Our 40th birthdays are often celebrated as a milestone. Since ancient times 40 has always been a revered number. In the bible, Noah waited for 40 days, the Hebrews lived outside the promised lands for 40 years and Jesus fasted for 40 days. Muhammad was 40 when he received his first revelation from Gabriel.

40 is also the percentage weight given to defensive assets in most balanced portfolios using the traditional 60/40 split. For decades investors have relied on this type of portfolio with the intention of smoothing out stock market volatility and still meet retirement goals. No more.

The 40 has become a problem.

Jack Bogle who pioneered index investing is also credited for popularising the 60/40 portfolio. The 60/40 portfolio represents the split between growth assets and defensive assets. The importance of diversifying beyond a single asset class has been a cornerstone of investing for as long as there has been stock markets. In the Intelligent Investor, Benjamin Graham, advocated:

  • Using a 50/50 stock/bond allocation as a baseline, and
  • Shifting as far as 25/75 in either direction, based upon current market conditions.

Graham states, “The sound reason for increasing the percentage in common stocks [beyond 50%] would be the appearance of ‘bargain price’ levels created in a protracted bear market. Conversely, sound procedure would call for reducing the common-stock component below 50% when in the judgment of the investor the market level has become dangerously high.”

Graham is approaching asset allocation as if the stock, or growth component is the variable investors should consider when determining their asset allocation. This may be due to the relative dependability of bonds compared to stocks in 1939 when he wrote the book. Bonds and other defensive assets preserved capital and provided dependable income.

Fast forward eighty years and bonds, while still preserving capital, can no longer be relied upon to provide dependable income. At the time of writing, the 10-year Australian government bond is yielding 0.94%. That compares to an average of approximately 5.5% over the last 30 years.

We wonder how Graham would approach this new world.

A number of financial professionals and institutional investors have suggested investors diversify to other asset classes beyond bonds. Another global asset manager recently suggested non-traditional asset classes such as infrastructure and property will evolve from optional to indispensable over the next 10 to 15 years. These sentiments were shared by hedge fund principal Bridgewater Associates founder Ray Dalio who went further, stating, “In my opinion, don't own bonds, and don't own cash because they're producing a lot of debt and producing a lot of money to fund it, and so that's changing the nature of capital flows.”

Portfolio construction presents many challenges, the defensive allocation puzzle is far more complex now more than ever and can be stifling for the ill-advised. This reinforces the value of financial advice. The alternatives to bonds and cash suggested by the aforementioned financial professionals and institutional investors have traditionally only been accessible to large institutions. This is no longer the case. ETFs allow all investors to diversify their portfolio into a range of asset classes and VanEck offers a number of these on ASX which can be found here.

While we don’t think the 60/40 portfolio is dead, we do think the alternatives need serious consideration. There are a number of alternative income and defensive ETF opportunities worth considering. ETFs are the enabler and democratise the opportunity set for investors. The time for empowerment is now.


Published: 27 November 2020


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