60-40 Is Dead. Long Live 60-40

RIAs are giving a face-lift to the traditional balanced portfolio to maintain its relevance for today’s financial market conditions.


Has the 60-40 equity/fixed-income portfolio outlived its usefulness? Many wealth managers believe the traditional balanced investment formula is now passé or, at the very least, in need of a major overhaul.

Count Bob Rice, co-founder and managing partner at New York–based Tangent Capital Partners, among the most skeptical. He argues that fixed income no longer performs its insurance function in today’s ultra-low-rate environment.

“Bonds were historically thought of as the ballast to stocks, so they were the downside protection,” Rice explains. “If the stock market tumbled, the bond market would improve.” But that’s a highly debatable proposition when yields on the U.S. Treasury’s benchmark ten-year notes have been hovering just a touch above 2 percent, he says, adding, “There are only so many numbers between two and zero. The math just doesn’t work.”

The other part of the balanced formula — equities — is just as problematic, Rice contends. Key valuation metrics such as the Tobin’s Q (a company’s market value divided by the replacement value of its assets), gross domestic product divided by market capitalization and the Shiller cyclically adjusted price-to-earnings ratio are “standing at pretty close to two standard deviations north of the long-term averages,” he says, constraining stocks’ upside potential. “You cannot argue that, historically speaking, stocks aren’t extremely rich right here.”

Stock valuations could go higher, Rice acknowledges, as long as the U.S. Federal Reserve Board keeps printing money “ad infinitum,” but that’s not likely to happen, given comments by Fed chair Janet Yellen in late September that “most” of her colleagues thought a rate hike would be appropriate this year. In light of the comments, he says, “how can you justify being in the 60-40 portfolio when there are so many other good options to consider?” Rice cites activist investing, global macro and equity long-short strategies among possible alternatives to the classic balanced portfolio. He also contends that distressed debt is on the cusp of coming back into favor.

Notwithstanding critics like Rice, the 60-40 portfolio has staying power. Balanced mutual funds managed $556.5 billion in assets as of late October, according to research firm Thomson Reuters Lipper.

“You can look at the past few years, and the 60-40 has really kind of beaten everything out there,” says Kevin Dorwin, managing principal with Bingham, Osborn & Scarborough, a San Francisco–based registered investment adviser that manages about $3.5 billion. “It’s done a pretty darn good job even after the financial crisis, when everyone had written it off.”

For example, the $25.2 billion Vanguard Balanced Index Fund Investor Shares, which tracks two broad U.S. stock and bond indexes to produce a 60-40 portfolio, has earned an average annual pretax return of 6.3 percent over the past decade. The S&P 500 returned 6.80 annually over that period, whereas the Barclays U.S. Aggregate Bond Total Return returned 4.76 percent. Although 60-40 funds suffered during the financial crisis, they handily outperformed equities. The Vanguard Balanced Index Fund lost 22 percent in 2008, compared with a 37 percent drop for the Standard & Poor’s 500 index.

Dorwin emphasizes that 60-40 can include foreign, small-cap and value stocks, as well as different types of fixed income. The key is how the adviser structures the allocation, he adds.

Joe Zappia, principal and co-CIO at $3 billion LVW Advisors, a registered investment adviser based in Pittsford, New York, believes 60-40 will continue to work but that advisers and investors who use it need to lower their return expectations. They also need to consider making some significant adjustments to the basic model, he says, something his firm has done for its clients.

LVW deploys a 60-40 allocation with a stock portion includes hedged equity. “The managers we are selecting are using long-short strategies and are in most cases net long about 70 percent,” Zappia says. “In the large-cap area, we are using both a public fund and a hedge fund structure. In small and midcap, we are using a hedge fund structure.”

The firm substitutes a multistrategy approach for roughly half of the traditional 40 percent fixed-income allocation. The multistrategy assets track the credit markets more than the equity markets, Zappia explains. They have included absolute-return hedge funds, catastrophe bonds and master limited partnerships in midstream energy companies, which own processing, transportation and storage infrastructure. The goal of this approach is to invest in assets with differentiated returns that can produce bondlike results with less risk than traditional fixed income, he says.

Although LVW still uses traditional bonds for the other half of its fixed-income allocation, Zappia says that paper merely serves as ballast for stocks and protects against deflationary risk. He doesn’t expect it to deliver much in the way of return.

There’s no ideal replacement for 60-40, which helps explain its continued popularity, says Dorwin. “The problem is that the argument against bonds is to use either more equities, to use alternative investments or to increase the risk level of the types of fixed income that you would normally use in a portfolio,” he says. “We think that is potentially very risky for many private investors.”