Research report

The traditional “40” is broken

Declining rates have left the traditional “40” struggling. Investors need to find ways to fix their fixed income allocation by seeking alternative sources of income, return and diversification.

Robert Hoffman
October 6, 2020 | 8 minute read

The search for income has been well documented as global interest rates have played a continuous game of limbo for the past few years; how low can they go? But the implications of these low rates extend beyond low yields and investors’ resulting meager source of income. In this note, we discuss what we believe is the biggest source of risk to the universal standard 60/40 portfolio, and what investors can (and should) do now to fix what is broken.

A 40% allocation to a mixture of Treasuries and high-quality corporate bonds has historically served multiple purposes in a portfolio, including income, capital preservation and diversification. But we believe core fixed income is ill-equipped to meet these goals going forward. After a multidecade secular decline in interest rates and the massive fiscal and monetary response to the health crisis, rates are hovering near or below zero throughout the world. Not only do low rates starve income-seeking investors, but the historic risk-return assumption of bonds – the very basis for their inclusion in a balanced portfolio – has been fundamentally altered.

Key takeaways

  • Bonds, and by extension balanced portfolios, face enormous headwinds.
  • Declining rates have left portfolios bereft of income and more sensitive to interest rates than ever before.
  • Fixed income no longer serves as a guaranteed equity hedge and should inflation re-enter the picture, bonds will be even more challenged.
  • Investors need to find ways to fix their fixed income, either by diversifying their “40” or seeking alternative solutions.

This information is educational in nature and does not constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment. FS Investments is not adopting, making a recommendation for or endorsing any investment strategy or particular security. All views, opinions and positions expressed herein are that of the author and do not necessarily reflect the views, opinions or positions of FS Investments. All opinions are subject to change without notice, and you should always obtain current information and perform due diligence before participating in any investment. FS Investments does not provide legal or tax advice and the information herein should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact any investment result. FS Investments cannot guarantee that the information herein is accurate, complete, or timely. FS Investments makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.

Any projections, forecasts and estimates contained herein are based upon certain assumptions that the author considers reasonable. Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the projections will not materialize or will vary significantly from actual results. The inclusion of projections herein should not be regarded as a representation or guarantee regarding the reliability, accuracy or completeness of the information contained herein, and neither FS Investments nor the author are under any obligation to update or keep current such information.

All investing is subject to risk, including the possible loss of the money you invest.

Robert Hoffman, CFA

Managing Director, Investment Research

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