Why We Don’t Believe Time is Right for 60/40 Portfolios

What is a 60/40 portfolio?

A 60/40 portfolio is a traditional investment strategy that allocates 60% to equities for growth and 40% to bonds for stability and income. The idea is to balance risk and return. Stocks typically offer higher growth than bonds but also more volatility. Meanwhile, bonds generally provide more stable returns and can help cushion losses during equity market downturns.

The strategy relies on negative correlations between equity and bond returns to work satisfactorily. Equity and bond returns have indeed been negatively correlated for much of the last 45 years, which is why the strategy has become so successful. Nobody knows precisely how much money is managed this way, but tens of trillions of dollars seems like a reasonably good estimate. The number is so high because many large pension funds follow the model one way or the other. It is also an extremely popular strategy amongst private investors.

1980-2020 marked the golden age of 60/40 portfolios, and the reason is simple. During this 40-year period, every time economic growth weakened and equities sold off as a result, bond prices rose, i.e. bonds proved an effective hedge against falling equity prices. Consequently, portfolio returns still looked reasonably good. The one critical difference between then and now is that strong disinflationary powers prevailed during this 40-year period. Now, they don’t.

Source:  Office for National Statistics

Why it makes a massive difference whether inflation is low or high

To start, inflation is, to a significant degree, driven by inflation expectations. If you expect low inflation over the next few years, you will happily settle for a lower pay rise; hence actual inflation should also be modest. This little twist is a big part of the reason inflation wasn’t a serious problem between the early 1980s and 2020.

Then came the COVID pandemic which caused serious supply chain problems, and inflation became an issue again. Now, when we finally thought we were out of the woods, President Trump decided to go to war in the Middle East. The Strait of Hormuz was closed, and that greatly affected inflation through rising oil and gas prices.  

The problem for investors is that, when inflation is modest, bond and equity returns are typically negatively correlated; however, when inflation spikes, the correlation turns positive (equity and bond prices move in the same direction at the same time), and the 60/40 model breaks down. That is what has happened recently. Hence the crucial question; at what inflation level do investors worry more about inflation than about weak economic growth, i.e. when does the correlation between bond and equity returns turn positive?

We wish there was a simple answer to that question but there isn’t; however, we can provide some guidelines. On average, the correlation is negative when inflation is below 2.5-3.0% and positive when inflation is higher than that. Note, we work with a range rather than a single number, because the critical point has changed over time.  After all those years with disinflation, inflation expectations moderated, effectively lifting the critical point. Where, 40 years ago, it was more like 2.5%, it is closer to 3% today.

Inflation is not the only reason why bond yields are rising

Up to this point, we have made it sound as if inflation concerns are the only reason bond yields are rising, but that isn’t the case. Take for example the fiscal situation in the U.S. which is out of control. In 2024, Trump campaigned on a pledge to fix USA’s public finances, which were already in dire shape back then; however, precisely the opposite has happened. The U.S. government has continued unashamedly to add more debt to an already overloaded economy, and, in mid-August, U.S. federal debt crossed the $40Tn mark for the first time. $40Tn is an almost incomprehensively large number – $40,000,000,000,000! When measuring national debt as a percentage of GDP, the USA is now more indebted than Greece and Italy, the two most indebted countries in Europe. No wonder Trump’s nickname is “The King of Debt”.

We worry that the current mayhem in the U.S. turns into a full-blown debt crisis where investors demand significantly higher yields (returns) to own US debt causing debt interest repayments to rise further.

Is inflation likely to return to 2% anytime soon?

As these lines are written, the latest published headline CPI inflation rates (year-on-year) and 10-year government bond yields in the G7 are as follows:

Source:           Bloomberg

First and foremost, as you can see, inflation and bond yields are not fully synchronised. Other factors must therefore affect bond yields as well. Take for example the UK which, in the G7, ‘enjoys’ the highest bond yields but not the highest inflation. Two possible explanations: (i) the UK has a long history of being quite inflation-prone, i.e. investors may demand a higher risk premium when investing there, and (ii) the BoE has deliberately been slow to react to relatively good inflation numbers, as they remain unconvinced the UK is out of the woods inflation-wise (their words, not ours).

Back to the question: Apart from Japan, is inflation likely to return to 2% anytime soon? Not in our opinion:

1. Trump and his administration are struggling to find a way out in the Middle East. Meanwhile, little oil passes through the Strait of Hormuz every day with an oil-hungry world instead relying on oil inventories to satisfy their needs. However, those inventories won’t last forever, and we consider rising oil prices over the next few months more likely than falling oil prices.

