Maven Asset Partners
March 14, 2019
By emphasizing the application of technology and a systematic investment process, Maven delivers a series of strategic and tactical asset management strategies.

The 60/40 Problem

The following is another excerpt from our recently published whitepaper, The 60/40 Problem: Examining the Traditional 60/40 Portfolio in an Uncertain Rate Environment.

You can download a full copy of the whitepaper here .

Executive Summary

The investment industry is facing a “60/40 problem.” Over the past several decades, advisors have leaned on the 60/40 portfolio to deliver a less-volatile, but still relatively reliable return for balanced investors due to their lack of tolerance for the volatility and drawdowns of a pure equity allocation. While the addition of bonds to an otherwise non-diversified portfolio of equities does indeed reduce the beta of the overall portfolio, the correlation to equities remains high given that “the 60” has been 3 times as volatile as “the 40.” In our view, the 60/40 problem boils down to an underestimation of future risks for both bonds and stocks. Rather than solving a new problem with an old solution, Blueprint has considerable evidence of a better way.

 

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Historically the trade-off between equities and bonds has conformed to intuition and been in sync with financial theory – as rates fall, bond prices increase and stocks become more attractive on a relative basis. Investors during interest rate regime changes were left with a relatively simple choice – bonds near new highs or stocks near new lows… or the converse. With U.S. stocks and bonds both at or near all-time highs, the choice today is significantly more complicated. At this juncture, investors are confronted with a changing interest rate landscape following an environment where equities and bonds have both generated Sharpe ratios above their full sample average. Could rising rates cause an economic crisis? Could equities and bonds continue to rise in tandem? What is an advisor to do in these uncertain times? Our answer at Blueprint utilizes traditional asset class diversification while also incorporating time diversification or trend following.

 

Using simple models to show the robust properties of this approach, we tested the effects of utilizing a trend following model applied to a 60/40 portfolio during each of the U.S. interest rate regimes vs. buy-and-hold. Using 8 and 12 month moving averages (T8 and T12 respectively), we analyzed the absolute and risk-adjusted returns to determine if the addition of trend following could benefit a traditionally allocated portfolio during rising and/or falling rate environments. The two trend following strategies included a 20% buy-and-hold component and 80% trend following component. The buy-and-hold component was included to allow for the benefits of asset diversification as well as to guard against investors making emotionally-charged decisions impacted by Availability and Hindsight biases. Regarding trend following strategy rules, when the most recent month’s closing price was above the moving average, the asset was determined to be in an uptrend. When the most recent month’s closing price was below the moving average, the asset was determined to be in a downtrend. Allocations were then shifted from downward trending assets to upward trending assets or cash.


You can download the remainder of the whitepaper here .

 

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