Key takeaways:
- The validity of the 60/40 model portfolio is increasingly being questioned as its risk-adjusted returns have deteriorated in recent years.
- Asset allocators are turning to new 50/30/20 model portfolio blueprint which includes real estate and sustainable infrastructure investments.
- We explore how real assets mitigate portfolio volatility in this new model portfolio paradigm
For decades, the traditional ‘60/40’ portfolio has been among the most recognized portfolio allocation strategies in asset management. Based on Nobel Prize winner Harry Markowitz’s Modern Portfolio Theory (1952), the principle established itself as a fundamental model of portfolio optimization to achieve an ideal balance of risk and return. But in today’s changing market environment, does this conventional allocation strategy remain valid?
This article explores why advisors should be looking beyond the 60/40 portfolio to incorporate alternative investments like real estate investment trusts (REITs) and renewable energy infrastructure investments and how they have their rightful place in the modern-day portfolio.
What is the 60/40 portfolio approach?
The 60/40 portfolio is founded on a strategy that allocates 60% to equities and 40% to fixed income, aiming to achieve a balance between growth and stability while pursuing moderate risk-adjusted returns. Its widespread appeal arises from the low correlation between risk assets and fixed income, which aids in hedging risk while providing stable income.
At the heart of the portfolio’s risk-hedging power lies the frequent negative correlations seen in equities and bonds. A strong negative correlation means bonds often gain when equities decline, helping offset portfolio losses typically seen during recessionary phases of the business cycle. As shown below, this relationship has held during every recessionary period (circles) since World War II, except the brief, pre-pandemic driven recession of 2020 (triangle).
But as the old axiom goes: ‘The only constant in life is change.’ This, too, applies to the 60/40 portfolio, whose inherent hedging power between risk and fixed income has waned over time.
Between 2022 and 2024, it has been reported that bonds lost money in fourteen of the months coinciding with negative returns in equities, with the U.S. Aggregate Bond Index participating in nearly half the downside of the S&P 500 Index on average. That outcome was deeply inconsistent with historical expectations and has challenged long-standing assumptions about optimal model portfolio diversification.
In turn, this has prompted asset allocators to re-evaluate the role of bonds as a reliable risk mitigator.
Post-pandemic decline in 60/40 risk-adjusted returns
After a deviation from the usual negative relationship between stocks and bonds noted in 2020, the associated decline in risk-adjusted returns following COVID has further questioned the effectiveness of the 60/40 portfolio.
According to Morningstar, returns fell to an annualized 4% from 2022 to 2024, in contrast to 11% annually from 2012 to 2021. Even more notable: Volatility, as indicated by the standard deviation of monthly returns, increased to 13% from 8% in the preceding period. This significant rise resulted in investors facing considerably greater risk for diminished returns, thereby undermining overall risk-adjusted performance. And while we need to be careful about making conclusions based on recency bias, the data may suggest that the traditional bond hedge is evolving.
Simply put, the data could suggest the diminishing hedging effectiveness of fixed income may be increasingly influenced by how investors position along the yield curve. Due to rising sovereign debt concerns and persistent low growth prospects, long-term yields may prove less responsive to rate cuts than in prior cycles. If this “new normal” persists, it could permanently erode the traditional negative correlation held between stocks and bonds and undermine the role of long-duration bonds as a reliable counterbalance to risk asset volatility.
As a result, asset allocators should consider whether the traditional 60/40 portfolio suitably balances growth and downside protection, and if not, whether specific private investment alternatives can bridge the gap.
The rise of private investment allocation in the modern portfolio
As the dependability and risk-reduction features of the traditional 60/40 portfolio comes under examination, alternative portfolio frameworks are being increasingly investigated to protect against potential losses while maintaining exposure to risk assets. This shift in mindset has already started and is not confined to retail advisors; it is increasingly impacting capital allocation strategies at the institutional level.
According to a PGIM Private Alternatives survey conducted over the spring and summer of 2024, global private markets held $13.1 trillion in assets under management as of June 2023—a figure that has grown at nearly 20% per year since 2018. Topping the list of these investments, real estate equity received the highest allocation at eighteen percent (18%) followed by private credit (11%), private equity (10%) and real estate debt (10%). Furthermore, the survey found a significant minority of institutions are likely to increase holdings of an array of private assets, from private real estate debt (42%) to sustainable equity (40%) over the next two years.
A similar theme was echoed in Barclay’s Private Annual Report 2024, which opined that family offices and wealthy individuals are showing increasing interest in private markets. Among the reasons cited was the ability for private investment to enhance the risk/reward profile for client portfolios, reflecting a broader move away from the traditional 60/40 approach.
We do not believe this broad-based allocation shift among Tier-1 global institutions is an accident. Should traditional fixed income continue to fall short as a quality risk asset hedge, we expect the move toward private investments to continue, as investors seek more effective risk mitigation and reposition toward more modern portfolio models.
Skyline provides exposure to the 20% allocated to alternatives
In an evolving investment landscape where conventional asset allocations are being redefined, Skyline provides a range of private alternative solutions designed for contemporary portfolios. Our private REITs yield steady income with minimal correlation to public equities or bonds, offering investors an effective means of diversifying beyond traditional assets and reducing exposure to public market volatility. As market cycles progress, these income-generating assets present stability and potential growth, making them an excellent foundation for the private allocation within any portfolio.
In addition, Skyline Clean Energy Fund, specializing in renewable energy investments, produces dependable cash flow from clean energy power generation, giving investors access to a sector pivoting to a transition to sustainable energy. The consistent income strategies from these assets takes on dependable fixed-income characteristics with minimal exposure to interest rate risk.
Collectively, these private investments integrate effortlessly with the emerging 50/30/20 model, establishing Skyline as an ideal provider for the private segment component of a diversified portfolio.