A balanced portfolio traditionally involves a 60/40 mixture of equities and bonds, with the proportion of bonds rising after retirement to reduce volatility. But with bond yields at very low levels, private investors are looking elsewhere.
Other low-risk investment options are emerging as alternatives as individual investors and fund managers look beyond the conventional portfolio structure. They’re now taking full advantage of new and evolving asset classes like cryptocurrencies and property.
Mike Deverell, partner and investment manager at Equilibrium Investment Management, thinks the days are behind us when a balanced portfolio relied on equities and bonds.
“Central banks are likely to put up interest rates over the next few years – perhaps only to 1% here in the UK and maybe 2% in the United States, but substantially higher than the near-zero levels they are at now,” he says. “They will also want to scale back or even reverse quantitative easing. If this happens it will probably be bad for bonds, where yields tend to go up and prices go down when rates rise.”
That could have a knock-on effect on the stock market, which has been supported by low yields and quantitative easing. Big tech stocks in the US would be vulnerable, while inflation could erode purchasing power.
Keeping it real
Deverell believes the balanced portfolio of the future should have an allocation to ‘real assets’ like infrastructure, selected property and alternatives like forestry, which will benefit from the green agenda as businesses look to offset their carbon.
“If chosen wisely, these assets can provide a solid, high level of income, which tends to increase at least with inflation,” he says.
Adam Walkom is co-founder at Permanent Wealth Partners, a firm of financial planners. For him, the traditional 60/40 Balanced portfolio is dead.
“In a low and rising interest rate world, having a significant portion of your portfolio in an asset class that is almost guaranteed to lose money is not diversification – it’s stupid,” he says.
Thanks to the traditional 60/40 approach it “became too easy for the adviser to bundle a client into a balanced portfolio because they ticked boxes on the risk questionnaire a certain way. Good for the regulator, bad for the client”.
If you won’t need the funds for 20 or more years, you should hold 100% equities, Walkom says. For shorter time-based needs – say, five years or so – an “all-weather” portfolio could be an option. This uses a spread of different assets for the non-equity portion, such as property or real estate investment trusts (REITs), gold, private equity and perhaps some inflation-linked bonds.
Traditional bonds just don’t maintain purchasing power for investors today, thinks
Hinesh Patel, portfolio manager at Quilter Investors. Instead, he suggests they look for selective opportunities in real assets like infrastructure projects, care homes and warehouses that can provide attractive income yields.
ESG opportunities
Some wealth managers think thematic investing, not geographical boundaries, is the strategy of the future. Over time, there will be a continued increase in exposure to theme-based investing, potentially at the expense of geographic allocations, says Chris Ainscough, director of asset management at Charles Stanley.
“Geographies are a clean and easy way to break up the investable universe, but they don’t always take into account the overlapping exposures across the globe or the fact that the domicile of an investment may be very different from the economic exposure of that investment,” he says.
Having a significant portion of your portfolio in an asset class that is almost guaranteed to lose money is not diversification – it’s stupid
An example might be the green energy transition, which will likely have no borders as the world unites to tackle the problem. This thematic move will also involve a shift to real assets like property and gold as an alternative to traditional fixed income exposures.
The heightened awareness of environmental issues and climate change has also given individual investors a reason to be more vocal about how their money is invested. Environmental, social and governance (ESG) issues have come to the fore in investment decisions.
“The fastest evolution of asset markets in recent years has been to cater to clients’ preferences regarding ESG, impact and other ethical concerns that they may have,” Ainscough says. “The construction of a balanced portfolio will have to adapt to cater to these.”
Changing preferences
While the principles guiding portfolio diversification will remain the same, investor preferences are changing, says Dr Harjoat Bhamra, associate professor of finance at Imperial College Business School. “In the future, a well-balanced portfolio will have more exposure to greener assets,” he says.
Another alternative to traditional bonds is exchange traded funds (ETFs) focused on investment-grade green bonds. This could be a useful option for investors at a time when the EU has started to issue green bonds.
“With most government bond yields at rock bottom levels, the traditional income and diversifying role they have played in portfolios for many decades is challenged,” says Vivek Paul, senior portfolio strategist at the BlackRock Investment Institute.
The other key question facing investors is how they can integrate sustainability, Paul adds.
“There is a deeper and more widespread understanding that sustainability risk is investment risk. Climate change affects every aspect of modern life, so it is no surprise that it is shaping portfolio construction too.”
David Ko and Richard Busellato are the co-founders of Rethinking Choices, a sustainability agency, and authors of The Unsustainable Truth. They argue that bonds offer a poor investment choice in the current environment due to the inflation and credit risks.
“The future well-balanced portfolio needs to be underweight in those companies that rely on volume growth, clever leverage, or significant ongoing investments selling images of perfect futures,” says Ko. Instead, investors should seek out street smart, resilient companies which know how to thrive in a hostile environment and produce genuinely needed goods and services, adds Busellato.
