Navigating the Bond Slice of a 60/40 Portfolio

Timothy Ralph of Merit Financial Advisors believes the “new regime” of higher interest rates and inflation brings active management into play.

Timothy Ralph, managing partner and wealth manager at Merit Financial Advisors, specializes in investment management, small business planning, retirement planning and estate planning. His area of expertise is comprehensive financial planning. We caught up with him to discuss the challenge of managing the fixed-income slice of a balanced portfolio. 

Jeff Benjamin 

Jeff Benjamin: With all the turmoil in the bond markets, is there still a case to be made for the traditional portfolio of 60% stocks and 40% bonds?  

Timothy Ralph: Fixed income finally offers income after yields surged globally. This has boosted the allure of bonds after investors were starving for yield for years. In portfolio management, contractual returns are important. 

By contrast, we can know the stated return and income from the bond. It provides stability and certainty. This is not the case for equity returns. For the last eight years or so, we have not had the opportunity to use fixed income as a return spectrum for the portfolio or income retirement planning. Bonds are back.  

JB: How are you navigating the bond side of client portfolios? 

TR: We are in a new regime for interest rates, living with inflation and elevated global risks, where active management is essential. 

Our view has been to take a granular bond investment approach to capitalize on this, rather than taking broad, aggregate exposures. Investors can look to implement more dynamic strategies through active bond management or unconstrained managers. Alternative strategies such as managed futures have also historically done well during periods of inflation, commodity inflation and higher interest rate environments.  

JB: Bonds are often viewed as the ballast in a diversified portfolio. Is that still the case, or are bonds now riskier than stocks?  

TR: History shows that 10-year bond returns follow interest rates and tend to outperform when the fed-funds rate is greater than inflation, the Fed stops raising rates and when short-term rates are higher than long-term rates. 

Additionally, when the 10-year real yield, after inflation, is positive, which is it now, the price correlation to the S&P 500 decreases. It may be fair to say, the Fed has adjusted the ballast in the portfolio through their interest rate policy.  

JB: What do you see as the biggest risks in a bond portfolio at this point? 

TR: Interest rate duration continues to be the greatest challenge for managers and investors. 

In the last 18 months, many investors flocked to short-term, high-yield money-market funds or CDs. With the Fed expected to lower rates toward the back half of 2024, when does one move from a two-year bond to a five-,10- or 20-year bond to lock in the high-interest rates for longer? Our answer is slowly and surely. Lock in the higher rates for longer.  

JB: What kinds of adjustments are you making to overall client portfolios? 

TR: For investors who have an income focus, we have initiated a few strategies and tactics to address clients bond portfolios ahead of and during this rising rate environment. 

Strategically, we moved many clients out of bond mutual funds and ETFs into diversified individual bond portfolios. This provides the client with more certainty that they will get their money back within the stated period or at maturity. 

If the underlying issuer does not go bankrupt, the client has the worst-case scenario built in. Tactically, portfolios positioned short-term taking advantage of higher yields and limiting the price fluctuations in the portfolio.

Interestingly, many high-yield corporate bonds are short-term in nature, maturing in less than two years, providing elevated contractual returns.  

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