Beyond the 60/40: Strategic Asset Allocation in a Changing Investment Landscape
Patrick Cooper
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April 7, 2025
Beyond the 60/40: Strategic Asset Allocation in a Changing Investment Landscape
Investors are constantly chasing portfolio optimisation, seeking to adapt their asset allocations to the current and anticipated economic climate, with the objectives of maintaining portfolio resilience and maximising returns.
The paper “Safe Equities: An Alternative Allocation to Bonds,” published in the Financial Analysts Journal, suggests that substituting traditional bond allocations within a 60/40 portfolio with low-volatility equities can enhance returns across market cycles. This paper has prompted our examination of the potential benefits of replacing bonds with a diversified private credit fund within a 60/40 portfolio framework.
While identifying an accurate Australian proxy with an extensive private credit track record is challenging, the iPartners Investment Fund, a diversified private credit fund with over 5 years of track record offers a relevant starting point for our analysis following.
The 60/40 Portfolio: A Historical Perspective
For many years, the traditional 60/40 portfolio, comprising 60% equities and 40% bonds, has served as a cornerstone asset allocation strategy. Its enduring popularity stems from the role of the fixed-income component in mitigating downside risk during periods of equity market underperformance usually during recessions or as a response to economic shocks. In these scenarios, central banks typically implement interest rate reductions to stimulate economic activity. Consequently, bond yields decline, and bond prices appreciate, providing a hedge against portfolio losses.
However, the efficacy of this diversification strategy is based on a negative correlation between bonds and equities. The current post-pandemic inflationary environment has disrupted this relationship, with the correlation between these asset classes exhibiting a positive upward trend.
The investment landscape of 2022 illustrated the limitations of the 60/40 portfolio with double-digit losses in both equity and bond markets. Investors are now confronted with the critical question of how to reposition portfolios to optimise returns and maintain robustness in an environment characterised by persistent high inflation and potentially constrained interest rate cuts.
Strategic Allocation to Alternative Investments
Incorporating alternative investments into portfolios can serve a dual purpose: providing a ballast during periods of underperformance in both equities and bonds, and enhancing risk-adjusted returns across times of both high and low inflation.
Diversification through alternative investments can provide access to competitive returns with a low correlation to traditional asset classes. However, investors must conduct thorough due diligence when considering allocations to alternatives, carefully assessing the associated risks and selecting high-quality investments and asset managers.
The optimal allocation to alternative investments will vary based on investors’ liquidity profiles, risk tolerance, investment horizons, and objectives. Private market funds can offer a diversified exposure to various alternative strategies, providing an additional layer of portfolio diversification.
The past five years have presented significant challenges to investment portfolios, marked by heightened volatility and periods of positive correlation between equities and bonds, particularly impacting the effectiveness of the 60/40 portfolio. During these periods, portfolios with allocations to alternative investments have generally demonstrated greater resilience as seen in the following portfolio analysis.
Comparative Portfolio Analysis
To illustrate the potential benefits of incorporating alternatives, two model portfolios have been constructed over a five-year period.
Portfolio 1: A 60/40 portfolio comprising 60% ASX 300 Accumulation Index and 40% iPIF, with monthly reinvestment of dividends and distributions.
Portfolio 2: A traditional 60/40 portfolio, with the 40% allocated to the Bloomberg AusBond Composite 0+ Yr Index that measures the Australian debt market.
Both portfolios experienced the market volatility associated with the pandemic. However, during the subsequent market recovery and persistent inflationary environment, the portfolio with an allocation to alternatives demonstrated superior returns relative to the traditional fixed-income allocation, without taking on excess volatility.
Over the five-year period, the 60/40 portfolio incorporating a high-quality alternatives fund generated returns that were double those of the traditional 60/40 portfolio. Notably, from early 2022 onwards, the divergence in returns between the two portfolios widened, coinciding with the increasing positive correlation between equities and bonds. This highlights the diminished effectiveness of bonds as a hedging instrument against equity market underperformance in recent years.
Analysis of the individual asset classes reveals that both alternatives and bonds exhibit lower volatility compared to equities, enabling them to function as portfolio stabilisers. However, alternatives have not only provided hedging benefits but have also delivered superior performance, with the iPIF generating a total return of nearly 60% over five years, accompanied by lower volatility than public market investments.
Volatility and Risk-Adjusted Return Analysis
Given that private market funds, such as the iPIF, are not publicly traded, direct observation and measurement of volatility are limited. To provide a proxy for private market volatility, we can examine the Sharpe ratio of the iPIF, utilising research completed by Hamilton Lane who have analysed the volatility levels of different types of credit.
The Sharpe ratio provides a metric for evaluating the excess return over the risk-free rate generated by an investment per unit of risk assumed.
Using the proxy of the annualised volatility figure of All Private Credit along with the returns of iPIF and the average risk- free rate over the last 5 years in Australia, the Sharpe Ratio equates to 1.33. When comparing this to public market equities, such as the ASX 300 with a Sharpe Ratio of 0.24 over the past 5 years, the iPIF presents an attractive opportunity to add to an investor’s portfolio in comparison to only including bonds to one’s portfolio of equities.
Over the past 5 years the 60/40 portfolio, comprising 60% equities and 40% iPartners Credit Investment Fund (iPIF), demonstrates a Sharpe Ratio of 0.68, calculated using the 6% volatility assumption for private credit.
This delivers approximately triple the excess return per unit of risk relative to the traditional 60/40 portfolio, which exhibits a Sharpe Ratio of 0.22.
Drivers of Superior Performance in Alternative Investments
The superior risk-adjusted returns generated by alternatives and private market funds such as iPIF can be attributed to several factors.
Private market investments are inherently less liquid than publicly traded assets. This illiquidity premium compensates investors for committing capital for extended periods, resulting in higher potential returns.
Furthermore, private market investments are less susceptible to the short-term market fluctuations, pricing distortions, and sentiment-driven trading activity that characterise public markets. This relative insulation contributes to reduced volatility.
The pricing of these assets is also less transparent compared to public assets. Private market investments involve comprehensive due diligence and access to proprietary information, potentially leading to enhanced returns and more informed investment decisions.
Finally, actively managed private market funds offer the advantage of direct involvement in individual investment structuring and deal negotiation. This enables fund managers to tailor investments to mitigate risk and implement targeted diversification strategies.
Conclusion
The traditional 60/40 portfolio may no longer provide the same level of stability and performance observed in the past. In the current post-pandemic economic environment, characterized by positive correlation between equities and bonds, diversifying beyond traditional assets has become a prudent strategy for many investment portfolios.
Allocating to high-quality private market investments can provide a hedge against market volatility while enhancing overall portfolio returns. Strategic incorporation of alternatives can offer the benefits of uncorrelated returns, reduced volatility, and the potential for outperformance in both inflationary and disinflationary environments. However, careful selection of alternative investments and private asset managers is paramount to achieving these objectives.
References
Stephen Penman & Julie Zhu (2025) Safe Equities: An Alternative Allocation to Bonds, Financial Analysts Journal, 81:1, 63-81, DOI: 10.1080/0015198X.2024.2437982
https://www.hamiltonlane.com/en-us/insight/buying-senior-credit
https://www.blackrock.com/us/individual/insights/60-40-portfolios-and-alternatives
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