Investors with a 60/40 portfolio may want to shift focus into fixed income now
Portfolio managers who've traditionally used a 60/40 stocks-to-bonds split for clients say that now is the time to consider buying more heavily into fixed income to weather volatility and economic weakness ahead. Both asset classes have had a rough year. Bond yields have rebounded lately, and some areas of the market are showing solid income for investors. Yields move opposite bond prices. "Bonds are more attractive than they've been in a while, probably over a decade," said Barry Gilbert, an asset allocation strategist for LPL Financial, adding that they make the most sense for investors who are more conservative or looking to pad income in their portfolio. At the same time, stocks have been volatile and are likely to continue to whiplash. That's already prompted investors to sell out of the riskier assets in exchange for the safety of fixed income. The ratio between equities and bonds has fallen since mid-August, Credit Suisse analyst David Sneddon wrote in a Monday note. "This suggests that we may be seeing a more decisive turn lower and a more sustainable downtrend as investors move out of equities further and finally start moving into bonds, with the equity downtrend itself expected to gather pace," he said. Which bonds make sense The threat of a potential recession is spurring movement into bonds, especially as continued high inflation and rate hikes from the Federal Reserve weigh on stocks. "We think equities have further room to fall particularly as earnings are at further risk in a recession scenario," said Michael Reynolds, Glenmede's vice president of investment strategy. In such an economic environment, being underweight market risk makes sense. It also seems sensible to turn to fixed income for some protection. Historically, bonds mitigate risk and blunt volatility that equities usually see. Although this year has been rough on both asset classes, it hasn't changed that fact, according to Anthony Saglimbene, chief market strategist at Ameriprise Financial. "What has changed this year is that income is looking more attractive today with yields coming back up," he said. "When you start getting 4% for the two-year and near 4% on the 10-year, those are attractive yields." Currently, the yield on the two-year U.S. Treasury is about 4.14%, while the yield on the 10-year is 3.75%. Shorter duration bonds are popular with investors right now due to these higher yields. For instance, rates on the U.S. one-year and three-year bonds are above 4%. "Right now, we are putting our over weights into short duration fixed income," said Reynolds. "We're also less exposed there to rise in interest rates." He noted that the firm's sweet spot is in the two-to-three-year range, as that's where they're finding the best value. Those with more bonds in their portfolio would want to lean more heavily on the shorter end of the yield curve for the most protection and income, according to LPL's Gilbert. However, investors with a more traditional 60/40 split would probably want to hold duration around six or seven years, he said. Of course, if there is a recession in the next few years, there will come a point when it makes sense to beef up on bonds even more and look for investments farther out on the yield curve. "In recession environments you want to have a little bit of duration and if interest rates come in you can get a big payoff on those bets," said Reynolds of Glenmede. Now, he noted, that bet is a little premature because interest rates are likely to go a bit higher. Other areas of fixed income To be sure, investors may be wary of bonds as they've also been hit hard this year, resulting in price declines on both sides of the 60/40 portfolio. For those that are looking for income but don't want to play too heavily in bonds, there are some other options, according to Rob Burnette, CEO and financial advisor at Outlook Financial Center in Troy, Ohio. That includes blue-chip stocks that pay solid dividends like IBM or looking at other investments such as preferred securities or structured notes. Preferred securities are fixed income instruments that hold some qualities of stocks and bonds and generally offer higher yields, while structured notes are debt issued by financial institutions. It may also make sense to have a larger cash holding on the sidelines ready to go back into equities. "It's good to have some dry powder on the sidelines in the environment like this, you never really know what sort of opportunities will arise," said Reynolds. It may also be a good time to buy stocks and bonds now and move back toward a 60/40 split, said Gilbert. "You should be looking at opportunities when it feels the worst to do it," he said. It might make sense to rebalance Investors who want to position appropriately for the coming months may not have to do much to bring their portfolios in line, given the sell-off in equities year to date. Still, it makes sense to regularly reassess the balance of bonds, stocks and cash to make sure your allocation meets your goals. Many investors may find that even if they haven't seen great gains this year, they're still set up for success in the long term and shouldn't make any emotionally driven changes. "A well-diversified portfolio continues to be the best path forward for investors," said Saglimbene.