Can the 60/40 Allocation Help During Volatile Times?
Sources: Sources for data in tables: Equity Market and Fixed Income returns are from JP Morgan as of 2/28/2020. Rates and Economic Calendar Data from Bloomberg as of 2/28/2020. International developed markets measured by the MSCI EAFE Index, emerging markets measured by the MSCI EM Index. Sector performance is measured using GICS methodology.
Global equity markets plunged drastically lower last week, as amplified concerns over the spread of the coronavirus (COVID – 19) stoked investor’s fears. In the U.S., the S&P 500 Index fell to a level of 2,954, representing a loss of 11.44%, while the Russell Midcap Index retreated 11.92%. The Russell 2000 Index, a measure of the Nation’s smallest publicly traded firms, returned -12.01% over the week. Those looking for a respite from negative returns were unable to find relief in international equities, as developed and emerging markets moved 9.55% and 7.23% lower. Finally, the 10-year U.S. Treasury yield fell to 1.13%, down 33 basis points from the previous week.
Over the last few years, some have argued that the traditional 60/40 stock to bond asset allocation is dead. The justification for such an argument has been underpinned by the reality that interest rates are well below historical averages, and thus unable to offer investors an attractive income stream. However, the fastest 10% correction in the history of the S&P 500 might lead some to change their tune on this thought process.
In our view, the balanced 60/40 approach can offer the best of both worlds; downside protection through the fixed income allocation and upside potential through the equities allocation. We have always contended that fixed income, specifically investment-grade fixed income,can play a crucial dual-role in an investor’s portfolio by offering relative price stability and income production potential . Additionally, any income generated can be reinvested in riskier assets that are liable to be at depressed values during volatile time-frames.
To drive this point home, we’ve compared the performance of three separate portfolios starting on February 19th, the first day that global equities sold off materially, and ending on February 28th. The first portfolio was solely invested in the S&P 500 Index, while the second portfolio allocated 80% to the S&P 500 Index and 20% to the Barclays U.S. Aggregate Bond Index, and the third portfolio invested 60% in the S&P 500 Index and 40% in the Barclays U.S. Aggregate Bond Index.
An examination of the results over the previously mentioned time-frame supports our view that the 60/40 allocation is indeed alive and well! Consider that the all-stock portfolio lost 12.28%, the 80/20 portfolio fell 9.49%, and the 60/40 allocation decreased by 6.7%. More importantly, risk and return metrics over the last three years tell a similar story. Of the three models, the 60/40 allocation produced the highest Sharpe Ratio; a statistic used to judge return relative to risk, indicating that this asset mix delivered the most profit per unit of risk over this time period. Of course, it is important to always remember that past performance is not indicative of future results.
While we do believe that the 60/40 asset allocation has a place in today’s low interest rate and often volatile capital markets world, we also understand that it might not be appropriate for everyone. As a result, we encourage investors to stay disciplined and work with experienced financial professionals to help manage their portfolios through various market cycles within an appropriately diversified framework that is consistent with their objectives, time-frame, and tolerance for risk.
Disclosure: Hennion & Walsh Asset Management currently has allocations within its managed money program and Hennion & Walsh currently has allocations within certain SmartTrust® Unit Investment Trusts (UITs) consistent with several of the portfolio management ideas for consideration cited above.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.
There are special risks associated with an investment in real estate, including credit risk, interest rate fluctuations and the impact of varied economic conditions. Distributions from REIT investments are taxed at the owner’s tax bracket.
The prices of small company and mid cap stocks are generally more volatile than large company stocks. They often involve higher risks because smaller companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions.
Investing in commodities is not suitable for all investors. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity.
Products that invest in commodities may employ more complex strategies which may expose investors to additional risks.
Investing in fixed income securities involves certain risks such as market risk if sold prior to maturity and credit risk especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than original cost upon redemption or maturity. Bond Prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the value of your investment.
MSCI- EAFE: The Morgan Stanley Capital International Europe, Australasia and Far East Index, a free float-adjusted market capitalization index that is designed to measure developed-market equity performance, excluding the United States and Canada.
MSCI-Emerging Markets: The Morgan Stanley Capital International Emerging Market Index, is a free float-adjusted market capitalization index that is designed to measure the performance of global emerging markets of about 25 emerging economies.
Russell 3000: The Russell 3000 measures the performance of the 3000 largest US companies based on total market capitalization and represents about 98% of the investible US Equity market.
ML BOFA US Corp Mstr [Merill Lynch US Corporate Master]: The Merrill Lynch Corporate Master Market Index is a statistical composite tracking the performance of the entire US corporate bond market over time.
ML Muni Master [Merill Lynch US Corporate Master]: The Merrill Lynch Municipal Bond Master Index is a broad measure of the municipal fixed income market.
Investors cannot directly purchase any index.
LIBOR, London Interbank Offered Rate, is the rate of interest at which banks offer to lend money to one another in the wholesale money markets in London.
The Dow Jones Industrial Average is an unweighted index of 30 “blue-chip” industrial U.S. stocks.
The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
DJ Equity REIT Index represents all publicly traded real estate investment trusts in the Dow Jones U.S. stock universe classified as Equity REITs according to the S&P Dow Jones Indices REIT Industry Classification Hierarchy. These companies are REITs that primarily own and operate income-producing real estate.