Managing your asset mix: past, present and future

Every couple of years, we come across articles calling for the “death” of the 60/40 balanced fund – the traditional portfolio of stocks and bonds that has long been viewed as fundamental to a successful investment strategy. These assertions often seem to surface after periods of strong performance such as the one we experienced in 2020, when returns were magnified by ultra-easy monetary measures aimed at limiting the pandemic’s economic damage. 

Doubts about balanced funds rest on claims that the current environment of low interest rates and lower expected returns will make it difficult for a 60/40 asset allocation to continue to meet investors’ return requirements. While it is true that expected returns for many asset classes may be more muted going forward, we believe that holding a well-diversified portfolio will continue to be an investor’s most important investment strategy. 

That said, a constantly changing investment landscape requires investors to always be evaluating how they diversify their portfolios and whether they are positioned to achieve their long-term objectives. That includes understanding the powerful changes in markets, most importantly the low interest-rate environment and the likelihood that it will be around for a long time.

60/40 Balanced portfolio: 10-year rolling returns from 1900 to 2020

Past: A history of strong performance

Today’s investors have seen long periods of exceptionally strong returns from both stocks and bonds. This backdrop has led to consistently robust performance for most traditional 60/40 portfolios. Three key developments have contributed to this success. The first is a 40-year bull market in bonds during which the yield on the 10-year U.S. Treasury bond has fallen from peak levels of 16% in 1981 to slightly over 1% today. Second is a bull market in stocks fueled by extraordinary monetary-policy support since the 2008-2009 financial crisis. Last has been the dependable ballast provided by bonds during periods of equity market volatility, helping to provide a more consistent investment path. While it has been a great run for both bonds and stocks over the last decade, expectations that returns will be more muted over the next decade, particularly from bonds, has many investors rethinking their traditional asset mix. 

Present: Challenges to the traditional asset mix 

Today’s low-interest-rate environment and lower expected returns present several challenges for the traditional 60/40 portfolio and those who invest in them. Bond yields have reached historical lows, with sovereign bond yields in particular near zero in many countries. In response to the economic and financial impact stemming from the pandemic, central banks have committed to keeping short-term interest rates low to stimulate economies and financial markets, even as the recovery gains traction. This central-bank commitment has important implications for investors who hold bonds – lower expected returns and reduced income. Historically, bonds have provided not just income, but also liquidity and insurance against equity market volatility. However, the realities of today’s low-interest-rate world mean that investors, particularly more conservative investors whose portfolios are tilted heavily toward fixed income, are going to need to evaluate whether their portfolios are positioned to achieve their long-term investment objectives.  

The decade-plus bull market in stocks has left equity-market valuations stretched by some measures, especially for large-cap U.S. stocks, and investors will need to moderate their total-return expectations for equities as well. While we continue to believe that stocks will outperform bonds in the decade ahead, our expected returns for both asset classes, and therefore for a balanced strategy, are lower than what investors have become accustomed to. 

Historical performance versus long-term expected returns

Positioning your portfolio for the future

At RBC Global Asset Management, we believe there are a number of ways that investors can position their portfolios to support returns, improve income generation, manage volatility and provide stability: 

1. Improve diversification by allocating to global markets 

By taking a more global approach, investors can access a larger number of investment options which allows for better diversification and should ultimately lead to a smoother investment experience by reducing the impact of localized downturns on a portfolio. Last summer, we increased the allocation to global equities across several of our portfolios, sourcing the funds from Canadian equities. Given the varying impacts of COVID-19 on different economies and the potential for heightened volatility going forward, we believe that diversifying across multiple regions will continue to be an important tool for investors.

2. Revisit your allocation to stocks

Lower return expectations mean there is a higher likelihood that returns for balanced portfolios will fall below levels of recent decades, increasing the risk that investors fall short in reaching their financial goals. For many investors, boosting stock market exposure is a good first step toward bolstering portfolio returns, though this outcome depends on your tolerance for risk as higher return expectations are typically accompanied by additional risk. Our analysis shows that investors will be reasonably well rewarded over the longer term for accepting a journey that is a bit bumpier in the short term. Earlier this year we increased our strategic equity weight across many of our portfolios, sourcing the funds from fixed income. 

