This article is part of the latest Trends and Opportunities report, which seeks to provide therapy for recent market shocks by offering long-term perspective and potential solutions.

A successful allocation to a balanced fund may help investors maneuver these difficult markets by encouraging them to stay the course and avoid the temptation of market timing.

YTD Recap

• During the first half of the year, equities entered into bear market territory as a result of rising global inflation, geopolitical conflict and central banks embarking on a regime of quantitative tightening (QT).
• Unfortunately, this strong shift to QT sent bond returns sharply negative alongside equities, resulting in underwhelming performance for the classic “60/40” equity/bond portfolio.
• In fact, the 60/40 has seen its worst six-month drop since 1988 and its second-worst year (so far) in total returns since the Global Financial Crisis in (-16.1% in the first half of 2022 vs. -22.1% in 2008).

Diversification and risk mitigation: The 60/40 portfolio historically experienced lower drawdowns and faster recoveries

Source: Bloomberg, Portfolio Construction and Strategy, as of 08/31/2022.

Outlook

• The sell-off in both equity and fixed income markets can largely be attributed to the shift from a quantitative easing to a tightening environment, and we believe much of the repricing has already occurred.
• A successful allocation to a balanced fund may help investors maneuver these difficult markets by encouraging them to stay the course and avoid the temptation of market timing.
• Although returns have been painful, a double-digit decline in a 60/40 portfolio is not uncommon. History shows us that investors who were patient with their portfolios during corrections were often rewarded with a rebound within the 12 months following a bear market.

The 60/40 portfolio intra-year declines in perspective

Source: Morningstar, Portfolio Construction and Strategy, as of 08/31/2022.

PCS Perspective

• Balanced strategies comprise a large, diverse category of managers that can be primarily used in three different ways, with three different risk considerations:
  • To outsource an entire portfolio: Consider pairing differentiated managers to reduce idiosyncratic risk
  • As a core portfolio: Counterintuitively, seek out managers with higher correlations to a typical 60/40 allocation, indicating high core and lower satellite exposures
  • As a tactical overlay: Avoid managers categorized as merely “static” or “dynamic” and focus on “flexible” (i.e., largely unconstrained) managers to maximize
• A successful 60/40 “balanced” allocation needs a clear intention as to its role in the broader portfolio, including risk behavior, time horizon, and objective, as well as a thorough due diligence of its regional, sector, and asset class exposures.

PORTFOLIO CONSTRUCTION AND STRATEGY

TRENDS AND OPPORTUNITIES

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