“Is 60/40 dead?” muses Rathbones’ head of multi-asset David Coombs in a meeting room at the firm’s Finsbury Circle office. After a moment’s thought, he adds: “No, it’s suddenly resuscitated.”
Investing used to be a much simpler art: put 60% of your portfolio in equities and 40% in bonds and leave it to do its magic.
But along came the global financial crisis and the resulting intervention of central bank policy to revive global economies and keep inflation in check, and suddenly this traditional form of asset allocation became somewhat obsolete.
Yet in the resulting world of negative yields and the continued march of equities, Coombs (pictured left above) believes things have come almost full circle. At least that is the case with the medium-risk Rathbones Strategic Growth portfolio, which currently looks not dissimilar to an old-school 60/40 strategy.
“All this multi-asset, sexy stuff and we look like a portfolio did 30 years ago. But it’s horses for courses, right? That’s the environment we’re in. It would have looked nothing like that four or five years ago, and I suspect it’s probably quite different to a lot of our competitors right now.”
Bucket list
Rathbones multi-asset portfolios allocate to asset classes based on its ‘LED’ framework, which comprises three buckets: liquidity, equity risk and diversifiers.
The liquidity bucket, as the name suggests, is for asset classes that are liquid, but not just by definition. Coombs explains they also need to have a negative correlation to risk-on during times of market stress.
“Drawdowns are typically at their biggest during market stress. Reducing that means you’re going to have better cumulative returns because you’re not destroying capital. You also give your investors a better ride.”
He explains: “We’re not looking at average annual liquidity but at what your liquidity was during dotcom, the global financial crisis and during Enron.”
In the liquidity bucket are assets such as cash, G10 government bonds with an A-rating or above, investment-grade bonds and certain currencies, including the US dollar, euro, yen and sterling.
By contrast, the equity risk bucket contains asset classes that are highly correlated to equities during market stress. This can include any equity market, including emerging, corporate bonds below an A-rating, high yield and the full spectrum of credit, property Reits, as well as the Australian and Canadian dollar hedged back to sterling.
According to Coombs, a style analyst would regard the portfolio’s equity exposure as more growth than value-oriented, given it contains names such as Adobe, Amazon and Google, and that it has a US bias. But Coombs, together with Rathbones multi-asset fund manager Will Mcintosh-Whyte (pictured right above), is agnostic on style and geography.
Finally, the diversifier bucket includes assets with a high probability of negative correlation during periods of market stress but will likely have poor liquidity. Coombs is quick to point out this does not simply refer to alternative assets because private equity, for example, would fall into the equity risk bucket, as would a long-short equity product.
Examples of assets used as diversifiers would be precious metals – gold, silver and platinum – and commercial property, although the portfolio does not hold any of the latter at present. Similarly, infrastructure would be in there if held, as would non-G10 sovereign bonds, and this bucket currently contains some Singapore dollar bonds.
Steeper protection
The diversifier bucket also holds structured products, such as yield curve steepeners and put options. Curve steepener trades use derivatives to benefit from escalating yield differences that occur because of increases in the yield curve between two treasury bonds of different maturities.
“When we strike it, we calculate it will pay a certain number of times whatever the difference between those two yields is,” says Mcintosh-Whyte. “Our structured product will actually pay us 11 times whatever the difference is between the five and the 10- year, as it happens.”
The steepener was a three-year trade with the payoff being 11 times the difference paid as an annual coupon. It also benefits if the yield curve inverts, says Mcintosh-Whyte, paying a positive return of 11 times down to -0.25% difference.
He says: “The point is that in those scenarios, where yields are rising and that is driving a risk-off environment, a taper tantrum- style of which we saw in 2013, that would give us some element of protection.”
S&P put options were added to the portfolio’s ‘D’ bucket in early 2018. According to Coombs, the idea was that while they are not cheap and come with counterparty risk, they are 100% negatively correlated to a riskoff event – and they are liquid. “It’s like insuring your house,” he says.
“I can get the insurance cheaper if I don’t buy the flood piece, just the fire. But if I’m living next to a river, I’m screwed.” “If we could buy put options at 1% per annum, we’d cover the entire portfolio,” he adds. “At the moment, we’re 30% covered.”
No middle ground
Overall, the ‘L’ bucket is 25% of total assets, ‘E’ 64% and ‘D’ 11%. Looking at the portfolio from a more traditional asset allocation perspective, the pure equity risk is 61% and, bar the put options, yield-curve steepeners and gold, the rest is made up of fixed income, predominantly sovereign bonds.
That is why Coombs feels inclined to call it a ‘60/40’ portfolio. “There is simply no middle ground to invest in,” he says. “There’s no shades of grey in there. It’s pretty black and white. You’re either a safe haven or you’re going to generate some return for us.
“There’s no peer-to-peer lending, student accommodation, medical. None of that nonsense. There’s nothing in between as far as we’re concerned that’s investible right now.”
Coombs argues that the market backdrop means it is entirely necessary for investment strategies to look completely different to how they have before, and if they don’t then questions need to be asked.
“We’ve never had this before. A lot of quants and passive investors are struggling because textbooks have never had to negotiate negative yields, so no model can help you here. If your strategy doesn’t look different, I’d ask questions.”
