Building the balanced portfolios of the future

A bal­anced port­fo­lio tra­di­tion­al­ly involves a 60/40 mix­ture of equi­ties and bonds, with the pro­por­tion of bonds ris­ing after retire­ment to reduce volatil­i­ty. But with bond yields at very low lev­els, pri­vate investors are look­ing else­where. 

Oth­er low-risk invest­ment options are emerg­ing as alter­na­tives as indi­vid­ual investors and fund man­agers look beyond the con­ven­tion­al port­fo­lio struc­ture. They’re now tak­ing full advan­tage of new and evolv­ing asset class­es like cryp­tocur­ren­cies and prop­er­ty.

Mike Deverell, part­ner and invest­ment man­ag­er at Equi­lib­ri­um Invest­ment Man­age­ment, thinks the days are behind us when a bal­anced port­fo­lio relied on equi­ties and bonds.

“Cen­tral banks are like­ly to put up inter­est rates over the next few years – per­haps only to 1% here in the UK and maybe 2% in the Unit­ed States, but sub­stan­tial­ly high­er than the near-zero lev­els they are at now,” he says. “They will also want to scale back or even reverse quan­ti­ta­tive eas­ing. If this hap­pens it will prob­a­bly be bad for bonds, where yields tend to go up and prices go down when rates rise.”

That could have a knock-on effect on the stock mar­ket, which has been sup­port­ed by low yields and quan­ti­ta­tive eas­ing. Big tech stocks in the US would be vul­ner­a­ble, while infla­tion could erode pur­chas­ing pow­er.  

Keeping it real 

Deverell believes the bal­anced port­fo­lio of the future should have an allo­ca­tion to ‘real assets’ like infra­struc­ture, select­ed prop­er­ty and alter­na­tives like forestry, which will ben­e­fit from the green agen­da as busi­ness­es look to off­set their car­bon. 

“If cho­sen wise­ly, these assets can pro­vide a sol­id, high lev­el of income, which tends to increase at least with infla­tion,” he says.

Adam Walkom is co-founder at Per­ma­nent Wealth Part­ners, a firm of finan­cial plan­ners. For him, the tra­di­tion­al 60/40 Bal­anced port­fo­lio is dead. 

“In a low and ris­ing inter­est rate world, hav­ing a sig­nif­i­cant por­tion of your port­fo­lio in an asset class that is almost guar­an­teed to lose mon­ey is not diver­si­fi­ca­tion – it’s stu­pid,” he says.  

Thanks to the tra­di­tion­al 60/40 approach it “became too easy for the advis­er to bun­dle a client into a bal­anced port­fo­lio because they ticked box­es on the risk ques­tion­naire a cer­tain way. Good for the reg­u­la­tor, bad for the client”. 

If you won’t need the funds for 20 or more years, you should hold 100% equi­ties, Walkom says. For short­er time-based needs – say, five years or so – an “all-weath­er” port­fo­lio could be an option. This uses a spread of dif­fer­ent assets for the non-equi­ty por­tion, such as prop­er­ty or real estate invest­ment trusts (REITs), gold, pri­vate equi­ty and per­haps some infla­tion-linked bonds.

Tra­di­tion­al bonds just don’t main­tain pur­chas­ing pow­er for investors today, thinks 

Hinesh Patel, port­fo­lio man­ag­er at Quil­ter Investors. Instead, he sug­gests they look for selec­tive oppor­tu­ni­ties in real assets like infra­struc­ture projects, care homes and ware­hous­es that can pro­vide attrac­tive income yields. 

ESG opportunities

Some wealth man­agers think the­mat­ic invest­ing, not geo­graph­i­cal bound­aries, is the strat­e­gy of the future. Over time, there will be a con­tin­ued increase in expo­sure to theme-based invest­ing, poten­tial­ly at the expense of geo­graph­ic allo­ca­tions, says Chris Ain­scough, direc­tor of asset man­age­ment at Charles Stan­ley.

“Geo­gra­phies are a clean and easy way to break up the investable uni­verse, but they don’t always take into account the over­lap­ping expo­sures across the globe or the fact that the domi­cile of an invest­ment may be very dif­fer­ent from the eco­nom­ic expo­sure of that invest­ment,” he says. 

An exam­ple might be the green ener­gy tran­si­tion, which will like­ly have no bor­ders as the world unites to tack­le the prob­lem. This the­mat­ic move will also involve a shift to real assets like prop­er­ty and gold as an alter­na­tive to tra­di­tion­al fixed income expo­sures.

The height­ened aware­ness of envi­ron­men­tal issues and cli­mate change has also giv­en indi­vid­ual investors a rea­son to be more vocal about how their mon­ey is invest­ed. Envi­ron­men­tal, social and gov­er­nance (ESG) issues have come to the fore in invest­ment deci­sions.

“The fastest evo­lu­tion of asset mar­kets in recent years has been to cater to clients’ pref­er­ences regard­ing ESG, impact and oth­er eth­i­cal con­cerns that they may have,” Ain­scough says. “The con­struc­tion of a bal­anced port­fo­lio will have to adapt to cater to these.”

Changing preferences 

While the prin­ci­ples guid­ing port­fo­lio diver­si­fi­ca­tion will remain the same, investor pref­er­ences are chang­ing, says Dr Har­joat Bham­ra, asso­ciate pro­fes­sor of finance at Impe­r­i­al Col­lege Busi­ness School. “In the future, a well-bal­anced port­fo­lio will have more expo­sure to green­er assets,” he says. 

Anoth­er alter­na­tive to tra­di­tion­al bonds is exchange trad­ed funds (ETFs) focused on invest­ment-grade green bonds. This could be a use­ful option for investors at a time when the EU has start­ed to issue green bonds.

“With most gov­ern­ment bond yields at rock bot­tom lev­els, the tra­di­tion­al income and diver­si­fy­ing role they have played in port­fo­lios for many decades is chal­lenged,” says Vivek Paul, senior port­fo­lio strate­gist at the Black­Rock Invest­ment Insti­tute. 

The oth­er key ques­tion fac­ing investors is how they can inte­grate sus­tain­abil­i­ty, Paul adds. 

“There is a deep­er and more wide­spread under­stand­ing that sus­tain­abil­i­ty risk is invest­ment risk. Cli­mate change affects every aspect of mod­ern life, so it is no sur­prise that it is shap­ing port­fo­lio con­struc­tion too.”

David Ko and Richard Busel­la­to are the co-founders of Rethink­ing Choic­es, a sus­tain­abil­i­ty agency, and authors of The Unsus­tain­able Truth. They argue that bonds offer a poor invest­ment choice in the cur­rent envi­ron­ment due to the infla­tion and cred­it risks.

“The future well-bal­anced port­fo­lio needs to be under­weight in those com­pa­nies that rely on vol­ume growth, clever lever­age, or sig­nif­i­cant ongo­ing invest­ments sell­ing images of per­fect futures,” says Ko. Instead, investors should seek out street smart, resilient com­pa­nies which know how to thrive in a hos­tile envi­ron­ment and pro­duce gen­uine­ly need­ed goods and ser­vices, adds Busel­la­to.