One of the most popular things to write about in the last few weeks has been to assess whether or not 60/40 is dead and then what to do about it. Most articles tell you to stick with it for the most part, maybe offering an idea or two about how to tweak 60/40.
If you've been reading my blog posts in various places over the last 15 years you probably wouldn't be surprised to hear me say that if 60/40 is dead, it died years ago not in 2022. The reason I say that is, repeat idea coming, as yields kept going lower the risk embedded in 60/40, specifically the 40% allocated to bonds had gone way up. The consequence for that risk finally mattered in 2022. It could have mattered sooner than 2022 or later but it was going to matter at some point and that point happened to be 2022.
Part of the argument for sticking with 60/40 as we've always known it is that most of the damage, that is that most of the rate increases, has already been done. That absolutely could be the case. The FOMC is looking to top out around 5.1% and if that turns out to be correct (no guarantee that will be the terminal rate) then the variable would be whether the rest of the curve is also close to done rerating higher. Why couldn't the curve steepen such that the short T-bills creep up to 5% while 10-20 year bonds go up to 7-8%? I am not predicting that, I have no idea, no one does but if that is the outcome then there's still plenty of carnage and regret to be had in the bond market.
The other side of that idea came from Michael Collins from PGIM this morning on Bloomberg. He talked about reinvestment risk as a reason to go further out on the curve in case rates go back down. He is correct about reinvestment risk if, I say if, rates do go back down. Will they? I have no idea, no one does but if you think ten year yields aren't likely to go back close to zero any time soon then going further out on the curve takes on more risk than there is reward which is typically the opposite of what investors want to do.
Here's a bad article on the subject from Barron's that includes this ridiculous opinion; Most investors are better off “holding and systematically rebalancing nothing but index funds,” says Chris Brightman, CEO and chief investment officer of asset manager Research Affiliates. That is so condescending it actually annoys me, implying that individual investors are stupid. "Most investors are better off..." Is a great time to tune out. The suggestion of rebalancing index funds is of course valid but what most investors are better off doing is implementing a strategy that they can stick to, have the time to manage and have a reasonable basis to believe will get them to their desired outcome. That might be rebalancing index funds but it could 100 other valid approaches.
The Barron's article then goes on to recommend about as plain vanilla of a portfolio imaginable, taking in no forward looking analysis whatsoever. It would be just as good or bad at any point in any cycle. Being plain vanilla, it is of course valid but it is difficult for me to believe the portfolio has any application for anyone interested enough in investing that they read Barron's.
Jason Zweig wrote about this too. His article hit a little more on idea that there is now less risk in implementing 60/40 because of the hit that bonds took last year. The context here is relying on the 40% to help manage equity volatility which is of course what all of this is about. By definition, if a longer dated bond fund dropped 25% last year or an aggregate bond index fund dropped 14% last year then yes, of course, by definition they are cheaper and there is less risk. There is less risk buying a 20 year treasury at 4% than at 1%.
I've been mostly avoiding long duration fixed income for many many years. At some point in the middle of 2022 I started referring to longer duration bonds as being a source of unreliable volatility. What I mean by that is that a portfolio exposure can be very volatile but you generally know what you're getting. Products tracking the VIX are volatile as hell but you know they are generally going to go the other way as the stock market. There are other things that are very volatile but don't have too many surprises with how they correlate to equities.
Bonds used to be that way. I am saying they are no longer reliable. The volatility has gone up as measured by the MOVE Index to the point of, in my opinion, being unreliable for managing equity volatility the way they have been for the last 40 years.
Unreliable bond volatility is not something I want to have a whole lot of in client portfolios. Just before the middle of last year I added one year treasuries and a one year CD. The yields I got hadn't been available for a long time. I was early of course. Between now and next summer, I don't perceive the reinvestment risk to be that great, I think I will be able to get better yields than I got last summer. We are now many months into this event, whatever it is, and high yield spreads continue to be fairly valued, not indicating complacency for being too narrow or indicating the end is nigh for being to wide. The GFC was a credit event. This one is looking like it won't be. I have exposure to floating rate, shorter dated high yield and investment grade corporates and bank loans. Other than floating rate, those were all down some last year but not as bad as the aggregate index. The worst performing fixed income exposure was an actively managed fund that did about the same as the agg.
Other than the treasuries and CD, I made no changes last year. All of those fixed income sectors, plus short dated TIPS that I own, now offer yield without anywhere near the interest rate risk of longer dated treasuries and bonds that dropped 20, 25, 30% last year.
To buy the longer dated stuff now is to take on equity-like volatility in your fixed income sleeve. Do you want to do that? No wrong answer, is that what you want to do? You might get a great trade but it is equity-like volatility which needs to be understood to able to evaluate whether it is suitable for you or not.
There was no mention of alternatives in either article. We really dove deeply on those throughout 2022. There are generally two types, ones that will usually go up (more than bonds used to) when stocks go down and ones that will look like horizontal lines that tilt up slightly. No claims of infallibility with those but you can look into the archives of this site to get more on them but for economy of words in an already long post, I have positions in these types of alts that I will maintain for clients.
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