Mar 15 2016
3 active steps to enhance portfolio returnsContributor Jeff Geller
The 60/40 allocation has two problems—the “60” and the “40”
By: Jeff Geller Co-Chief Investment Officer and Phil Camporeale Client portfolio manager, Multi-Asset Solutions, J.P. Morgan Asset Management
What a world we live in. Never in the history of financial markets have the four major developed market currencies—the dollar, euro, pound sterling, and yen—delivered a “risk free” rate as close to zero. At the same time, moving out on the risk curve into sectors such as core fixed income does not offer many inspiring opportunities for return.
Quantitative easing (QE) by central banks, intended to stimulate growth and raise inflation expectations, has acted more as a steroid than a medicine—pumping up equity valuations by nearly 200% (as measured by the S&P 500 from March 9, 2009 through year-end 2015), but proving less potent in boosting underlying growth or raising core inflation to meet central bank targets.
What does this mean for the returns of a static 60/40 portfolio over the long term? Our 10- to 15-year estimates suggest below average beta (or index) returns relative to the past. We believe that, in such an environment, active alpha generation—through careful manager selection, dynamic asset allocation and prudent implementation—is more important than ever.
A downshift in long-term return expectationsEach year J.P. Morgan Asset Management publishes its Long-Term Capital Market Assumptions, 10- to 15-year annualized return and risk estimates for roughly 50 major global asset classes. Our 2016 assumption for a static 60% U.S. equity (S&P 500)/40% fixed income (Barclays Aggregate Index) asset allocation is now down to 6.4% annualized. This is a direct reflection of a quicker than expected run-up in equity prices (flattening the trajectory of long-term returns), as well as anticipation of a continued moderate growth, low interest rate environment. Our 6.4% annualized number is well below the whopping 11.9% return the same static 60/40 portfolio delivered for the period March 2009 through December 2015, and, as seen in the chart, over 100bps lower than our assumptions ten years ago.
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Opinions and statements of market trends that are based on current market conditions constitute our judgment and are subject to change without notice. These views described may not be suitable for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations. Past performance is no guarantee of future results. JPMAM Long Term Capital Market Assumptions: Given the complex risk-reward trade-offs involved, we advise clients to rely on judgment as well as quantitative optimization approaches in setting strategic allocations. Please note that all information shown is based on qualitative analysis. Exclusive reliance on the above is not advised. This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. Note that these asset class and strategy assumptions are passive only–they do not consider the impact of active management. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Assumptions, opinions and estimates are provided for illustrative purposes only
J.P. Morgan Asset Management is the marketing name for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide.
Investments in bonds and other debt securities will change in value based on changes in interest rates. If rates rise, the value of these investments generally drops.
International investing bears greater risk due to social, economic, regulatory and political instability in countries in "emerging markets." This makes emerging market securities more volatile and less liquid developed market securities. Changes in exchange rates and differences in accounting and taxation policies outside the U.S. can also affect returns.
Securities rated below investment grade are considered "high-yield," "non-investment grade," "below investment-grade," or "junk bonds." They generally are rated in the fifth or lower rating categories of Standard & Poor's and Moody's Investors Service. Although these securities tend to provide higher yields than higher rated securities, they tend to carry greater risk.