Key facts
- US investors are reassessing the traditional 60% stock, 40% bond portfolio strategy due to rising government debt yields.
- Yields above 5% across parts of the US Treasury curve offer more attractive income and potential future returns.
- The 60/40 strategy's diversification became less reliable as bond prices rose with stocks.
- Analysts believe bond yields may be close to peaking.
- Investors are favouring income strategies with lower interest-rate sensitivity or different credit exposure.
- The '40' allocation now extends beyond Treasuries and investment-grade credit to include securitized assets, municipal bonds, preferred securities, and floating-rate instruments.
US investors are reassessing the traditional 60% stock, 40% bond portfolio strategy as a selloff in government debt lifts yields to levels that offer more attractive income and potentially stronger future returns. The 60:40 strategy had fallen out of favour since the 2008 financial crisis as ultra-low yields left bonds contributing little beyond asset diversification, and their usual reverse relationship with stocks had become less reliable.
However, the latest rise in yields has changed the calculation. With yields above 5% across parts of the US Treasury curve, investors can earn substantially more income from bonds, which many see as cushioning them against any further decline in bond prices. While rising oil prices and worries about inflation have driven bond yields to multi-decade highs, many analysts believe they are close to peaking.
Monty Gandhi, an interest-rates strategist at SMBC Group, said that at current yield levels, it makes more sense to buy bonds, citing good carry. Bank of America's October fund manager survey found investors would need the US 10-year Treasury yield to rise to about 5.9% before bonds become attractive enough to trigger a meaningful rotation out of equities. Rajat Kumar, senior executive officer at Three Pins Capital, suggested a move in the 10-year Treasury yield towards 5.5% could materially slow the US economy, limiting further Federal Reserve rate hikes and strengthening the case for locking in current yields.
Royal London Asset Management reversed its bond underweight in late September after concerns about inflation, stating it was adding back to bonds. The rolling 36-month correlation between global equities and government bonds stood at about 0.59 at the end of September, compared with an average of minus 0.24 from 2009 through 2021. Fund flows indicate investors are selective, with September seeing $14.5 billion into short-term US government bond funds and $4.9 billion into loan-participation funds, while corporate and high-yield bond funds saw outflows. Goldman Sachs noted that bond funds have become underweight duration, reaching extremes that have historically seen lower yields over subsequent quarters.
Analysts suggest the '40' allocation now extends beyond Treasuries and investment-grade credit to include securitized assets, municipal bonds, preferred securities, and floating-rate instruments like leveraged loans and AAA-rated collateralised loan obligations (CLOs). Fidelity analysts believe leveraged loans can fit within the 40% allocation due to their floating-rate coupons, which provide income while keeping interest-rate sensitivity low. They argue the debate should be about the evolution of the 60/40 portfolio, not whether it is 'dead', as the '40' can now do more to manage risk and provide return sources.