Low interest rates across the world are drawing out pessimistic prognostications over the future of balanced portfolios.
But such arguments are meeting resistance in a year where balanced funds have booked double-digit gains while limiting sharp swings in the portfolio’s value. Such funds split their holdings into stocks and government bonds with the idea that bonds will act as a ballast when equities take a hit.
“Most have not been able to outperform a 60-40 portfolio. There’s a reason why it exists,” said Scott Kimball, a portfolio manager at BMO Global Asset Management.
But the continued outlook for depressed interest rates in a world where economic growth appears structurally weak, driven down by aging populations and anemic productivity growth, has raised lingering questions as to whether bonds can continue to rally from here.
Along with the Federal Reserve, many major central banks have cut interest rates to rock-bottom levels this year to help shore up their economies during the COVID-19 pandemic.
“The fact is we’re in a low rate environment that doesn’t give you the kind of returns you’re looking for in Treasury bonds,” said David Norris, head of U.S. credit at TwentyFour Asset Management.
With the 10-year Treasury note yieldBX:TMUBMUSD10Y offering less than 1% in yield, Wall Street banks and global money managers have advocated unconventional alternatives to government bonds, telling their clients that they have no choice but to steel themselves for more ups and downs in their portfolios if they want to meet their expected returns.
“There’s almost no way to get around the fact that investors are being pushed to take more risk,” said Yung-Yu Ma, chief investment officer at BMO Wealth Management.
Bond fund managers like TwentyFour Asset Management have touted the importance of investing in assets that are more exposed to the vicissitudes of the economy, if they want to shore up the income earned from their portfolios.
But owning these alternatives can leave investors uncomfortably exposed to swings in equity markets and are often less liquid.
And some have advocated for so-called liquid alternative investments such as collateralized-mortgage obligations, which offer higher yields but are advertised as easy to trade and largely immune to broader market turmoil much like government bonds
But during the March market crash, many of these fixed-income instrument markets seized up and some instruments like CLOs were among the slowest to recover to their pre-pandemic prices.
“Liquid alts are an oxymoron,” said Kimball.
Another successful year
The same conditions that have precipitated worries about balanced funds arguably have also contributed to their success.
The ability of bonds to diversify against stock-market drawdowns largely emerged after inflation was put to bed in the 1980s, the beginning of a three-decade long bull market for Treasurys. At the same time, muted prices pressures have allowed central banks to push interest rates lower without having to worry about an inflationary backlash.
Some see inflation returning though next year as economies normalize after a COVID-19 vaccine rollout, but most analysts remain skeptical that it will get out of hand.
“This is a scenario where the balanced portfolio tends to shine,” said Kimball.
The Vanguard Balanced index fund
which follows the 60-40 allocation, has gained nearly 13% year-to-date. That’s only a bit short of the 14.5% returned by the S&P 500
and much higher than the 4.9% earned by a basket of investment-grade government and corporate debt, tracked by the iShares Core U.S. Aggregate Bond exchange-traded funds.
It’s no wonder U.S. investors are reluctant to depart from a tried-and-tested strategy.
“It’s a bit amazing how many investors still cling onto that as their comfort zone. It truly does seem to be well ingrained in U.S. investors’ minds,” said Anders Persson, chief investment officer of fixed income at Nuveen.
Persson said some of the stubbornness around 60-40 funds may reflect the persistence of higher yields offered by the U.S. over the rest of the world. Homebound Americans have rarely had to search abroad for investment opportunities thanks to a profusion of riches on their own shores.
“With $15 trillion of negative-yielding debt across the world, we’re a bit spoiled in the U.S,” said Persson, who conceded even now U.S. government bonds continued to draw strong interest overseas.
Whereas, European and Japanese insurance companies faced with a paucity of high-yield investments in their own markets have been quicker to size up opportunities in these more exotic debt investments, said Persson.
In the end, some investors say it will be hard to give up on government bonds altogether and they are likely to remain a prominent part of investors’ portfolios in the coming years if only because they can hold up their value during market turbulence.
“Why do you own it? You own it for stability to brings to your portfolio,” said Todd Jablonski, chief investment officer at Principal Global Asset Allocation.