The past 25 years have been an incredible run for the 60/40 portfolio. During this period, with very few exceptions, the simple combination of the S&P 500 Index and the Barclays Aggregate Bond Index has consistently outperformed more diversified portfolios at less risk. While this has confounded asset allocators to no end, there is hope that 2017 may finally represent a turning point. First, the record:


As you can see, the lone period of outperformance for this Diversified portfolio (blue bars) was 2016 but it required more risk to achieve, resulting in a lower Sharpe ratio. While a mixed bag, advisors can take some comfort that they have a stronger hand going into this year’s annual reviews compared to the past several years.  

2017: A Turning Point?

The case for a lasting turning point starts with investment grade fixed-income. While many have been forecasting a turn in rates for several years, there’s growing consensus that July of 2016 marked the end of a 35-year bull market in bonds. Assuming that longer-term rates have bottomed, it’s hard to make a strong case for expected returns on investment grade bonds exceeding their coupon. In fact, the current coupon is slightly below the 2.7% total return in 2016 but nearly 300bp below its 25-year average annual return of 5.6%. And, volatility is expected to pick up.

The case for US large cap stocks is not as clear but many expect a stronger dollar and current valuations may create a headwind that mute returns. In 2016, small caps outperformed handily and emerging markets largely matched returns on the S&P 500. High Yield, Commodities and REITs also posted strong returns. In fact, the range of returns across asset classes was much healthier in 2016 compared to the compressed range of returns in 2015. We’ll see whether 2017 marks a turning point but this string of outperformance is one for the record books and one that asset allocators would like to see go away.

Source: Data from Morningstar. The diversified portfolio used in this example consists of 30% S&P 500 index, 20% Barclays Aggregate Bond index, 10% in MSCI EAFE index and Barclays High Yield index respectively, and 5% each in MSCI EM index, Russell 2000 index, Bloomberg Commodity index, NAREIT All-Equity index, Barclays L-T Treasury index and Gold. Both portfolios are re-balanced annually.

by | Jan 18, 2017 | Asset Allocation

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