The 60/40 portfolio has been besieged on all sides since bonds failed to protect against the correction in equities last year. Many see salvation in alternative assets, while others preach flexible allocation.
Bonds offered no protection
The balanced portfolio saw its biggest losses since 2008 in 2022, and the conventional wisdom that stock and bond prices are inversely correlated proved wrong this time. Stubbornly high inflation and aggressive interest rate hikes by central banks, including the Federal Reserve and ECB, caused bonds and equities to fall in tandem.
Since the 1990s, the Federal Reserve came to the rescue with monetary easing when the economic outlook worsened and the stock market corrected. First there were interest rate cuts, later the central bank also started buying up fixed-income securities, causing bond prices to rise. These two measures were possible because inflation remained low. Monetary easing drove yields on some bonds to unprecedented depths (sometimes negative). These interventions grew the belief that the correlation between the two asset classes is negative and bonds always provide protection against equity corrections.
However, the reality is that the correlation between stock and bond prices fluctuates between positive and negative and investors only have a problem with positive correlation when both asset classes fall.
Future
The success of the 60/40 portfolio is likely to depend largely on inflation trends. If inflation remains high, some strategists say this could cause lasting problems. But if the Fed and ECB get inflation under control (and certainly if the economy slips into recession), central banks will presumably move to interest rate cuts, allowing bond prices to rise again. Adding to this, nominal bond yields today are much higher than a year ago which provides a cushion against volatility as bond investors receive a higher income stream. After the SVB fiasco and problems at Credit Suisse, more and more investors are taking such a scenario into account, as evidenced by the sharp rise in bond prices.
Alternatives
While the 60/40 portfolio remains a good starting point, interest in (small) allocations to real assets, currencies and derivatives continues to grow unabated. Less liquid assets such as infrastructure or logistics are also in demand in this regard, while a group of often younger individual investors is still attracted to cryptocurrencies. Dynamic, sometimes complex allocation strategies are also on investors’ radar.
Morningstar’s flexible allocation category is a heterogeneous group where funds have a largely unrestricted mandate to invest in several asset types. Often, these dynamic strategies have more leeway to adjust weightings to equities, bonds and alternatives, and also use tactical allocation and derivatives.
Top 5
For this week’s top five, we look at mutual funds in the Morningstar Category EUR Flexible Allocation - Global whose distribution fee-free fund class is available in the Netherlands. These five funds have shown the best performance based on returns over the last 12 months.
R-co Valor
In first place is R-co Valor, a fund offered by Rothschild. This strategy performed excellently against the competition over the last five years. This is mainly due to its aggressive allocation to equities. However, looking at its performance relative to the average aggressive euro allocation fund, it still looks excellent. The portfolio is more than 80% equities with the managers overweight in commodities including Ivanhoe Mines and Teck Resources, consumer companies such as Alibaba and Trip.com and the communications sector with a position in Tencent. The fund is underweight in technology.
Yoann Ignatiew has been managing this strategy since September 2008. Before Rothschild Asset Management, he worked at Banque Privée Saint Dominique, where he was responsible for investments and asset allocation. He has been assisted by Charles-Edouard Bilbault since July 2018.
DWS Concept Kaldemorgen
On the third step is DWS Concept Kaldemorgen, which has been nominated for the Morningstar Awards for Investing Excellence 2023. This flexible allocation strategy has proven its worth and receives a Bronze rating from Morningstar’s fund analysts.
The weighting between assets is based on the team’s market outlook and risk management considerations. Although the risk target of keeping volatility below 10% has been met since inception, the team allowed the fund to exceed its limit over the calendar year during the March 2020 turbulence. This is a minor blemish on their record, but the recovery was quick and allowed the team to avoid an aggressive sell-off.
Equities are generally the main source of returns, while bonds, gold and cash (including foreign currency positions) are additional portfolio components. The team actively manages currency exposure from the point of view of a eurocentric investor. Derivatives are used for tactical positioning or hedging.
After a brilliant career as an equity manager, Klaus Kaldemorgen founded this fund in 2011 and built the Total Return team around it, which now has eight portfolio managers, analysts and risk managers. DWS created clarity around the succession of lead manager and founder Kaldemorgen by sharing the leadership of this strategy with former comanager Christoph Schmidt. Kaldemorgen will remain with DWS for the foreseeable future, but is gradually phasing out his commitments after which Schmidt is likely to take over the torch.
Equity specialist Schmidt was there from the start and has successfully managed the ESG Dynamic Opportunities strategy since January 2013. He also became co-lead of the Total Return team in 2021. Two other portfolio managers Thomas Graby and Henning Potstada, who is lead manager of the DWS Invest Multi Opportunities fund (also in the top five) support Kaldemorgen and Schmidt.
Top 5: Flexible euro allocation funds
Thomas DeFauw is manager research analyst at Morningstar. Morningstar analyses and evaluates investment funds based on quantitative and qualitative research. Morningstar is one of Investment Officer’s knowledge partners and ranks five mutual funds or providers every Friday.