The long-term outlook: The return of the 60/40
The 60/40 portfolio, declared extinct by some commentators a year ago, has made a comeback. After a year of market turmoil, the core principles of investing are holding firm.
In our 2023 Long-Term Capital Market Assumptions (LTCMAs), our forecast annual US dollar return for a 60/40 stock-bond portfolio over the next ten to 15 years leapt from 4.30% last year to 7.20%. That comeback follows a series of powerful forces that roiled markets in 2022, leading to the worst drawdown of a 60/40 balanced fund since 2008.
At the start of the decade, a devastating pandemic triggered a short but severe recession and destabilised global supply chains. Generous government spending, coupled with unusually easy monetary policy, drove inflation to 40-year highs. Russia’s invasion of Ukraine has created a humanitarian crisis and further supply disruptions, intensifying inflationary pressures. In response, central banks, led by the Federal Reserve, have aggressively tightened policy, sparking the steepest losses in government bonds in over 30 years.
Markets are now experiencing a regime shift – from a world of low inflation and easy financial conditions to one of high inflation, tightening policy and higher rates. While further short-term market volatility is possible, these cascading crises may have created long-term investment opportunities that we haven’t seen for many years. This forecast stands in stark contrast to previous years, where forward returns had been challenged by stretched valuations and low yields.
It has taken a meaningful reset in asset markets to bring us to this point, and considerable pain for bondholders over a much shorter horizon than we had expected. Still we believe that the underlying patterns of long-term economic growth look stable, and the assumptions that underpin asset returns – cycle-neutral real cash rates, curve shape, default and recovery rates, and margin expectations – also haven’t changed meaningfully.
Given the improvement in forward return assumptions for public markets, a ‘back-to-basics’ portfolio is back on the table. With higher yields, bonds can once again provide a source of income and a potential safe haven. At lower valuations, equities offer an attractive entry point.
Caution is required, however, as the potential for a shift to an environment of positively correlated equity and fixed income returns may limit an investor’s capacity to diversify equity risk and may increase volatility. Ultimately, though, what is clear from the 2023 LTCMAs is that long-term asset return forecasts look a lot better for the next decade than they did for the last decade.
While the high inflation that finally stirred policymakers into action is likely to moderate, the underlying drivers of higher prices – shortages of important goods and commodities, tightness in labour markets, and heightened geopolitical tension – will remain risks for investors for the rest of the decade. Addressing these issues will likely require substantial investment. We may be on the brink of a capex boom just as central banks are raising rates and capital is becoming scarcer.
For investors, this all translates into a far better environment for returns from market beta, but also in terms of active alpha, as the end of free money, greater two-way risk in inflation and policy, and increased return dispersion across assets give active managers more to swing for.
Active is back
This is where we think the JPM Research Enhanced Index (REI) range of actively managed ETFs can add value. The REI process combines the qualities of passive (index-like regional and sector exposures) with active management, by applying the insights of our global team of research analysts.
The REI range covers both equity and fixed income, with eight equity ETFs and three credit ETFs. The equity REI ETFs incorporate best in class fundamental research with robust risk management, while keeping the structure of their portfolios close to their benchmark indices. J.P. Morgan’s large team of career analysts carry out in-depth research on over 2,500 stocks, utilising a disciplined valuation framework. These insights are then packaged into an index-like portfolio, by applying small overweight or underweight position in certain stocks. The end result is a style-neutral, sector-neutral and regionally neutral ETF portfolio, which has the same shape and feel as the index and is very diversified at the same time.
Our credit REI ETFs work in a similar fashion. JPM Corporate Bond Research Enhanced Index ETFs focus on efficiently replicating the risk profile of the credit investment universe while adding value predominantly through security selection. By systematically incorporating the proprietary security rankings produced by our credit research analysts, we aim to tilt the portfolios towards issuers we believe will outperform and away from those we think will underperform, particularly issuers at risk of being downgraded. This approach can help investors navigate these challenging markets by avoiding the losers rather than just picking the winners.
Furthermore, our REI ETFs apply a robust ESG framework, which systematically includes financially material ESG factors (alongside other relevant factors) in investment analysis and investment decisions.