2. A bad El Niño this year is expected to impact crop yields pushing up the price of many agricultural products. Current World Bank analysis has warned that the 2026–27 El Niño could reduce yields across Southern Africa, Central America, the Sahel, and parts of South and Southeast Asia; it identifies rice and maize as particularly exposed, with rice output in affected regions potentially falling by 20–50%.

In other words, 2% inflation is still far away in our opinion (ex. Japan) and the risk is probably greater that inflation rises from current levels.

Given our outlook for bond yields, how do we prefer to diversify equity risk?

If it isn’t already clear, our money is on bond yields to stay higher for longer. Bond investors do not appear convinced that conditions are in place for rate cuts. Therefore the basic premise of the 60/40 portfolio, that the bond element provides protection against an equity market fall, may not work for the foreseeable future. Bonds have problems of their own!

A few years ago, when we first saw the writing on the wall, we began to invest in commodities and other real assets. At first our commodity exposure was mostly in gold and agricultural commodities but, gradually, many other commodities came into play as well. Today, commodities of different sorts account for a material part of our clients’ portfolios.

Our logic was (and still is) quite simple. We should own the very things that are creating the rise in inflation to help protect our clients’ capital. When inflation is relatively high, commodities almost always outperform equities. If you take a look at the table below, you can see that this logic is quite convincing.

Inflation-adjusted returns by inflation band

Source:           The Felder Report

In addition to our commodity exposure, we have material exposure in portfolios to other real assets such as infrastructure. Here the returns from those assets are mostly inflation-linked so if inflation rises so do the returns.

Is 60/40 broken, or just not working right now?

2022 was an exceptional shock, not a permanent state of affairs. When central banks moved from zero rates to the fastest hiking cycle in a generation, bonds and equities were repriced simultaneously. A rare and painful combination, but a function of a specific policy shift rather than proof that the 60/40 model is dead. It’s also worth remembering that the strong bond returns of the 2010s were themselves a product of extraordinary circumstances. Zero interest rate policy and quantitative easing artificially suppressed yields for over a decade, meaning investors were often being paid very little in real terms to hold duration. That distortion has now unwound. With yields back in positive real territory across most of the G7, bonds are, for the first time in years, actually compensating investors for the risk they’re taking, which is a healthier, more sustainable starting point than the one we came from.

Our conclusion, therefore, isn’t that the 60/40 framework is broken beyond repair, but that the traditional expression of it, namely long-duration sovereign bonds as the automatic ballast, needs rethinking while inflation and fiscal risk remain elevated.

What we are doing

Rather than abandoning fixed income altogether, we favour reshaping the portfolio hedge itself. Shortening duration to reduce sensitivity to further yield volatility, favouring select corporate credit over sovereigns where spreads offer better compensation for underlying government fiscal risk, and holding a meaningful allocation to cash.

Alongside this reshaped approach to fixed income, commodities and real assets continue to play a meaningful role in client portfolios. Commodities are inherently cyclical, elevated prices typically incentivise new supply, which ultimately helps to moderate prices. For this reason, we do not view them as a permanent structural allocation. With that said, years of underinvestment in new supply, combined with heightened geopolitical risk and new sources of demand, mean they are likely to remain a feature of portfolios for the foreseeable future. Infrastructure remains equally important within our alternatives allocation, offering largely inflation-linked returns at a time when underinvestment in core utilities and rising electricity demand from AI are both driving structural need for capital.

We continue to monitor government bond markets closely and will be prepared to extend duration and raise our fixed income allocation once we believe yields are properly compensating investors for the risks being taken, but we are not there yet. There remains too much fiscal spending committed to welfare and defence, and too much supply side inflation still working its way through the system for us to make that shift with conviction. Today’s supply shock in commodity markets can sow the seeds of tomorrow’s demand shock as higher prices curb consumption and draw new supply online, disinflationary pressure should eventually reemerge, at which point fixed income becomes considerably more attractive again.

In the meantime, we are not just simply substituting one asset class for another. We are focused on diversifying both across and within asset classes. Within equities, that means favouring structural themes with durable, multi-year tailwinds, areas such as electrification, demand for water, and AI-related infrastructure, rather than relying on broad market beta alone. Within alternatives, it means allocating to absolute return strategies designed to generate returns independent of the direction of bond and equity markets, adding a further layer of diversification precisely when traditional correlations can no longer be relied upon. Our ability to analyse and navigate the shifting relationships between asset classes and to adapt portfolio construction as those relationships evolve remains at the core of our investment process, in pursuit of differentiated, inflation-proofed returns for our clients.

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