- JPMorgan’s top long-term strategist is advising investors to “significantly reduce” their holdings of safe government bonds.
- He says the era of zero yields has arrived sooner than expected and will be here to stay for a while longer.
- He offered alternatives for investors who have traditionally relied on the 60-40 allocation split between stocks and bonds.
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The death of traditional 60-40 portfolios may have been greatly exaggerated before this year — but JPMorgan now says the coronavirus crisis has ended them for good.
The 60-40 split between stocks and government bonds is the classic allocation recommended to long-term investors as a way of diversifying their portfolios. Bonds serve as a ballast for the risk that comes with investing in equities, while the outsize exposure to stocks brings in their outsize returns.
An investor who held this 60-40 split over the past 45 years and rebalanced annually would have earned a compound annual return of 10%, according to JPMorgan’s calculations. But the firm estimated returns would be 3.5% over the coming decade and recommended that investors pivot to new models of asset allocation.
“We think that investors should significantly reduce their holdings of ‘safe’ bonds,” Jan Loeys, JPMorgan’s global long-term strategist, said in a recent note. For the avoidance of doubt, those bonds include US Treasurys, which are the safest investment.
JPMorgan is not alone in urging investors to reduce their allocation to bonds. BlackRock said in a recent midyear outlook that it cut its allocation to sovereign bonds in strategic portfolios.
For Loeys, dumping bonds is a timely recommendation because yields are likely to remain near zero for an extended period of time. They had already been declining for the past 40 years; the 10-year was at 0.69% on Monday from 3% a decade ago. And then in 2020, the coronavirus crisis arrived out of left field and triggered a deep recession that all but guaranteed central banks would keep interest rates low for as long as necessary.
Lower bond yields have consequently increased the excess returns investors can get by adding riskier assets like stocks and corporate credit to their portfolios instead of bonds — otherwise known as the risk premia. This implies investors who hang on to the 60-40 model might experience a two-part loss: lower returns from bonds and less of a cushion when risk assets sell off.
On this basis, Loeys recommended that investors buy into hybrids: assets that straddle risk and safety by offering stocklike returns or bondlike protection. He highlighted four in particular:
- High-yield bonds. Broad exposure may be obtained via the iShares iBoxx High Yield Corporate Bond ETF.
- Convertibles. These are company bonds that can later be converted to shares.
- REITs. The Vanguard Real Estate ETF is a low-cost way of getting in.
- Utility stocks. They can be obtained via the Utilities Select Sector SPDR ETF.
Loeys further dissected his hybrids recommendation for two sets of investors.
For long-term investors who can stomach short-term volatility in risky assets, he advised a portfolio that completely dumps bonds and reduces its exposure to stocks. In the end, it would consist of 60% hybrids and 40% stocks. He estimated a 5% long-term annual return for this model portfolio versus 3.5% for the traditional 60-40 model.
Secondly, investors who do not wish to dramatically cut their exposure to stocks should consider a 20-40-40 split in bonds, hybrids, and equities. This portfolio has expected returns of 4% — lower than the aforementioned one. While the difference is not significantly higher than a 60-40 expected return of 3.5%, it will add up over years, Loeys said.
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