Are Balanced Portfolios dead?
Legend has it that in 1895 whilst in London, Mark Twain, who had been feeling a little poorly, on discovering that a journalist had written his obituary, quipped the following:
‘The reports of my death are greatly exaggerated’.
In the past few years, obituaries for a traditional ‘balanced’ portfolio of, say, 60% equity, 40% bonds have been written by quite a number of financial journalists and fund managers.
At Wells Gibson, we believe such a portfolio continues to be alive and kicking.
Good investing is grounded in three things:
1. Using investment logic to think clearly about what one puts into a portfolio;
2. Using empirical insights to inform us of the general longer-term characteristics of assets and how they work together in a portfolio, and the shorter-term exceptions to these generalities; and
3. The fortitude to stick with a sensible portfolio strategy through these shorter-term, trying periods.
A portfolio mix of bonds and equities balances the potentially severe downside falls in equity markets by owning far less volatile, good quality bonds that will not fall as far, if they do fall at all.
There is a general expectation that at times of severe equity market trauma, fearful money will move into high quality bonds pushing yields down and bond prices up – in other words, there is a see-saw effect between yields and prices – that is often but not always the case, as 2022 and 1994 demonstrated.
It is certainly fair to say that the past five-year period has been tough for 60/40 balanced portfolios, given that it included the global pandemic, the war in Ukraine, a rapid end to the era of low nominal and negative real interest rates, the highest inflation in 40 years in the UK, and a downturn in global equity markets in 2022.
Even so, it delivered a return that more-or-less matched inflation over this period, which should be regarded as a good outcome.
Furthermore, if we look at annualised, rolling real returns (after inflation) since 1970, for different investment horizons, we learn that the 60/40 structure has delivered growth of purchasing power in the vast majority of five-year horizons (and beyond). The longer one holds, the more consistent returns become.
Compare today to the 1970’s, which saw a decade of rampant inflation – up an alarming 240% cumulatively – between 1970 and 1979.
Five-year, after-inflation returns for a 60/40 balanced portfolio from 1970 to 1975 were, perhaps not surprisingly, negative.
Yet investors who stuck with it during this very difficult period ended up with positive real returns after 15 years, increasing purchasing power by around 50%.
Over the same period, holders of cash would have turned £100 into £85 of purchasing power.
As I’ve said many a time, investing is a long-term game.
For instance, between 1970 and 2022, the 60/40 balanced portfolio structure doubled an investor’s purchasing power every 15 years, on average.
Press articles are often influenced by recency bias, which encourages investors to make portfolio decisions based on recent events.
For example, the spectacular return of commodity futures in 2021-2022 hides their material underperformance compared to global equity assets over the longer-term.
Yet to include them in a portfolio, after a bout of strong short-term performance, fails the investment logic and empirical evidence tests.
Investment logic still suggests that shorter-dated, high quality bonds will remain a useful balance to extreme equity markets, if and when they occur, providing strong downside protection.
At market extremes, fearful money will still flow to these assets.
Bonds are now yielding substantially higher yields today than 18 months ago, providing more return and a greater buffer against any future yield rises.
Empirical evidence suggests that bonds are often, but not always, negatively correlated to equities (i.e. they move in the opposite direction).
It also suggests that markets work pretty well and trying to guess which asset class will do well this or next year is essentially impossible.
As such, having the patience to stick with an investment strategy over the longer term is really important.
The last five years may not have been spectacular but protecting investor’s purchasing power from inflation over this difficult and inflationary period suggests that the balanced portfolio is alive and well, despite the headwinds it faced.
The reports of the death of balanced portfolios are greatly exaggerated. Balanced portfolios are not dead and at Wells Gibson, we are sure Mark Twain would agree.
Note that this is not to suggest that a balanced portfolio is suitable for any specific investor. The decision as to what is suitable will be the result of an informed discussion between an investor and their adviser. This is not a recommendation.
For more information please get in touch with the Wells Gibson team.