3. Finding income in equities 

In addition to having higher expected returns relative to bonds, stocks can also provide an added income benefit. A U.S. 10-year bond is yielding about 1.1%, versus 1.6% for the current dividend yield on the S&P 500 Index, a premium not seen for some time. While the economic environment remains unclear, we anticipate that the yield advantage of stocks over bonds will persist. Our research suggests that U.S. equities will provide a total return of 4.4% in the long-run*, compared with a 1.1% return for 10-year U.S. Treasury bonds.

4. Adding alternatives to fixed income

Given the current low level of yields, it may be more challenging for bonds to act as a ballast against equity-market volatility. Investors would be well served to consider incorporating new asset classes and strategies that mimic the prior benefits of sovereign bonds or have relatively low correlations to traditional equities. Last November, we added to our allocation in direct real estate and introduced a position in liquid alternatives with the addition of an absolute-return credit fund in some of our balanced portfolios. These two asset classes have historically offered higher yields than sovereign bonds, and have the added benefit of low correlations to equities. Both are examples of how we are adjusting our asset mix and diversifying risk in reaction to a shifting investment backdrop. 

5. Continue to hold bonds, but diversify

While sovereign bonds certainly have their place in a portfolio, investors should consider diversifying their fixed-income exposure to include holdings that are less sensitive to the risks facing sovereign bonds. Such shifts can help mitigate interest-rate risk, preserve capital and lower portfolio volatility.  

Over the past 20 years, we have broadened our fixed-income allocations by including investment-grade, high-yield and emerging-market debt, sourced from sovereign-bond allocations. Moving beyond government-issued bonds, however, increases an investor’s exposure to default and must be monitored diligently to ensure the portfolio does not become too risky for a given investor’s profile.

5-year trailing returns of bond market sectors

Constant evolution is key

At RBC GAM, we spend a lot of time thinking and talking about our asset mix. In our view, it is the most important decision an investor makes and is a key driver of long-term investment returns. However, no single blend of assets will remain optimal over the long-term and small incremental changes need to be made to keep portfolios current. Our 30-plus years of experience in building and managing portfolios has taught us that evolving our asset mix as market conditions change has been, and will continue to be, key for investors. 

* Note: Forecast over 10 years, as of January 13, 2021.

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Please consult your advisor and read the prospectus or Fund Facts document before investing. There may be commissions, trailing commissions, management fees and expenses associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. RBC Funds, BlueBay Funds and PH&N Funds are offered by RBC Global Asset Management Inc. and distributed through authorized dealers.

This has been provided by RBC Global Asset Management Inc. (RBC GAM) and is for informational purposes. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. RBC GAM takes reasonable steps to provide up-to-date, accurate and reliable information, and believes the information to be so when provided. Past performance is no guarantee of future results. Interest rates, market conditions, tax rulings and other investment factors are subject to rapid change which may materially impact analysis that is included in this document. You should consult with your advisor before taking any action based upon the information contained in this document.

Information obtained from third parties is believed to be reliable but RBC GAM and its affiliates assume no responsibility for any errors or omissions or for any loss or damage suffered. RBC GAM reserves the right at any time and without notice to change, amend or cease publication of the information.

This document may contain forward-looking statements about a fund or general economic factors which are not guarantees of future performance. Forward-looking statements involve inherent risk and uncertainties, so it is possible that predictions, forecasts, projections and other forward-looking statements will not be achieved. We caution you not to place undue reliance on these statements as a number of important factors could cause actual events or results to differ materially from those expressed or implied in any forward-looking statement. All opinions in forward-looking statements are subject to change without notice and are provided in good faith but without legal responsibility.

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Published by

Sarah Riopelle, CFA

Vice President & Senior Portfolio Manager, Activator at SheEO?

Published ? 6mo

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