Asset Allocation Becomes More Active As Alternatives Stake Claim

Tom Burroughes

11 October 2024

Asset allocators will need to be more active than perhaps they were in the past, partly because new sources of return now come into the picture, particularly via alternative investments.

While the so-called “60/40” equity/bond portfolio split that held sway for decades has had its setbacks, in broad terms it retains a lot of traction. The sharp rise in interest rates after the pandemic, and subsequent cuts in the past few months, provide a broadly supportive backdrop to this strategy.

But with alternatives – a term covering an increasingly mainstream world of private equity, debt, venture capital, hedge funds, real estate and commodities – vying for investors’ attention, the split looks more like 60/30/10 today, with alternatives making the 10 per cent part.

The 60/40 asset allocation model is not dead, but it is also not going to be optimal in many cases, Jim Caron,Chief Investment Officer of the Portfolio Solutions Group at MSIM (Morgan Stanley Investment Management), told this news service recently.

In future, asset allocators/clients need to be more active and less passive. Also, other asset classes should be considered in the mix: alternatives (private equity, etc); however, they have different levels of liquidity, he said.

“People typically think about the period from 1980 to 2021 and the bond returns in that period. In US bonds, they were about 8 per cent policies have had other than a placebo effect.”

There is some risk, Graf said, that central banks might pursue excessively tight monetary policy. “Real rates are relatively healthy and attractive,” he said. Switching to the UK, Graf reckons that yields on UK government bonds look “attractive.” “Inflation in the UK is part of a cycle that is starting to turn,” he said.

Correlations
The 60/40 equity/bond split drew much of its appeal from the idea that bonds behave differently from stocks, with debt providing ballast in a portfolio. A word that comes up frequently is “correlation.” The problem is that diversification is not what it appears.

There is still a lot of correlation between bond and equity returns, says Morgan Stanley’s Caron.

There have only been two big periods between 1910 and today when correlations were low: immediately after WW2 and in 1980 when Paul Volcker, as Fed chairman, began to push up interest rates to kill inflation, he said. Three forces in the 1981 to 2021 period have kept bond returns steady: the defeat of inflation; globalisation of trade and capital flows, and the 2008 financial crash.

While private markets had a strong run from the end of the 2008 financial crisis, swept up by a tide of cheap central bank money, recent rate hikes have taken off a bit of shine, but the market is regaining its lustre.

The correction to illiquid markets that started in 2023 is now beginning to wind down, Caron said.

“For most people, if you ask them `would you like to add alternatives?’ they say yes but then ask how to do it?” he said.

With deeper conversations about moving, say, to a 60/30/10 split in a portfolio, it needs to be understood that putting money into alternatives depends on specific opportunities coming up, the types of assets involved, and so on.

“And this is where financial advisors can get a lot of help from people like us. We look at building portfolios and put these things together,” Caron added.