Why the 'Game Has Changed' for the 60/40 Portfolio: Schroders' Farstrup

Even recently, he explained, a 60/40 portfolio split across stocks and bonds worked well for retirement savers because it was both diversified and self-hedging: “In other words, you both got paid to carry bonds and benefited from their negative correlation to the stocks you owned.

“But what so many people fail to realize is that, yes, stocks and bonds may have been negatively correlated over the past 30 or 40 years, but that’s not a law of nature, and it’s not even the normal relationship between stocks and bonds,” Farstrup said.

Over the very long term, the average correlation between stocks and bonds is close to zero — and is a lot higher than that when inflation is high. Investors saw that principle play out during the market turbulence in 2022 and early 2023.

“So, when we talk about the 'death of 60/40,' it’s really just a colorful way of saying we need to think much harder about diversification,” Farstrup said. “The good news is that we have more tools in the tool box, and we can be more dynamic about asset allocation in a way that responds to the new reality.”

Investors Confront a '3D Problem'

Decarbonization is a major goal for economies across the globe, Farstrup discussed, requiring a shift to renewable energy sources. Building this capacity can generate news jobs and new industries, but it’s also costly and can be inflationary.

Likewise, deglobalization involves reorienting supply chains, and that can also be expensive and inflationary. Demographic changes, meanwhile, can lead to worker scarcity, potentially driving up labor costs.

“All of these trends are going to be with us for the long term and will require central banks to prioritize inflation and tackle it,” Farstrup observed. “That will make it harder for the U.S. Federal Reserve and other key central banks to use their traditional policy playbook of lowering rates to respond to weakening market conditions. In terms of volatility, it’s just a different outlook for the next decade versus what we’ve seen play out in the last 40 years.”

The economic consensus, then, is being challenged, he explained, and investors need to temper relying on the investment “maps” that have served them well over the past decade. Most important, Farsrup added, is understanding that the "Fed put" is no longer a reliable hedge against market disruption.

“Instead, investors need to focus on better diversification, the divergences now occurring and the fresh opportunities being created,” Farstrup advised.

Multi-Asset Outlook

Farstrup offered a high-level summary of his detailed and specific investment themes that advisors and their clients should consider in the discussion with ThinkAdvisor.

On equities, the team has downgraded its stance to neutral as aggressive trade policy has worsened the near-term growth and inflation outlook. The shock to markets has so far been self-inflicted, he noted, and a policy U-turn could see a rapid recovery.

With respect to U.S. government bonds, a sell-off following "Liberation Day" means that Treasurys appear cheap. Farstrup’s team remains neutral, though, not expecting government bonds to be an effective hedge against the U.S. trade war given the inflationary impact.

The view on corporate bonds has moved into the negative, he noted, with a particular focus on U.S. credit. In the team’s view, U.S. spreads are under-pricing equity market volatility, and they expect further widening from current levels.

The same neutral-to-negative theme is seen across many other asset classes that the team tracks, Farstrup noted, and that’s mostly a reflection of the inflation and tariff-linked uncertainty that defines the current moment.

Bottom Line for Worried Retirees

For real-world investors, the key is to be cognizant about what risks matter the most, Farstrup said.

“Let’s picture an investor who is five years out from retirement,” he said. “This is the point at which the challenge for an investor is the highest, because they essentially have two time horizons to contend with.”

Those investors need to keep generating returns so they don’t outlive their money if they have an extended longevity. But they also are exposed to sequence of returns risk and are highly sensitive to the drawdowns that have been seen frequently in recent years.

“It’s a difficult picture to balance, but the good news is that the industry had done a lot of work on managed volatility products and guaranteed income products, as well,” Farstrup said.

“In my view, guarantees definitely have a role to play in these investors’ portfolios, but many people still struggle with the idea of locking up their money early in retirement — and the lack of portability and the fees are a downside, no question,” he explained.

This is where private assets can come into the picture, but they can be difficult to access for middle class and mass-affluent investors.

“Many advisors are looking for more packaged solutions that can help their clients take advantage of less liquid assets without all the restrictions or downsides that can be hard for smaller investors to handle,” Farstrup noted. “For example, you see a real explosion of interest in private credit, and the industry is working hard to deliver on this.”

Across these considerations, he said, the investing backdrop has changed, and a dynamic approach to risk assessment is paramount.

“As an example of this, you can look back at our view on U.S. equities at the end of last year,” Farstrup said. “The economy looked like it was set for continued growth and earnings were robust.

"That might have made stocks look attractive, but the valuations were very high, so it was a tough picture," he added. "As it turned out, buying downside protection via options at that time was quite cost effective — and that call has really worked out well given what has actually played out this year.”

Credit: Adobe Stock