The possibility of enhanced returns.
Private investments in non-public companies.
For more than half a century, many investors have constructed their portfolios according to the 60/40 principle. This entails reserving 60 percent of your portfolio for public equities, and the remaining 40 percent for bonds. The overall aim of this set up is to achieve more consistent long-term returns while lowering levels of volatility.
Until recently, this largely worked. Measured against pure stock and bond portfolios from 1988 to 2018, the 60/40 strategy provided a buffer against volatility and a better long-term return.1
However, its recent success came in part from the fact that, for the last 20 years or so, bond and equity prices were negatively correlated – that is, when one asset class would decrease in value, the other would increase. This would help keep the portfolio diversified, given its ability to perform well in different market environments. Increasingly, however, this is no longer the case.
High inflation, increasing interest rates and high uncertainty are destabilising the relationship between bonds and equities,
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Given this shift, many institutional investors have been moving away from such models for decades, adding allocations to alternative asset classes such as private equity alongside existing stocks and bonds. This has helped reinstall diversification benefits, as well as add another source of returns. The wider investor community, however, is lagging behind.
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The 60/40 model first emerged in the 1950s as a by-product of modern portfolio theory.2 However, it did not come to the fore until the 1970s, when investment giant John Bogle made it a cornerstone of index investment at his newly founded Vanguard Group.3
The logic behind this mix is that the equity allocation would outperform in better times, while the bonds would provide a level of downside protection and resilience in the worse conditions. In essence, the latter’s relatively lower volatility would act to counterbalance uncertain equity markets, providing investors with the chance of better risk-adjusted returns. Indeed, according to Schroders, an investment of $1,000 in 1989 and measured through 2019 would have an annual return of 7.5 percent, outperforming pure stock or bond portfolios over that timeframe.4
The model served investors well for years, and no more so than during the last decade. Between 2011 and 2021, the 60/40 portfolio generated an 11.1 percent annual return.5
In the first six months of 2022, the Bloomberg US 60/40 Index – a tracker of that type of portfolio’s performance – was down around 17 percent.6
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Source: Bloomberg
In recent history, bonds have been a relatively reliable buffer when economic growth is slowing, as investors usually flock to safe-haven assets, such as sovereign debt, in uncertain times. However, increasing inflation can negate this, as rising prices reduce the real return on bonds, given they are mainly assets with a fixed rate. For stocks, meanwhile, rising rates and prices put pressure on companies' bottom lines, dragging down equity markets as well.
In 2021, for example, the S&P 500 notched 70 all-time highs through the year and gained 26.9 percent overall.7 With bonds, meanwhile, relatively low yields also offer a poor starting point for future returns, with even negative yields on offer in some core sovereign markets. Yet this ignores the clear change in relationship between the asset classes that is undermining their diversification.
In the first half of the year, the S&P 500 index dropped more than 20 percent, its worst first half performance in more than half a century.8 Bonds also came under pressure from rocketing inflation and rising interest rates. For example, in the same period, US Treasuries had delivered total year-to-date losses of 11 percent.9
If these high levels of uncertainty are maintained, equity and bond markets could continue to mirror rather than counterbalance each other.
In light of this, institutional investors have already been diversifying away from stocks and bonds and towards alternative asset classes, such as private equity. Today, market allocations for big institutions – including pension funds, endowments and foundations – generally range from 10 percent to 25 percent.10
Although past performance is not necessarily indicative of future returns, private equity’s track record of a long-term return profile could prove highly beneficial in an environment of lower returns from bonds and stocks. Between 2001 and 2021, private equity and private credit outperformed global public equity and credit markets in 19 of the 20 years.11
Adding this to a traditional portfolio can help bolster performance. Research by Hamilton Lane shows that between 2000 and 2020, a rigid 60/40 portfolio offered annual returns of around 7.5 percent. However, a portfolio with a larger allocation to private equity and real estate (42 percent public equity, 28 percent bonds, 18 percent private equity, 12 percent private credit) offered annual returns of 9.40 percent.
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Source: Hamilton Lane. Sharpe ratio is a measure of the risk-adjusted return of a portfolio.
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On top of the return potential, adding private markets can also help investors broaden their base, and diversify away from an ever-shrinking set of companies listed on stock exchanges. In the UK, for example, the number of companies listed on the country’s stock exchanges has fallen by 12.5% in three years.12
Adding a private market allocation to a portfolio means owning a wider and more diverse section of the investment landscape. It also provides access to companies and industries that are rarely on or too early for public markets, such as Silicon Valley startups. This, in turn, diversfies and spreads risk at a lower level through the portfolio, rather than concentrating it in one area.
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In Canada, pension plans have transitioned their strategic asset allocations to manage their risks by having higher allocations to alternative assets.
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Source: Mackenzie Investments
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We have access to retail friendly private businesses including private equity, private debt and private real estate. This means regardless of your investor accreditation status, you can access private securities through your MapleTree Private Wealth advisor.
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2 https://fortitudefinancial.co.nz/news-and-views/the-death-of-60-40
3 https://mutualfunds.com/retirement-channel/80-20-is-the-new-60-40/
7 https://www.cnbc.com/2021/12/30/stock-market-futures-open-to-close-news.html
8 https://uk.finance.yahoo.com/news/stock-market-news-live-updates-june-30-22-115133813.html
