If market returns are muted or more volatile, buy-and-hold asset allocation becomes considerably less effective.ĭispersion, however, is not dependent on market direction. The same applies to bond returns which are driven by prevailing interest rates, credit spreads, and coupon payments. These are heavily dependent on the direction of economic conditions and overall direction of equity markets. Equity returns are driven by growth in earnings, the valuation multiple of those earnings, and to a lesser degree the payment of dividends. Why? The returns of a 60/40 portfolio are based on market direction. Taking advantage of dispersion can act as another form of return in a portfolio that a traditional 60/40 construct overlooks. Long/short strategies can thrive in high dispersion environments because they can go long securities that may become outsized winners and go short securities that may become relative losers. Similarly, from a top-down macro perspective, divergence in inflation and growth data across countries has led to different policy responses from central banks-driving greater dispersion in country returns. For example, individual company returns have become more dispersed as businesses differ in their ability to adapt to challenges like persistent inflation and higher interest rates. Inflation and policy uncertainty tend to influence security dispersion. High dispersion implies a wide difference between winners and losers, while low dispersion implies a narrow difference between winners and losers. What is security dispersion? Dispersion is the difference between winners and losers in the market. This type of alternative strategy allows investors to access an alternative source of return, called security dispersion, that is not currently captured in 60/40 portfolios.
That dynamic is a stark contrast from the diversifying returns of bonds that many investors relied on in the 20 time periods.įigure 1: Bonds have become a less reliable diversifier compared to recent decades 10-year US Treasury returns on equity down days, 2000-2023 Treasury has, on average, delivered negative returns on equity down days. Figure 1 illustrates how over the last two years, the 10-year U.S. Post-pandemic, the dynamics underpinning the “diversified” 60/40 portfolio have changed.
This dynamic means that bonds can provide a shock absorber in the portfolio, helping to cushion overall returns when stocks are falling. While stocks tend to suffer in a recession due to lower earnings, bonds can rally because central banks typically cut interest rates to support the economy. When central banks ease policy, bond yields drop and bond prices rise. The main premise for the combination is that when growth assets, like stocks, sell off due to economic slowdowns, fixed income assets like bonds typically appreciate. The exact proportion of the mix is often adjusted based on an investor’s time horizon, risk tolerance and financial goals, but the simple, proportional stock-bond combination is core to what is considered by many to be a “diversified” portfolio. The breakdown of the defensive relationship that sheltered 60:40 investors so well in the past means any UK investor splitting capital between 10-year gilts (government bonds) and the FTSE All-Share index would have lost 5.4 per cent this year.The foundational 60/40 portfolio, where 60% is invested in stocks and 40% in bonds, is the initial starting point for many portfolios. In the year to date to 25 November, the total return on the MSCI World index has been -14.7 per cent, a drawdown in step with the -16.4 per cent price decline sustained by 10-year US Treasury bonds in the same period.īritish investors in either of these US-dollar denominated assets have been sheltered by currency gains, but a positive correlation between bedrock asset classes such as these undermines the premise of Modern Portfolio Theory, first set out 70 years ago by American economist Harry Markowitz.
#Difference bond stock mix portfolio drawdown free
Market timing is hard but doesn't have to be perfect when safeguards existĭiversification has long been touted as the only real free lunch for investors, but in 2022 the traditional 60/40 shares to bonds portfolio split was far from appetising.
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