A very tough year for investment portfolios

Weakness across bond, equity markets add up to losses for the 60/40 strategy

The gold standard model for a balanced investment portfolio — 60% stocks and 40% bonds — lost its shine during the market meltdown that has punished both asset classes from the start of this year.

Typically, when the price of stocks falls, the bond portion of a 60/40 portfolio acts like a shock absorber. But bonds did not provide their usual degree of protection this year. Instead, they lost almost as much value as stocks.

At one point, the Barclay’s Aggregate Bond Index — the most widely watched gauge of the bond market — was down 11%, which is the biggest drop in the index since 1982. Long-term treasury bond losses were even worse — down more than 30% from the alltime high set in July 2020.

“What’s happening in the stock market is not out of the ordinary. It was down as much as 20% at one point,” said Brian Koble, chief investment officer at Downtown-based Hefren-Tillotson, a Baird Co. “That happens every 3½ years on average since 1900. So, investors are accustomed to seeing that.

“What’s unusual are the losses in the bond market, which are the worst in 40 years,” Mr. Koble said.

Coming into 2022, stock prices had soared to record highs while interest rates for bonds shrunk to historic lows.

That situation didn’t leave much room for either asset to do well when the Federal Reserve embarked on a rate hiking path to combat inflation.

The silver lining is interest rates are higher than they were this time last year, which translates to higher income generated for people who own fixed income investments. In the long run, higher rates also will help the bond market rebound and be able to fulfill its traditional role of providing diversification from stocks.

“The reason you have bonds in a portfolio, historically, is to diversify from your equity market risk. It’s not really to provide long-term superior returns,” said Michael Godwin, chief investment officer at Fragasso Financial Advisors, Downtown.

“Bonds historically do a pretty good job of that,” he said. “They didn’t do a good job of diversifying from equity risk at the start of the year. But bonds are becoming a bit more appealing from a diversification standpoint.”

Inflection point?

The classic 60/40 portfolio has been a winning formula for years.

It has generated an impressive

10.34% average annual return over the last four decades and a return of 9.39% over the past 10 years, according to Chicago-based Morningstar Direct.

However, portfolios based on that strategy lost an average 11.15% from January to the end of May 2022.

In light of the recent losses, analysts at some financial institutions such as Bank of America are predicting doom and gloom for the future of the 60/40 portfolio.

Pittsburgh financial adviser David Root Jr., CEO of DBR & Co., Downtown, believes the best days for such portfolios are still ahead.

“The good news is that bear markets sow the seeds of future investment success 100% of the time,” Mr. Root said. “In fact, I think we’re very close to an inflection point where a 60/40 reentry makes more sense.”

The Nasdaq is squarely in bear market territory with a 23% loss on the year. Companies that have been stalwarts for the S&P 500 Index — until tech tumbled in late November — include companies like Amazon, Google (Alphabet) and Apple, all down 27%, 21% and 16% year-to-date, respectively.

“When great companies are ‘on sale,’ as a long-term investor you should buy more,” Mr. Root said.

“In buying the S& P, you’re not just getting great companies in hot sectors like energy, but also great companies like Amazon and Apple that have led the economy for decades. On the bond side, you could argue treasuries have become value-priced with the precipitous rise in interest rates this year.”

Now that interest rates have reset higher, the returns going forward for new bonds should be higher than they’ve been in the last five or 10 years.

The Barclays Aggregate Bond Index is currently yielding 3.4%, which means it’s reasonable for bond investors in treasuries, corporate bonds and other government bonds to expect the return on their bonds going forward to be in the range of 3% to 4%.

Mr. Koble said he believes the bond market has seen its worst days and is beginning to stabilize.

“When yields on the 10year treasury start to drift above 3%, it seems to attract a lot of buyers and it pushes yields back down,” Mr. Koble said. “The other dynamic we’ve seen is that as mortgage rates have pushed up it started to slow the housing market.

“Once the 30-year mortgage rose above 5%, we’ve seen the housing market slow down in recent weeks. Rising rates seem to be selflimiting to the extent it causes the economy to slow and that causes interest rates to fall again.

“So, I think we’ve seen the worst of the damage in the bond market,” he said. “I’d expect the stock market to remain volatile through the summer. A sustained rebound will only come after we have a line of sight on how and when inflation will fall to normal levels.”

Beyond bonds

While stocks are expected to remain challenged for the rest of this year, that doesn’t mean investors should sell equities and go to cash, according to Mr. Godwin.

Dollar cost averaging is a better strategy for stocks, but the portion of portfolios that would usually contain bonds could use a tune up.

“Bonds, even though they’re more appealing now going forward, their return profile is still going to be lower than what investors have been accustomed to over the last 20 years or so,” Mr. Godwin said.

Investors should look beyond bonds for opportunities to diversify portfolios.

He said financial markets have evolved significantly over the last 10 years and certain investments that were once only available to large institutions and endowments are now available to retail investors, such as private credit and private real estate investments.

“Your money is a little less liquid than traditional stocks and bonds, which you can buy and sell on a daily basis,” Mr. Godwin said. “We think going into less liquid products makes a lot of sense here.

“It helps mitigate a little of the volatility and hopefully get a little better returns going forward.”

“What’s happening in the stock market is not out of the ordinary. ... What’s unusual are the losses in the bond market, which are the worst in 40 years.”

— Brian Koble, chief investment officer at Hefren-Tillotson