Core Stock & Bond Portfolios Need New Look

November 01, 2016

This article is part of a regular series on thought leadership from some of the more influential ETF strategists in the money management industry. Today's article is by Andrew Gogerty, vice president of investment strategies at Boston-based Newfound Research.

At the beginning of 2016, Newfound published our market outlook for the coming decade. In it, we state that successful investing going forward will require a portfolio that’s built not only on a foundation of classic stocks and bonds, but also with significant allocations to alternatives, risk-managed strategies and satellite income asset classes.

Market outlook pieces from large global investment banks and research shops like J.P. Morgan echo many of our thoughts: Global equity valuations are stretched, and estimates for bond returns are unappealing.

As such, a fully passive, market-cap-weighted core stock/bond allocation profile that ignores macroeconomic trends, valuations, fundamentals and current risk levels may be suboptimal. If you believe the projections are correct, and that core stocks and bonds have valuation and income head winds, simply combining these two asset classes won’t get it done like it has in the past.

Core Allocation Need A New Wrinkle

Things get more interesting, however, when the universe of investments is expanded to include higher-income asset classes such as high yield, bank loans and emerging market debt.

As a quick example, using the capital market assumptions from J.P. Morgan, an optimized portfolio that matches the volatility of a traditional 60/40 core stock/bond allocation has only 35% in core stocks, 3% in core bonds, and 62% in satellite fixed-income asset classes and alternatives. (You can dig in with two hands into the nuts and bolts in our recent commentary here.)

The takeaway is clear: For a balanced portfolio to offer better expected returns than a traditional core stock/bond allocation, it must look different in today’s environment.

To say that portfolio allocation “deviates from the norm” is an understatement. This may cause issues, as the success of any investment philosophy is first based on whether you can stick with it.


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