Falling yields challenge case for 60/40 portfolio strategy
PremiumIt’s a good rule of thumb, but consider other factors also during asset allocation, say experts
The 60/40 investment allocation strategy has been one of the mainstays of portfolio construction globally over the past few decades. This strategy involves investing 60% of one’s portfolio in equity, be it large-cap or mid-cap stocks, and the rest in debt.
The idea is to provide protection against drawdowns, market falls and economic collapses to a certain degree and at the same time achieve growth, as the strategy is biased towards equity.
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However, over the past few years, this allocation style has come under criticism, globally. The key concern has been tepid returns in the debt portfolio. Loose monetary policy and stimulus injections to cope with the covid pandemic have left more than $17 trillion of bonds with negative yields.
According to a report by J.P. Morgan Asset Management, the impact on government bond yields of ultra-low interest rates is clear: over 85% of developed market government bonds are yielding below 1% and around 35% deliver negative yields.
Some experts say that the 60/40 style doesn’t fit in the Indian context. “60/40 is a very US concept, and very few in India will have 60% of their money in equity. The reason the strategy’s adoption is higher over there is that in the US, people don’t have Employee Provident Fund and the debt returns are quite low," said Mrin Agarwal, founder, Finsafe India Pvt. Ltd.
We look at whether Indian investors should follow this classic approach and the key challenges the strategy faces.
A 60/40 portfolio takes a more or less static approach, rebalancing back to this proportion if a rally or dip in the equity or bond market pushes the portfolio away from this ratio.
For example, if an equity market rally moves the weight of equity in the portfolio to 80%, the investor would sell the excess equity in such a proportion that the 60/40 composition is restored. This corrective action thus acts as a safety break from market downturns or irrational exuberance.
Investors can follow this approach either by investing in separate equity and debt funds or by investing in hybrid funds. The advantage of the latter is that the rebalancing inside the hybrid fund does not attract exit load or tax.
On the flip side, the investor cannot choose market segments (large-cap, mid-cap, etc.) when taking the hybrid route.
Srikanth Meenakshi, co-founder, PrimeInvestor, who has been using the 60/40 strategy for the past 10-15 years for his own retirement portfolio, says that this is a classic moderate-risk long-term portfolio. Meenakshi’s vision for a 60/40 portfolio also includes international funds and gold.
“A 60/40 portfolio would typically look like 20% in large-caps, 30% in a mixture of flexi-cap and mid-cap category and about 10% in international equity, as well as 20-30% in debt and the remaining 10-20% in gold, depending upon the investor’s preference for gold and international allocation. This allocation has got multiple compensatory factors to protect against downfalls. It is growth-tilted, but has significant protection elements," said Meenakshi.
The efficacy of the 60/40 strategy more or less depends on the outlook for debt and equity. In the Indian context, experts say that we are in a very tough situation in terms of economic growth. Due to localized lockdowns in the country, the Reserve Bank of India is very much determined to get growth back on track. Therefore, experts feel that liquidity is going to be surplus for quite some time.
“The returns on the debt side are going to be sluggish. The 10-year bond yields are going to be around 6%, meaning 5-6% returns for investors for a year or so till lockdowns and the covid situation eases," said Rushabh Desai, a Mumbai-based mutual fund distributor.
According to Desai, a 50/50 portfolio would be the perfect breakup for a portfolio. “However, as we are not seeing much return on the debt side, a 10-15% higher allocation to equity can really help averaging out the debt side and give more returns," he said.
Investment advisers say that in portfolio building, it is tough to determine what a thumb rule is and asset allocation is derived from an investor’s financial objectives.
“For a young investor, the underlying investment could be 75-80% equity and the rest in debt, but if someone is looking at the money in the next two-three years, then it could be almost 90% non-equity. The investor’s financial goals are also a factor. The overall portfolio works on the basis of the suggested asset allocation for each financial goal. So, the core asset allocation is nothing but the sum of all asset allocations of all the financial goals," said Harshad Chetanwala, a Sebi-registered investment adviser and co-founder of MyWealthGrowth.
Amol Joshi, founder, Plan Rupee Investment Services, a Mumbai-based mutual fund distributor, came out strongly against a higher equity allocation due to low yields.
“The determinant of asset allocation is risk appetite and not expected return. Yes, bond yields have fallen, but so has inflation. I don’t see a case to move someone more into equity simply due to a fall in bond yields," he said.
A 60/40 portfolio is a good rule of thumb, but the investor must also consider his or her age, financial goals, risk appetite and outlook for debt and equity markets while choosing an asset allocation.
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