Recent challenges to the 60/40 balanced portfolio rule shouldn’t sway institutional investors away from the strategy, said Steve Foerster, professor of finance at Western University’s Ivey Business School, during the Canadian Investment Review’s 2023 Investment Innovation Conference in November.
“Regardless of what’s happening now, we don’t want to confuse strategic asset allocation, which is what a 60/40 strategy is all about, versus tactical asset allocation. I’m not sure how many DB plans that I’m aware of would be proud to say ‘we’re market timers.’ We have to look at the strategic assets’ allocation versus the tactical asset allocation.”
He acknowledged there has been recent pushback to the 60/40 portfolio as a limited way to evaluate the market, adding recent market difficulties created a recency bias against the investment standard.
Read: The pros and cons of opting for a 60/40 balanced portfolio strategy
“We’ve got growth assets that tend to decline in a recession [while] fixed income assets tend to appreciate. Those stocks are declining in anticipation of lower profits. As bond yields start to decline, as central banks loosen monetary policy in a recession, bond prices increase. Bonds are acting as a portfolio shock absorber if you will. That’s the intuition.”
In his search for the origin of the 60/40 strategy, Foerster said he reached out to several industry stakeholders, including Marty Leibowitz, a Wall Street veteran and a senior advisor at Morgan Stanley; Keith Ambachtsheer, executive-in-residence at the Rotman School of Management, director emeritus at the International Centre for Pension Management and co-founder of KPA Advisory Services and CEM Benchmarking; and Bill Sharpe, STANCO 25 professor emeritus of finance at Stanford University.
But it was Edward McQuarrie, a retired professor from the Leavey School of Business at Santa Clara University, who suggested a new piece of evidence — a research paper from 1952 that evaluated mutual funds and which recommended a 50/50 approach for stocks and bonds.
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McQuarrie told Foerster it was likely first thought of at this time since it matches with the introduction of the first variable annuity by the Teachers Insurance and Annuity Association of America. At first, Foerster explained, there was a restriction in place so pensioners couldn’t invest over 50 per cent into the CREF, leading to a 50/50 split. But then the rules changed in 1967 when the allotment rule to CREF increased to 75 per cent.
During the session, he was asked by an audience member about the current value of U.S. stocks through the cyclically adjusted price-to-earnings ratio — also known as Schiller P/E, which calculates a price earning ratio based on average inflation-adjusted earnings from the previous 10 years. Foerster said the current average is about 30 for the S&P 500.
“Compared to 2022 it’s down from 34,” he said. “It’s down from 43 in 2000, which was the high-water mark . . . . [It’s] less expensive than it has been recently but still not cheap at all.”
Read more coverage of the 2023 Investment Innovation Conference.