Balanced portfolios are far from dead. Dr Benjamin Holdsworth on why they remain a valuable protector against inflation.
Legend has it that, in 1895 while in London, the novelist Mark Twain, who had been feeling a little poorly, discovered that a journalist had written his obituary and quipped: ‘The reports of my death are greatly exaggerated’.
In the past few years, obituaries for a traditional ‘balanced’ portfolio of, say, 60% equity, 40% bonds have been written by several journalists and fund managers. We think that such a portfolio continues to be alive and kicking.
Good investing is grounded in three things:
- Using investment logic to think clearly about what one puts into a portfolio;
- Using empirical insights to inform us of general longer-term characteristics of assets and how they work together in a portfolio – and the shorter-term exceptions to these generalities;
- The fortitude to stick with a sensible portfolio strategy through these shorter-term, trying periods.
A portfolio mix of bonds and equities balances the potentially severe downside falls in equity markets by owning far less volatile, good-quality bonds that will not fall as far, if they do fall at all.
There is a general expectation that at times of severe equity market trauma, what is known as ‘scared money’ – that is to say, those who are risk-averse – will move into high-quality bond, pushing yields down and bond prices up.
There is a see-saw effect between yields and prices. That is often but not always the case as 2022 and 1994 demonstrated.
It is certainly fair to say that the past five-year period has been tough for 60/40 balanced portfolios, given that it included the global pandemic, the war in Ukraine, a rapid end to the era of low nominal and negative real interest rates, the highest inflation in 40 years in the UK and a downturn in global equity markets in 2022.
Even so, it delivered a return that more or less matched inflation over this period, which should be regarded as a good outcome.
Data shows us that this structure has delivered growth of purchasing power in the vast majority of five-year horizons and beyond. The longer one holds, the more consistent returns become.
Compare this to the 1970s, which saw a decade of rampant inflation – up an alarming 240% cumulatively from 1970 to 1979.
Five-year, after-inflation returns for a 60/40 balanced portfolio from 1970 to 1975 were, perhaps not surprisingly, negative. Yet investors who stuck with it during this very difficult period ended up with positive real returns after 15 years, increasing purchasing power by around 50%.
Over the same period, holders of cash would have turned £100 into £85 of purchasing power. More proof if we needed it that investing is a long-term game.
From 1970 to 2022, the 60/40 balanced structure doubled an investor’s purchasing power every 15 years, on average.
Press articles are often influenced by recency bias, which encourages investors to make portfolio decisions based on recent events.
For example, the spectacular return of commodity futures in 2021-2022 hides their material underperformance compared to global equity assets over the longer-term.
Yet to include them in a portfolio, after a bout of strong short-term performance, fails the investment logic and empirical evidence tests.
Investment logic still suggests that shorter-dated, high-quality bonds will remain a useful balance to extreme equity markets, if and when they occur, providing strong downside protection.
At market extremes, scared money will still flow to these assets. Bonds are now yielding substantially higher yields today than 18 months ago, providing more return and a greater buffer against any future yield rises.
Empirical evidence suggests that bonds are often, but not always, negatively correlated to equities – that is to say, they move in the opposite direction.
It also suggests that markets work pretty well and trying to guess which asset class will do well this or next year is well-nigh impossible.
As such, having the patience to stick with an investment strategy over the longer term is really important.
The last five years may not have been spectacular, but protecting an investor’s purchasing power from inflation over this difficult and inflationary period suggests that balanced portfolios are alive and well, despite the headwinds faced.
Dr Benjamin Holdsworth (right) is a director of Cavendish Medical, specialist financial planners helping consultants in private practice and the NHS
The content of this article is for information only and must not be considered as financial advice. Cavendish Medical always recommends that you seek independent financial advice before making any financial decisions.
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