Every investor will have heard about the classic 60/40 investment strategy. In other words, allocating 60% of the portfolio to equities tracking the S&P 500 and the remaining 40% to 10-year Treasury bonds.
Indeed, this has stood as one of the most widely used formulas among investors for decades. It is no coincidence that, since the year 2000, this portfolio has only seen losses in five out of the 24 years in the series.
However, in recent years, this strategy has encountered certain challenges due to a range of economic and financial factors.
The historic rise in benchmark interest rates by the central banks of major developed economies, in response to high inflation, has negatively impacted bond performance.
In an environment of rising rates, the value of bonds tends to fall, affecting the 40% of the strategy allocated to fixed income.
Given the current scenario, we are beginning to see a correlation between equities and the bond market, which directly affects the performance of the 60/40 portfolio. In certain recent periods, like in 2022, both stocks and bonds declined simultaneously, thereby diminishing the portfolio’s diversifying component.
Persistent inflation can be analysed from a number of perspectives. Firstly, inflation reduces the real returns of a portfolio, requiring investors to demand higher nominal returns to offset its effects. Secondly, in periods of high inflation, central banks raise interest rates to combat it, which subsequently leads to a decline in the value of bonds.
Given these challenges and the evolving financial markets, we believe it could be prudent to make certain adjustments to the portfolio. The aim would be to insulate it from interest rate hikes and inflation while enhancing its diversification, thereby helping us to navigate any market conditions.
One of the strategies we find most sensible is investing in alternative assets, such as private equity or private debt. In fact, according to a study by asset manager KKR, the returns on a 60/40 portfolio could have increased by nearly 40% if private market strategies had been incorporated.
So much so that demand for these types of assets is showing no sign of slowing. According to Preqin’s estimates, private markets are expected to expand from their current USD 13 trillion to over USD 20 trillion by 2030.
Similarly, it is entirely logical for a diversified portfolio to reflect the progress of the real economy. If we examine the valuations of major US tech companies, they account for roughly 20% of the S&P 500, yet their combined revenues only represent about 4% of US GDP. On the other hand, according to the same KKR report, the number of publicly traded companies has fallen 30% over the past 40 years. As such, if we are striving for a diversified portfolio, we must pay close attention to private markets.
That said, investors must be mindful of the various risks associated with investing in private markets. These strategies are, of course, inherently illiquid, and many require long-term investment commitments.
Additionally, the dispersion of returns within these strategies is high, with a stark performance gap between managers across different quartiles. The ability to identify the best manager within each strategy becomes especially crucial.
For these reasons—illiquidity and the dispersion of returns—it is essential to rely on professional management that can grant investors access to the top managers in each strategy, since these managers are often particularly inaccessible to individual investors.
Ultimately, private markets can be one of the most effective ways to diversify a portfolio and achieve decorrelation from traditional assets. Furthermore, their combination of potentially higher returns and access to assets unavailable in public markets makes them a powerful tool for balancing risks and opportunities within a diversified investment strategy.
Funds People, 14.02.25