UBS expects a comeback for the 60/40 portfolio — and wants to limit cash

The 60/40 portfolio isn’t dead — in fact, it tends to outperform over the long term, according to UBS. That means investors hiding out in cash should think twice about staying out of the stock- and bond markets, the bank said. As interest rates fall, the returns on cash will dwindle , it said. There is currently more than $6 trillion sitting in money market funds, according to the Investment Company Institute . “Cash has underperformed historically over the long term. Based on data going back to 1926, a 60/40 portfolio of U.S. large-cap securities and bonds beat cash around 80% of the time over a five-year period,” Mark Haefele, chief investment officer for global wealth management at UBS, wrote in a note last week. The strategy revolves around a simple balanced portfolio, allocating 60% to stocks and 40% to fixed income. Traditionally, stocks and bonds move in opposite directions. Therefore the allocation, normally, has a tendency to lower the volatility of the portfolio, explained Leslie Falconio, head of taxable fixed income strategy in UBS Americas’ chief investment office. That theory was tested when both equities and fixed income slumped in 2022. The iShares Core Growth Allocation ETF (AOR) that mimics the strategy sank 17.4% in 2022, but rallied nearly 13% in 2023. Still, it underperformed the broader market, when the S & P 500 gained 24% last year. The stock/bond correlation that drives the 60/40 outperformance is “dormant, but not dead,” Falconio said. “Over the longer period, it will come back into play.” UBS expects that to happen when the Federal Reserve starts cutting interest rates from their current 5.25%-5.50%. Right now, the short end of the yield curve will stay elevated until the market feels confident that the Fed is going to act, Falconio explained. “The fixed-income market is very forward looking,” she said. “Once [Fed officials] cut, it will take future cuts and start pricing them in — and the short end starts to move down quite quickly.” So while attractive yields may be driving interest in cash right now, cash will go back to being used mainly for capital preservation and liquidity, then for its yield, she said. Crafting a balanced portfolio Falconio expects the new 60/40 construction to look a little different with the rise in popularity of alternative assets. Alternatives, like private credit, “are a great way to diversify and lower your volatility,” Falconio said. When it comes to traditional fixed income assets, UBS suggests holding strategic, diversified exposure throughout fixed income. It specifically favors high-quality bond segments. “You really need to pick your spots in terms of getting relative value,” said Falconio, who noted that spreads have become compressed. However, there have been some higher-quality areas that have underperformed, like agency mortgage-backed securities , she said. The products are debt obligations issued by agencies such as Fannie Mae, Freddie Mac and Ginnie Mae whose cash flows are tied to the interest and payment on a pool of mortgage loans. They are considered low credit risk because they are backed by the U.S. government. While spreads are tight, UBS still prefers investment-grade corporate bonds. Falconio called them a “carry price appreciation play.” In addition, the firm prefers 10-year Treasury inflation-protected securities. The assets’ principal portion rises and falls alongside the movement in the consumer price index for all urban consumers. At maturity, you get the greater of the increased inflation-adjusted price or the original principal. “We think real yields come down,” she said. “You have the ability to earn that inflation-adjusted income.” — Darla Mercado contributed reporting.