The Death of 60/40 Portfolios

The death of 60/40 portfolios

In 1952, Harry Markowitz made groundbreaking progress in understanding the risk and return tradeoffs that occur in investment portfolios. His Nobel Prize-winning study produced the foundations of Modern Portfolio Theory; the belief that humans are risk-averse and can construct portfolios that maximize expected returns for a given level of market risk. Plotted on a chart, Markowitz’s risk-return measures produced an easy-to-read efficient frontier showing the lowest level of risk for any given level of return. This became the gold standard for building clients’ portfolios, particularly the ubiquitous 60/40 portfolio used today.

But many things have changed in the last 70 years. A recent CNBC Op-Ed highlighted the CIO of a $38 Billion institutional asset manager who became the latest professional money manager to join the call pronouncing the end of the 60/40 portfolio. Their explanation is simple, straight forward, and worth some attention: “With yields at all-time lows and valuations near all-time highs, the traditional 60/40 portfolio will likely neither grow in excess of inflation nor provide much downside protection.”¹

If this is correct, which we believe it is, wrapping your head around this new normal could create quite a shock to your years of portfolio construction knowledge. The op-ed offered a solution for this new normal that is limited and has major drawbacks.

They suggest holding equities, high yield bonds, and higher than normal levels of cash for liquidity. They admit that this will create a much more volatile portfolio over the next 10 years and we do not think this is a viable solution for most clients. Luckily, there is another approach that addresses this coming problem.

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As tactical investment managers, our solutions seek to capture above average returns with lower levels of risk. We approach investing differently without being bound by the constraints of Modern Portfolio Theory. To begin, we actively manage money using a systematic, rules-based approach that seeks to create consistent, repeatable results. We utilize large, low fee ETFs to get broad equity exposure as stock prices are rising. And, contrary to many manager solutions, we use bonds as a safe harbor during market corrections rather than as an everyday dampener of volatility. The visualizations on an efficient frontier chart (below) can be striking.

Over the long run our flagship strategy, called TPSR, has beaten the S&P by close to 150 basis points annually, with annualized volatility closer to a 60/40 portfolio and drawdown that is less than a 50/50 portfolio. A key factor for our strategy's results is the low correlation to equity markets which produces true diversification during downturns.²

Unfortunately, most financial advisors won’t recognize the problems with their 60/40 portfolios until they have experienced it. Waiting for several years of underperformance before changing your portfolio positioning could be detrimental to your clients' plans. Today, we are suggesting to our clients that they add TSPR to portfolios to start making small changes and positioning for the bigger transitions that will be needed in the next 10 years. On the upside, if we are wrong about the death of the 60/40 portfolio, adding TPSR could still have the positive effects of pushing their portfolios to a new, more effective efficient frontier line.

¹ Traditional 60/40 portfolio has actually reached its expiration date, September 2, 2021, CNBC.com
² The referenced time period is from January 2004 to June 2021. This strategy has not been tested with actual trading for the entire time period. Actual results of component strategies have been verified since January 2017. Performance results prior to January 2017 are based on compounded daily returns from back testing, net of an annual 1% management fee. Please see the TPSR Fact Sheet for other important notes and legal disclaimers.

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This information is presented for illustrative purposes only. Past performance is not necessarily indicative of future performance. Investing involves risk and principal loss is possible.

McElhenny Sheffield Capital Management (MSCM) is a Registered Investment Adviser with the U.S. Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training. Important information pertaining to MSCM’s advisory operation, services, risks, and fees is set forth in MSCM’s current Form ADV Part 2A brochure, a copy of which is available upon request or at www.adviserinfo.sec.gov or www.mscm.net.

MSCM claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. MSCM has been independently verified for the period January 1, 2017 through December 31, 2024. The MSCM Trend Plus and Sector Rotation Composites have each had a performance examination for the periods January 1, 2017 through December 31, 2024. The Trend X Composite has had a performance examination for the period May 1, 2017 through December 31, 2024. The TPSR Composite has had a performance examination for the period April 1, 2018 through December 31, 2024. The verification and performance examination reports are available upon request by contacting info@mscm.net.

