Consider alternatives to the classic 60/40 portfolio

Do you manage your own portfolio? Are you thinking about adjusting its allocations? You may want to consider that the classic 60/40 split, between growth and safety, may no longer be effective in today’s environment.

“People are living longer and can’t get the returns they need out of fixed income,” says Nicholas Aristeo, vice-president and portfolio manager at 3Macs in Montreal. “Five-year bond yields are around 2% and that doesn’t even match inflation. So 60/40 is definitely out the window.”

Diversification through global strategies is easier and less expensive with products like ETFs, adds Eric Kirzner, professor of finance at Rotman School of Management in Toronto. “In the 1970s and early 1980s, global investing wasn’t easy. There were some countries you couldn’t invest in at all, such as India. But [that’s changed] and you don’t need the same conservative asset allocation” to achieve diversification, he says.

Tailored portfolio

That’s why tailoring your portfolio to your needs is more valuable than rigid portfolio models, as is more actively managing and rebalancing it according to your risk profile and investing objectives. Liquidity, or having cash on hand, is also important to take advantage of market opportunities as they arise.

Aristeo says the 60/40 portfolio isn’t useful if the investor has a high risk tolerance and time horizon that aligns with a blue-chip equity portfolio. “If there’s also no need to draw down on capital in the short term, then you theoretically don’t need any fixed income to match cash flow needs. You could be 100% equity, and 80% medium risk and 20% high risk,” he says, adding you would have decades before you needed to start drawing it down.

Market environment

Deborah Frame, president and chief investment officer for Frame Global Asset Management in Toronto, says that the old way of managing money—buy-and-hold at a 60/40 split—is effectively striving for the best stock picking returns as opposed to considering the probability of losses in your current market environment.

“So, a 60/40 portfolio typically looks the same in a growth versus recession environment. But, I’ve been through times where I couldn’t find any stocks that I thought were actually going to grow, and where I had to have a minimum of 40 stocks because of investment policy guidelines,” she says.

Another option, she adds, is to be as high or low in any asset class as you see fit, and to go to 100% cash if necessary. “That’s how we manage money: driven by a macro view, tactically unconstrained, and we look at downside risk,” Frame says.

Risk mix

Peter Wong, vice-president and portfolio manager at Raymond James in Vancouver, says instead of sticking to a 60/40 split between stocks and bonds, he uses the following mixes for higher-risk, medium-risk and conservative clients.

• Growth and income: 25% bonds and cash; 25% U.S./foreign stocks; 25% Canadian stocks; and 25% alternatives and sector funds or ETFs.
• Balanced: 35% bonds and cash; 30% U.S./foreign stocks; 15% Canadian stocks; and 20% alternatives and sector funds or ETFs.
• Income and growth: 45% bonds and cash; 20% U.S./foreign stocks; 20% Canadian stocks; and 15% alternatives and sector funds or ETFs.

For clients looking for more growth, the firm looks at alternatives such as gold and offering memorandum products, Wong says. If you’re seeking income, he suggests a look at long-short alternatives, which are typically part of a hedging strategy, as well as multi-strategy products. ETFs are also an option for investing in foreign assets.

Fixed income

Bonds, Aristeo says, are good when when cash flow needs come into play for older investors who need liquidity.

“If we know a client needs $50,000 per year for the next three years, then you look at the income that the portfolio sets out. You may have a steady flow of dividends, which is preferable. Still, even though bonds aren’t the right place to be investing, you may need to buy fixed income so you know the money a client needs is going to be there,” he says.

He adds: “Rates can stay at low levels for a while, but if you’re getting an average yield of 2% and you’re paying a 1.75% [management expense ratio] MER on a bond mutual fund, then what’s left? The solution for most people is to buy GICs, get a better rate of return and accept zero risk, or to buy lower-cost bond ETFs. For the latter, make sure you stay short duration and high quality, and then complement that with some convertible bond issues of good companies.”