Is the 60/40 portfolio strategy still effective?


The current investment environment we face is probably the most challenging in recent memory due to a myriad of adverse circumstances which ultimately resulted in significant losses for the majority of portfolios. These losses have caused most investors to question certain portfolio strategies employed by fund managers to protect capital and drive growth. These heuristic strategies include the famous 60/40 approach, naive diversification, which consists of equally weighting each asset class to avoid regret bias, the “120 minus your age” rule, the endowment model and the parity risks.

Given the current financial environment in which we find ourselves, we have chosen to focus our analysis on the 60/40 and equally weighted portfolio strategies to see which offers a better return.

The 60/40 technique allocates the investment to 40% fixed bonds and 60% equities. In this approach, the fixed income allocation is seen as providing the portfolio with risk-reducing benefits, while the equity allocation is seen as providing a platform for long-term growth. However, an ideal diversified portfolio is created if the stock and bond allocations are themselves varied.

On the other hand, an equally weighted portfolio spreads investments across different asset classes, including cash, bonds, real estate, and stocks. In this simplest asset allocation method, risk is spread evenly across all asset classes.

We compared these two techniques using the performance figures of mutual funds with a track record of 10 years and a large market capitalization of over R10 billion. The graphs below illustrate the performance of the two strategies as of August 17, 2022:

As the numbers above show, the 60/40 method outperformed the equally weighted portfolio by more than 170 basis points on average. This shows that, despite the substantial risk involved, a high equity allocation is vital for a portfolio. Additionally, the equally weighted portfolio was heavily impacted by the real estate asset class, which underperformed over the medium to long term, while the performance of the 60/40 strategy, which aims to provide equity-like returns with volatility similar to bonds, was stellar over a period ranging from one month to five years.

So what can we conclude from this brief comparison of the two approaches? Should we continue to use the 60/40 strategy to boost returns in these tough times, or should we shift our focus to an equal-weighted approach among other ways of investing to weather the storm?

To answer these questions, there is no single investment method, so to address these concerns, we advise you to stick with an approach or program that takes into account your financial objectives, your liquidity needs, your time horizon, risk tolerance, and other special needs you may have. Also, because markets are cyclical, success depends on maintaining discipline within a certain program or investment approach.

Last but not least, to withstand any wave of investment, no matter how large, effective investment governance is essential. This includes clearly defined long-term and short-term investment objectives, the allocation of decision-making rights and responsibilities, the development of an investment policy statement, and the strategic asset allocation of the investment program.

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Don F. Davis