All strategy performance results, including investment characteristics, shown in the presentation are net of the MSCM Trend Plus, Sector Rotation, and TPSR strategies’ highest model fee of a 1% annual management fee, applied 1/12th of 1% (0.0833%) each month and net of the MSCM Trend X strategy’s highest model fee of a 2% annual management fee, applied 1/12th of 2% (0.1667%) each month, and for the Trend X strategy a 20% performance fee, applied quarterly to the net profits in the account and subject to a “high water mark.” The net of fee strategy performance results are calculated by MSCM by deducting the strategy’s highest model fee from the gross of fee performance returns. Index and strategy returns are inclusive of dividends and reflect total return (TR). Index returns are not net of advisory fees, the indices are not actively managed, and it is not possible to invest directly in the index. Fees and expenses vary based on custodial relationships, trading costs, management fees, and other factors. Individual client results could significantly differ from the performance results being presented. The performance of client accounts can be more volatile at times and may not be comparable to the performance of any index. The charts, graphs, and index information shown are presented for illustrative purposes and should not be relied on to predict future movements of the market or for guidance on when to invest. Nothing in this presentation is intended to be relied on as investment, legal, or tax advice. Investors should consult their tax advisor or legal counsel for advice and information concerning their particular situation.

There can be no assurance that the strategy will be implemented as designed, or profitable, or that clients will not lose money. The tactical strategies use a variety of market indicators and stop levels that seek to identify upward or downward trends in the U.S. equity markets. If an indicator or stop level fails to detect significant downturns in the market, the strategy will continue to be exposed to underlying positions that could lose value during such downward periods. Similarly, if the indicators fail to timely identify a reversal of a downward trending market, the strategies will continue to be exposed to defensive exchange traded funds (“ETFs”) at a time when there is significant appreciation in the equity markets. Either scenario could result in the strategies underperforming other strategies that do not employ these strategies. There can be no guarantee the tactical strategies will correctly or timely identify the industries, sectors, or asset classes that will outperform during a given quarter or that the strategies will correctly or timely identify market trends. The tactical strategies invest in other investment companies and ETFs which result in higher and duplicative expenses. Investing in ETFs are subject to risks that the market price of the shares will trade at a discount to its net asset value (“NAV”), an active secondary trading market will not develop or be maintained, or trading will be halted by the exchange in which they trade. Brokerage commissions will reduce returns.

The Standard & Poor’s 500® Index (S&P 500 Index) includes 500 leading companies listed on U.S. stock exchanges. The Nasdaq Composite Index (Nasdaq Comp.) includes more than 3,000 stocks listed on the Nasdaq Stock Market and, along with the S&P 500 Index, is one of the most followed broad-based stock market indices in the U.S. The Benchmark 60/40 Index (Benchmark 60/40) is a blended index calculated by YCHARTS with a 60% allocation to the S&P 500 Index and a 40% allocation to the Bloomberg Aggregate U.S. Bond Index, a broad-based fixed income index considered to be representative of the U.S. fixed income market. The Benchmark 60/40 represents a traditional “balanced” investment allocation for a U.S. investor of 60% stocks and 40% bonds. Annualized volatility, a common measure of risk, is the standard deviation of monthly returns. Maximum Drawdown reflects maximum peak-to-trough decline in an investment, security, or index over a specific time period, as measured by the difference in the highest value during the time period and the subsequent lowest value during the time period. Alpha is the excess return of an investment relative to the return of a benchmark index. Beta is a measure of a security's or portfolio's systematic risk, indicating its volatility relative to the overall market (e.g., S&P 500 Index). R-squared is the proportion of a strategy’s price movements that can be explained by movements in a benchmark index. Sharpe Ratio measures the average return in excess of the risk-free rate per unit of volatility or total risk. Sortino Ratio is like Sharpe but focuses on downside risk. Treynor Ratio measures the return earned in excess of the risk-free rate per unit of systemic or market risk. Calmar Ratio evaluates the return of an investment over the risk of its maximum drawdown. A Chartered Financial Analyst (CFA®) charter is a designation given to those who have completed the CFA® Program and completed acceptable work experience requirements. The CFA Program is a three-part exam that tests the fundamentals of investment tools, valuing assets, portfolio management, and wealth planning. The Certified Financial Planner (CFP®) certification is a professional certification for financial planners conferred by the Certified Financial Planner Board of Standards. To receive authorization to use the designation, a candidate must meet education, examination, experience, and ethics requirements and pay an ongoing certification fee.

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