. But having all those events happen at once in the pandemic, a war, the reopening, all that at once was certainly an unusual set of factors. But I do think people need to view it as a blip and understand that it wasn't a sea change.

Speaker 3 (19:44): And we've always heard these arguments, well, this time's different. And then you always have that mean reversion where you see things turning back to their historical norms. But I do think people also need to realize when you look at bonds, we're not in a case where we were at say 1980s where we had Paul Volker jacking up interest rates and you had double digit yields on bonds If yield should pull back, and right now you are seeing traders price and perhaps a rate cut occurring possibly in the fall. And those odds, I do wanna say are very much subject to change. You're talking about coming off of a much lower base for interest rates. So you're not gonna have this huge tailwind behind bonds. But it doesn't mean that bonds can't serve as an effective hedge. It doesn't mean that perhaps short-term bonds can't work well for preserving short-term cash flows or that you can't get by perhaps laddering bonds. So you're spread your maturities. There's still things that can happen, but I think people have to realize that although 60/40 is gonna hold up some of the drivers that had say from 1980 to say 2020, you won't have that huge tailwind on the bond side anymore.

Speaker 1 (20:46): Thank you so much for being here with those insights, Matt and Charles, and for our listeners, that concludes part one of this conversation. You can tune in to part two of this episode for more on staying the course or shifting gears on the 60/40 portfolio. To listen to additional podcast episodes, you can find us on Apple, Spotify, and Google Podcasts or at yourthrivingpractice.com. I'm Dan Corcoran. Thanks so much for listening.

Speaker 4 (21:22): The opinions, beliefs, and viewpoints expressed by the guests on this podcast do not necessarily reflect the opinions, beliefs, and viewpoints of Global Atlantic Financial Group. Global Atlantic Financial Group, global Atlantic is the marketing name for the Global Atlantic Financial Group LLC and its subsidiaries including for forethought Life Insurance Company and Accordia Life and Annuity Company. Each subsidiary is responsible for its own financial and contractual obligations. These subsidiaries are not authorized to do business in New York.