Is the Traditional 60/40 Portfolio Obsolete?

In Institutional Investor, Ron Lagnado asks if the 60/40 portfolio is obsolete.

The traditional 60/40 mix of stocks and bonds, commonly portrayed as an optimal portfolio, is supposed to mitigate the effects of this sort of extreme market volatility and deliver returns that pension fund managers can rely on. But the 60/40 mix is an artifact from another time. The optimal mix presumes it is possible to achieve a high rate of return while simultaneously constraining volatility. In practice, it limits portfolio volatility in benign market environments over the short term while making huge sacrifices in long-run performance. The so-called optimal portfolio is, in effect, the worst of all worlds. It offers scant protection against tail risk and, at the same time, achieves an under-allocation to riskier assets with higher returns in long periods of economic expansion, such as the past decade.

Lagnado thinks options-based tail-risk hedging strategies can do better than bonds.

I think the optimal portfolio is all cash all the time. In my view, the 60/40 misses something fundamental. Bonds are an asset. Stocks are equity. They’re not the same thing.

An asset is just a thing like gold or copper or even a house. But equity is a working business that takes assets to make a product. Copper is just a rock (ok, ok, an element). It just sits there. In 1,000 years, it’s still the same thing. Only when people come along can copper be employed to do something useful.

The 60/40 view assumes that bonds are like adding a calming agent to some chemical formula. Instead, equity is completely different from other classes of investments. It’s the only one that captures human ingenuity, which is the ultimate asset.

Posted by on August 17th, 2020 at 2:08 pm


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