What to do when magical 60:40 formula doesn't work

However, according to a recent Morgan Stanley report, till 30 June this year, a 60:40 portfolio of the US equities and the Aggregate Bond Index lost around 16% of its value, wiping out all 60:40 gains since September 2020. Portfolios in the Europe suffered a similar fate, data showed.

In India, a 60:40 portfolio comprising S&P BSE 500 index and S&P BSE India Bond Index is also in the negative zone, but has fared much better than its global peers— at -2% till 31 July.

In the Indian context, a moderate investor who wants to beat inflation and doesn’t want to take a lot of risk bets on a 60:40 portfolio. This strategy also works for those who have already built their wealth, and now want to focus on saving their investments.

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Globally, the 60:40 investment strategy has been one of the mainstays of portfolio construction over the past few decades as it usually works because equities and debt have negative correlation. However, stocks and bonds have fallen in tandem this year, raising questions over this strategy.

 

Inflation has been going up steadily, and to combat it, global central banks have been on an interest rate hike spree. “Interest rates going up have reset equity valuations. And even though, in the long run, equities tend to beat inflation, in the short term, it does have an impact on the risk-free rate calculation. Therefore, valuations seem to correct. Similarly, when rates go up, the NAV (net asset value) of debt MFs take a hit, depending on the duration of the papers," said Rishad Manekia, founder and managing director, Kairos Capital.

Given the high inflation scenario, a 60:40 portfolio is on route to give net negative returns this year for the first time since 2018 in India.

However, returns will also depend on the kind of asset allocation and papers you put in the portfolio.

Kirtan Shah, founder and CEO, Credence Wealth Advisors, suggests splitting the equity allocation equally between large, mid and small-cap stocks. “Further, your debt side of the portfolio has to be largely on the side of taking duration risk."

Shah feels that interest rates will top out globally, provided China and Taiwan tension does not intensify. “Rates will start topping out, so, duration as a play will look very interesting for the coming 2-3 years. If you’ve done a large, mid, small-cap split in equity, and are playing duration on the fixed income, you will easily be able to beat inflation,“ he said.

An alternative to a 60:40 portfolio is investing in separate equity and debt funds or hybrid funds. The benefit is that rebalancing inside a hybrid fund does not attract exit load or tax, however, the disadvantage is that an investor won’t have a say over allocation to equity market segments.

Direct investing or not, experts warn that 60:40 is not a magical formula that investors can blindly follow.

The key aspects of building a portfolio are understanding one’s risk appetite and the investment horizon.

“For example, if an investor is 35 years old and has 20-25 years of investment life left, it would make very little sense to invest in a 60:40 formula. If you make broadly five buckets, one bucket will obviously will have 60:40 allocation, which will fit 20% of the people. This isn’t a magic bullet or formula that everybody should follow," said Amol Joshi, founder of Plan Rupee Investment Services.

According to experts, an Indian investor who is aggressive can look at 80:20 or 90:10 portfolio, which is tilted towards equity. On the other hand, a conservative portfolio should have 80% of the allocation in fixed income and the rest 20% in equity. “Somebody who is young and has 10-15 years of investment horizon or more, can digest volatility. For them, 80:20 or 90:10 equity portfolio would make more sense," said Shah.

While the 60:40 portfolio can be an ideal portfolio for some, one must customize it as per their income and goals

“Given the high-inflation, you may want to consider upping your equity investments for the long term. Liquid funds that offered 3.5% returns in the past few months now offer 4.7% and are expected to improve to 5.25%, and that should support your other debt investments," said Adhil Shetty, CEO, BankBazaar.com

Ideally, a 60:40 portfolio is debt and equity-based. But given the state of inflation, adding other asset classes may make sense. “You can look at investing in gold as a hedge against equities and bonds, however, keep it below 5% of your overall portfolio. Gold has long periods of stagnation followed by brief and sharp spurts in price. The returns from gold in the last year were negative, and the 10-year return is around 5-6% (annualized)," said Shetty.

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