Over the past few decades, owning a balanced investment portfolio, comprised of company shares and bonds, has met most investors’ needs. Whenever stockmarkets have fallen in recent decades, bond markets have typically risen, and vice versa. This negative correlation between the two major asset classes has underscored the success of the traditional ‘60/40’ multi-asset fund. Such portfolios, consisting of roughly 60% company shares, or equities, and 40% bonds, have delivered steady, positive returns with relatively low levels of fluctuation in value.
In recent periods, however, this negative correlation has broken down. The reasons for its dilution are multi-faceted, but it brings into question the ability of the traditional multi-asset portfolio to continue delivering balanced returns going forward.
This is especially so when the long-term prospective returns from many mainstream bonds are compromised by the high prices at which they currently trade. Trillions of pounds of government bonds trade at negative yields, meaning investors would be guaranteed to lose money if they held these securities until they matured.
The case for a more tactical approach
In this context, we therefore believe a more dynamic approach to investing is needed to meet investors’ needs going forward. Rather than relying on asset class allocations to drive long-term returns, we think multi-asset investors will need to be more tactical in their approach.
This will involve looking to take advantage of short-term market volatility. In practice, this may mean cutting or adding to positions more quickly in order to seize opportunities when they arise.
As ever, it is important for multi-asset investors to remain appropriately diversified across different assets, sectors and markets, to better navigate periods of market volatility. This means there is a continued role for bonds to play, even at their current prices.
For instance, in our opinion, US government bonds which mature decades in the future have the potential to act as powerful diversifiers in a portfolio, since the US government is widely seen as a solid long-term borrower. We also see value in bonds issued by emerging market governments, which generally offer higher prospective returns than their developed market counterparts.
Company shares too continue to present long-term opportunities. Although share prices have recovered considerably from their lows in early 2020, when they plummeted in value, they continue to offer investors the prospect of growth that most bonds cannot.
The challenge of generating income
As of June 2020, the prospective income yield – the annual income return as a percentage of the price of an asset – on a ‘60/40’ balanced portfolio had fallen to its lowest level for over the past 40 years.
While this downward trend has largely been driven by falling government bond yields, the income yield on equities has been reduced by recent dividend cuts. Many large companies have reduced or suspended their pay-outs to shareholders in response to the coronavirus-induced economic downturn.
We believe though that stronger companies should soon be able to resume paying out dividends to their shareholders. Given that the virus-induced recession is a temporary shutdown of economic activity, rather than a result of overborrowing or a misallocation of capital, the damage need not be permanent.
There is still the possibility that dividends are not entirely cancelled, just suspended for now and may be paid later. The transient nature of the dividend cuts means that multi-asset income investors such as us should not have to change the way we approach income generation. We do need to be strategic though, and seek exposure to those companies and sectors whose dividends are unlikely to be affected for long.
Recent dividend cuts will obviously make it more challenging for income-focused multi-asset funds to provide their investors with a high and rising income. For the short term, at least, income expectations will have to be moderated. Over the longer term, however, we believe dividends can continue to play a key part in meeting multi-asset investors’ needs.
Past performance is not a guide to future performance
The value and income from a fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested.
The views expressed in this document should not be taken as a recommendation, advice or forecast.