Bond volatility has busted safety valve of 60/40 portfolio

BLOOMBERG

The biggest swings in bonds in more than a decade this year are a fresh challenge to the time-honoured 60/40 investment strategy.
Holding 60% of portfolios in stocks and 40% in bonds, revered as reliable for decades, fell 17% last year, the worst performance since 2008. While it’s unlikely such a dismal result will be repeated this year, some big Wall Street names are suggesting investors look for alternative diversification given the volatility in debt markets.
“We are keen to diversify our stabilising layer so that we are not overly reliant on government bonds,” said Catherine Doyle, an investment specialist for real return strategy at Newton Investment Management. “Recent volatility within bonds makes it less attractive for 60/40 portfolios.”
The 60% allocation to stocks is intended to provide capital appreciation while the 40% holding of bonds acts as a safety valve for stock risk. For it to work, ideally the correlation between the two assets should be negative and bond volatility should be low — or at least lower than equities. Both theories are being put to the test.
While bond markets have calmed down a touch after wild swings in March following the collapse of three US banks, there’s plenty of uncertainty ahead that could bring back the turbulence. Sticky inflation means central banks may not be able to pause rate hikes as soon as hoped, raising the risk of recession or further corporate collapses to follow those of Silicon Valley Bank and Credit Suisse Group AG.
BlackRock Inc said that 60/40 doesn’t work in an environment where central banks are likely to raise interest rates into a recession to bring down inflation.
The ICE BofA Move Index, which tracks expected swings in Treasuries, has started to pick up again after tumbling by nearly 40% since a 15-year high in mid-March. By contrast, the VIX Index, the most common gauge of stock volatility, is holding near a one-year low.
The 60/40 strategy suffered in 2022 because bonds and stocks fell in tandem as central banks raised interest rates. Low bond yields at that time also provided little protection for the portfolio. Yet there are still plenty of 60/40 believers for the long run, despite the recent setback.