June 2021 Issue: End of 40-year Fixed Income Bull Market Raises the Urgency of Diversifying-End of 40-year Fixed Income Bull Market Raises the Urgency of Diversifying by Locorr Funds Research Team

End of 40-year Fixed Income Bull Market Raises the Urgency of Diversifying by Locorr Funds Research Team

Pdf Summary

Experienced investors typically include both stocks and bonds in a well-diversified investment portfolio. However, generating steady returns with a traditional 60/40 portfolio has become more challenging in today's low-interest-rate environment. Bonds have performed well in the past, but with interest rates near zero, it is unlikely they will continue to provide the same returns. As an advisor, it is important to re-examine portfolio allocations and consider alternative strategies.<br /><br />Based on current data, a hypothetical allocation to Treasuries and corporate bonds would only yield returns of 1.1% and 1.9%, respectively, if interest rates remain unchanged. Even a small increase in interest rates would negatively affect bond prices and returns. This is a different outcome from what bond investors have experienced in the past 20 years.<br /><br />To maintain a 5% total portfolio return in a 60/40 portfolio, the equity component would need to return an impressive 9.5% if interest rates increase by 0.5%. This raises the question of whether equities can make up for the potential shortfall, or if investors should reconsider their fixed income allocations.<br /><br />Parking capital in low-yielding fixed income investments with asymmetric risk could be detrimental to expected portfolio returns. It may be necessary to evolve asset allocations and consider other diversifying assets beyond fixed income. Adding a third leg to the portfolio, such as alternative investments, can potentially create a smoother and more consistent ride for client portfolios.<br /><br />The new 60/40 portfolio allocation may look more like 60/20/20 or 60/30/10, with a portion of the fixed income allocation being replaced by low-correlating strategies. These strategies can help reduce risk and potentially increase portfolio returns. It is important to evolve portfolio construction to include equity, diversifiers, and alternatives that can adapt to the current low-rate climate.

Keywords

experienced investors

stocks

bonds

investment portfolio

diversified

low-interest-rate environment

interest rates

alternative strategies

Treasuries

corporate bonds