UBS says those sounding the death knell of the traditional 60/40 portfolio after a nasty 2022 are wrong. But a little fine tuning is needed.
A historic inflation rise, followed by rapid central bank hiking, drove both stock and bond valuations to the downside.
The traditional 60/40 portfolio suffered one of its worst years as a result, with some calling the strategy irrelevant in today’s markets.
But huge money manager UBS says that far from being dead, the 60/40 set-up just needs some finetuning, and should remain a part of everybody’s long term portfolio strategy.
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According to UBS, diversification is still important and helps to reduce the role of “luck” in investment outcomes, by tapping into a broader variety of other factors.
UBS said that to have a good diversified portfolio, investors would first need to finetune their asset allocation by getting the mix right.
“You will need to hold on to, and even add to, asset classes that have underperformed in recent years,” said the bank.
UBS said commodities and commodity related stocks had proven their worth as a tactical asset class and should always be part of a diversified portfolio.
The bank also said it continued to have a “most preferred” view on crude oil and energy-related stocks.
“To maintain diversification, investors also need to maintain a strategic balance between growth and value exposure, including a healthy allocation to international markets,” it said.
UBS had advice to people questioning whether their portfolio was diversified enough.
“If there’s something in your portfolio that you hate, it’s a good sign that you’re diversified,” it said. “By the same token, if everything is working at once, there’s a chance that your portfolio will experience an environment where everything stops working at once.”
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Bonds still have a big role to play
Meanwhile, other experts believe the strategy of allocating 40 per cent of your money into bonds within the 60/40 portfolio is still intact in today’s market.
Gaby Rosenberg, a co-founder of Blossom, a micro-investing app focused on bonds, believes the bond market has a positive outlook, and is a good choice for investors looking to diversify.
“While bonds and equities can exhibit positive correlation during extreme market conditions, example during Covid, they often have a negative correlation over the long term,” Rosenberg told Stockhead.
She explained that bonds and equities were influenced by different underlying risk factors – making them a good hedge for each other.
“Bonds are influenced by interest rates, credit quality, and inflation expectations,” she said. “By combining these different risk factors, investors can potentially reduce the overall risk of their portfolio.”
Risks in buying bonds
Like any asset class, there are risks in bond investments – the main one being a rise in interest rates (bond prices fall as interest rates rise).
Rosenberg warned that investors needed to be particularly careful around Fed announcement dates, when volatility could lead to shifts in interest rates, affecting bond prices.
There were also other risks that bond investors needed to manage – such as credit risk, duration risk, liquidity risk, as well as inflation risk.
“The enemy of bond investments are basically rising interest rates, declining credit quality, movements in the maturity profile, and their relative attractiveness of other asset classes,” Rosenberg said.
She said that with regards to credit risk, the debt ceiling crisis and a potential US debt default had made investors question whether there was such a thing as a credit risk-free asset these days.
US Treasuries are supposed to be risk-free, and it could be argued that if the US Treasury defaulted, there would be nowhere safe to go.
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Given that risk, Rosenberg said the vast majority of individual investors should hand the management of bond portfolios over to experts.
She explained that, for example, the Blossom Fund, which was diversified across more than 500 exposures and had enjoyed 100 per cent positive months, was expertly managed by a professional fund manager.
“I believe there’s value in having an allocation to the bond sector right now, but I would not encourage retail investors to buy individual bonds on their own,” she said.
Aussie bonds ‘cheap’ right now
Rosenberg added that for an individual investor, she would prefer the Australian bond market over that of the US.
“The US market adds a layer of complexity with currency decisions to make,” she said.
“It’s also very hard for an Australian to assess the credit quality of US bonds, so I would recommend sticking to the home court advantage of the Australian bond market.”
Rosenberg believes that Australian bonds are cheap right now, and might get cheaper still, which will provide a window to buy on the dip.
“There is good value in Australian bonds right now, and that is what our fund manager has been waiting for. It might get worse before it gets better,” said Rosenberg.
On the ASX, bond ETFs listed include the BetaShares Australian Composite Bond ETF (ASX:OZBD), the Global X US Treasury Bond ETF – Currency Hedged (ASX:USTB), and the iShares Core Composite Bond ETF (ASX:IAF).
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This content first appeared on stockhead.com.au
The views, information, or opinions expressed in the interview in this article are solely those of the interviewee and do not represent the views of Stockhead. Stockhead has not provided, endorsed or otherwise assumed responsibility for any financial product advice contained in this article.
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