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The 60/40 Portfolio Is Alive and Well

Is the 60/40 stock-bond portfolio dead? We don’t think so.

An edited version of this blog was originally published in the Financial Times on 22 December 2020.

In a year when investors questioned whether a traditional mix of stocks and bonds, the so-called 60/40 portfolio, is obsolete, the closely watched benchmark1 for the strategy delivered 11% returns as of 15 December. This follows three decades of annualized returns of 7.6%, despite ever-falling interest rates and concern that the secular bull market for interest rates was over. The new year will inevitability bring new concerns for bonds, and the question remains whether 60/40 portfolios can continue to deliver a fitting return for investors, and more specifically whether bonds offer an effective complement to riskier asset classes, like equities.

Returns over the secular horizon may be harder to achieve, but bonds will still play a very important role in portfolios. Indeed, bonds have offered diversification and volatility suppression (see Figure 1) in multiple-asset portfolios, which could be especially beneficial in the years ahead as a bumpy recovery and secular shifts in the global economy create much greater volatility than the market has experienced over the last decade.

Figure 1: All-stock portfolios tend to have higher volatility than stocks and bonds together

Figure 1 is a line chart comparing rolling three-year realized volatility of an all-stock portfolio with that of a 60% stocks / 40% equities portfolio over the time frame 1995–2020 (index proxies for both portfolios are listed below the chart). Though both portfolios saw increases in volatility during periods of market stress, such as after the global financial crisis and the onset of the COVID-19 pandemic, the all-stock portfolio consistently demonstrated higher realized volatility over the time frame, peaking at 25% in 2010, when the 60/40 portfolio reached 15% realized volatility. As of 30 November 2020, the all-stock portfolio had volatility of 18%, and the 60/40 portfolio had volatility of 11%. Additional takeaways from Figure 1 are discussed in the main text.

Traditionally, investing in fixed income assets, like U.S. Treasuries, offered the dual benefit of yield enhancement as well as diversification for those investing in multiple assets. The fixed, reliable yield of U.S. Treasuries has averaged 4% over the past three decades, which has complemented the total return of multi-asset portfolios. In fact, 2.3% of the return from the above 60/40 multi-asset portfolio over the past 30 years has come from fixed income. This return carried little risk of capital loss, providing investors with exposure to some stability during periods of volatility in riskier portions of the portfolio.

This historic hedging property of fixed income has helped make the 60/40 portfolio popular. While equities over the past three decades have returned 8.8% per year, volatility2 of the asset class has been high – 15%, with three periods of drawdowns where the market, as measured by the MSCI ACWI Index, fell in excess of 30%. While a high-returning asset class, equities can also inject substantial risk into portfolios, and diversification across the asset class often fails when it is needed most.

Bonds, however, have provided a ballast. Over the past two decades, the correlation between stocks and bonds largely has been negative (see Figure 2), meaning when stocks have fallen, bonds have typically risen. This negative correlation, or dampening effect of bonds, has delivered volatility to the above multi-asset portfolio of 9.1% over the past 30 years, which is 5.9 percentage points lower than the all-stock portfolio.

Figure 2: Bond returns remain negatively correlated to stocks

Figure 2 is a line chart showing the rolling three-year correlation between stock and bond market returns over the time frame 1995–2020 (index proxies for both markets are listed below the chart). Since 2000, the correlation between the asset classes has been negative, meaning that when stock returns fell, bond returns rose, and vice versa. The negative correlation reached a low point of −0.7 in 2012, and stands at −0.4 as of 30 November 2020. Additional takeaways from Figure 2 are discussed in the main text.

These historical relationships between stocks and bonds, however, are under stress in today’s low, or some cases negative, interest rate world. Volatile periods when investors seek “safe havens,” however, such as markets experienced in the first quarter of this year, have stress tested fixed income as an equity hedge amid ultra-low rates. Despite a low starting point for yields at the start of 2020, fixed income still performed as expected as a diversifier of risk. In the case of Germany, 10-year Bund yields started 2020 already slightly negative and then plunged to a record low -0.86% during the COVID-related volatility in the first quarter. Moreover, U.S. Treasuries have historically provided a positive nominal return in all U.S. recessions over the past five decades.

In the years ahead, market volatility is likely to be higher than experienced over the past 10 years, particularly as monetary and fiscal accommodation wanes, inflation gradually rises and trade deglobalization and populism remain potential political destabilizers. Moreover, economic and market disruption brought about by technological change and demographic shifts will lead to fatter market tails and higher levels of uncertainty. It will therefore be crucial for most investors to maintain exposure to volatility dampeners, like bonds, in their portfolios to help offset equity risk during times of stress.

With regard to yield enhancement, traditional fixed income such as developed-market nominal yields offer little opportunity to deliver attractive yield. The policy action and risk aversion in response to COVID-19 has forced developed-market sovereign bond yields to even lower levels. Instead, investors are finding that they must target specific regions and parts of the yield curve in order to maximize return and diversification potential. There are opportunities in high quality assets receiving policy support, such as agency mortgage-backed securities and AA/AAA rated investment-grade corporates, emerging market hedged local bonds as well as diversifying alternative strategies.

By deconstructing the value of fixed income into its two subcomponent parts – 1. a hedging asset, and 2. a yield asset – investors can create a well-diversified fixed income portfolio that can still provide tremendous benefit to multi-asset portfolios.

For detailed insights into our views across asset classes, read our December 2020 Asset Allocation Outlook, Early Cycle Investing: Navigating the Growth Rebound.”

Erin Browne is a managing director and portfolio manager in the Newport Beach office, focused on multi-asset strategies.



1 60% MSCI All Country World Index Total Return (USD unhedged) / 40% Bloomberg Barclays Global Aggregate Index (USD hedged)
2 annualized standard deviation
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Erin Browne

Portfolio Manager, Multi-Asset Strategies

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Disclosures

Past performance is not a guarantee or a reliable indicator of future results.

A “safe haven” is an investment that is perceived to be able to retain or increase in value during times of market volatility. Investors seek safe havens to limit their exposure to losses in the event of market turbulence. All investments contain risk and may lose value.

Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Diversification does not ensure against loss.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision. Outlook and strategies are subject to change without notice. It is not possible to invest directly in an unmanaged index.

PIMCO’s Capital Market Assumptions, February 2021
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