If policies change, do portfolios need to change too?

U.S. economic policy has changed a lot over the past year – and investors would have been wise to not change portfolios based on every single headline. Zooming out, it’s important to recognize that policies have changed significantly over the past five years - in ways that have created a very different investing landscape versus the previous 15 years. If policies change, do portfolios need to change too? Over the next 10-15 years, three major global themes will define portfolio construction: economic nationalism, fiscal activism and AI investment and adoption. A traditional 60/40 stock-bond portfolio may fall short of investor objectives, so a 60/40+ portfolio is needed.

Rising economic nationalism around the world is adding friction to trade and labor supply, dragging on growth and boosting inflation. This has precipitated a decisive response in global fiscal stimulus, defense spending and capex incentives. In the near-term, AI will power capital spending further and could potentially lead to long-term productivity gains. These interwoven themes should mean that markets outperform economies.

Worrying only about what can go wrong is not the answer, as the opportunity cost of not being invested is large. Over the next 10-15 years, we project average annualized cash returns of 3.1% versus 6.4% for a 60/40 and 6.6% for a 60/40+¹. However, it’s crucial to change portfolio construction given shifting landscapes:

1. Inflation/rates shocks to be more frequent:  Investors need to account for inflation and rate shocks, as well as economic growth shocks.
2. Way assets behave is changing: We project elevated inflation and rate volatility, with U.S. long duration assets particularly affected. The correlation between stocks and bonds is projected to remain unstable and drift higher into positive territory. The correlation between U.S. equities and the U.S. dollar might also be changing, turning positive over the past year after being negative over the past 15 years.
3. Limits to bonds as sole diversifier:  Bonds remain reliable diversifiers during recessions, but their limitations are exposed during other shocks (like an inflation upturn). Investors should keep 2022 in mind, when a 60/40 fell 17% with both bonds and stocks down. U.S. assets also show their limitations when U.S.-specific risk is the cause of volatility. Investors should remember 1Q 2025, when U.S. assets led on the downside while international markets and currencies were positive.
4. Diversifying the diversifiers is a feature not a bug: Investors should diversify beyond U.S. core bonds — incorporating international currencies, alpha strategies and uncorrelated alternative assets. In 2022, a portfolio with 10% diversified alternatives would have seen a shallower drawdown of 15%, as alternatives were positive that year. In 1Q 2025, having non-U.S. dollar exposure would have helped, as international equities outperformed U.S. equities by 1,100bps.
5. Move beyond public markets to create a 60/40+: Adding a small allocation to diversified alternatives (10%) can boost the overall portfolio’s Sharpe ratio by nearly 10%². Given shifting market structure, incorporating private credit is key to boost income, while private equity/venture capital are key to boost returns. For uncorrelated returns to public markets, real estate, infrastructure, gold and absolute return hedge funds can improve portfolio resilience.

¹ Includes 55% stocks, 35% bonds, and 10% diversified alternatives. 

² There is no one-size-fits all portfolio, with individual liquidity needs, risk tolerance, and portfolio objectives defining the exact asset mix.

eacd7d98-af52-11f0-addd-012ef1508282