Diversification isn’t dead: the case for balanced 60/40 portfolios
Investors are experiencing unprecedented volatility in financial markets. A common indicator of volatility, the Cboe Volatility Index (VIX), closed at an all-time high last week.¹ Yet, one silver lining is that diversification has helped smooth the ride for balanced portfolios of stocks and bonds.
Bonds as a buffer
Despite predictions that the traditional 60/40 portfolio (60% stocks and 40% bonds) was doomed, the recent volatility has again proven the benefits of a diversified investment strategy.
Of course, fears over the coronavirus (COVID-19) outbreak have led to losses in nearly every asset class as investors have rushed to the safety of cash. However, fixed-income securities have provided a buffer for equity portfolios during the recent and sudden sell-off.
For example, the S&P 500 Index has declined nearly 30% over the past month, while the Bloomberg Barclays U.S. Aggregate Bond Index has only lost about 2%.² Although bonds have lost some value, they've helped limit the damage when compared to pure equity portfolios.
A key takeaway is that balanced portfolios have helped dull some of the volatility, which can support an investor’s ability to maintain a long-term view during particularly difficult markets.
Remember bonds’ role
Recently, the Bloomberg Barclays U.S. Aggregate Bond Index has shown a negative correlation³ with the S&P 500 Index. This reinforces the diversification properties of fixed-income holdings for stocks.
Remember, correlations change depending on market dynamics, and stocks and bonds can move in the same direction at times. Yet, fixed-income investments have generally done a good job providing a counterbalance to the recent drop in stock prices.
This is a reminder of one of the key roles that bonds can play in a portfolio: to diversify equity exposure and provide a potential ballast during volatile periods. Bonds can really prove their worth when they help investors preserve capital and allow them to stick with their long-term investment plans. Also, don’t forget bonds can provide income, as well.
Flexibility and looking forward
Looking ahead, balanced funds may be an attractive investment strategy for investors who want to stay invested in the market, but prefer to take on less potential volatility than they’d get in an all-equity portfolio. If volatility continues, the bond allocation may act as a buffer and make it easier to stay invested during the turbulence.
Put another way, investors may get some upside protection when stocks are moving higher, and some downside protection when the market is selling off.
However, we believe balanced portfolios that have more flexibility than the static 60/40 allocation are better positioned for several reasons. For example, managers can shift more into stocks or bonds if one asset class is more attractively valued than the other. Within the broader equity market, managers that have the flexibility to invest globally and across styles and market capitalization may offer advantages over the long term.
Notably, within the bond allocation, flexibility to invest in both investment-grade and high-yield bonds may be attractive due to the new historical lows in U.S. Treasury yields. Various types of bonds have performed differently during the last month’s volatility, and we believe some are offering more value than others as we look at U.S. Treasuries, municipal bonds, mortgages, corporate debt, and emerging markets, to name a few. Therefore, we believe security selection within fixed-income markets is important for a balanced portfolio to fire on all cylinders and complement the equity allocation.
Many investors today are wondering if they should invest in the equity market and risk further losses if stocks fall, or stay on the sidelines and risk missing a potential market rebound. We think balanced funds with flexibility can be a core solution for investors seeking diversified, all-weather portfolios they can stick with through thick and thin.
1 “Stock Market Volatility Tops Financial Crisis With VIX at Record,” Bloomberg, March 16, 2020. 2 Bloomberg, as of March 18, 2020. 3 Correlation is a statistical measure that describes how investments move in relation to each other, which ranges from -1.0 to 1.0. The closer the number is to 1.0 or -1.0, the more closely the two investments are related.
A widespread health crisis, such as a global pandemic, could cause substantial market volatility, exchange-trading suspensions and closures, affect the ability to complete redemptions, and affect fund performance; for example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other preexisting political, social, and economic risks. Any such impact could adversely affect the fund’s performance, resulting in losses to your investment.
The value of a company’s equity securities is subject to change in the company’s financial condition and overall market and economic conditions. Fixed-income investments are subject to interest-rate and credit risk; their value will normally decline as interest rates rise or if an issuer is unable or unwilling to make principal or interest payments.
The S&P 500 Index tracks the performance of 500 of the largest publicly traded companies in the United States.
The Bloomberg Barclays U.S. Aggregate Bond Index tracks the performance of U.S. investment-grade bonds in government, asset-backed, and corporate debt markets.
The Cboe Volatility Index (VIX) shows the market’s expectation of 30-day volatility and is constructed using the implied volatilities of a wide range of S&P 500 Index options.
It is not possible to invest directly in an index. Past performance does not guarantee future results.
Diversification does not guarantee a profit or eliminate the risk of a loss.