In recent years, traditional portfolio constructions -- most notably the classic 60/40 equity/bond allocation -- have served investors well. They are simple, have been effective over the long term, and have historically offered diversification.
Restoring Diversification
Is the diversification of a 60/40 portfolio just on a break, or has it ‘left the building’?
We have previously examined the equity/bond allocation and asked, ‘Is 40/30/30 the new 60/40?’ Well, yes, we think it is. Our work shows a long-term correlation between equities and fixed income that is frighteningly close to 1.0.[1] This increased correlation fundamentally alters the effectiveness of traditional portfolio construction.
How to allocate to – and among - the complex and diverse array of alternatives available?
Labels and descriptions such as ‘uncorrelated’ may not provide the full picture of how an alternative strategy behaves in different types of financial markets. We test a diversification using alternatives based on their function
- Downside protection in stressed markets using Long/Short Directional
- Uncorrelated with minimal market exposure through Market Neutral, or
- Enhanced market returns in upside markets with Upside Alpha strategies
Keeping it simple.
Part of the longevity of the familiar 60/40 equity/bond allocation is its simplicity, and its historical success.
We believe we have developed a 40/30/30 methodology that can be simply implemented – for large and small investors alike.
Step by step.
- Our work shows that over the last 25 years, the simplest 40/30/30 allocation -- a global equity index, a US Treasury index, and a broad hedge fund index -- enhanced return and reduced volatility and drawdown over the traditional 60/40 mix of global equities and bonds.
- In our next step, we replace the hedge fund index with a risk-weighted basked of three functional alternatives indices. Return was further enhanced, with another step down in volatility and drawdown.
- Our final step is periodic reweighting of the functional alternatives bucket depending on forecasts of market conditions --- for example, more of the upside alpha alternatives when markets are forecast to be stronger. Yet another improvement in return, and a further reduction in volatility and drawdown.
Our white paper, and the results we summarize here, include scenarios which reflect the hypothetical historical performance of combinations of indices, not all of which can be replicated. These examples are hypothetical and is for illustrative and educational purposes only; they do not reflect actual investment results.
What would the last 25 years have looked like with these allocation steps?
[1] Source: Candriam, 7 May, 2025. Based on the MSCI World (Equity) Index and Bloomberg US Treasury Index, both for the period of our white paper, 1999 to 2025, the correlation was 0.97, and for the longer period of 1980 to 2025, the correlation was 0.98.
Want more detail?
Find our new white paper here