Consider a Tactical Approach to Keep Your 60/40 Portfolio up to Speed

Being tactical with asset allocation can help investors better adapt to shifting markets and sudden risks.

In the recent webcast, Long Term but Tactical Aware: A Better Approach to Your 60/40 Allocation, Matthew Bartolini, head of SPDR® Americas research at State Street Global Advisors, pointed out that a medley of investor concerns from supply chain disruptions to Federal Reserve tapering fears have caused large-caps to see their worst monthly performance since March 2020. Looking ahead, while average historical volatility in Q4 is not substantially higher than other periods, Q4 tends to have more significant surprises or outliers in both bond and equity markets.

Despite the differential compressing between stock and bond fund flows, Bartolini noted that the numbers are still in the top quintile, which is reflective of continued risk-on positioning among investors. Among the various market segments, valuations of U.S. small-caps have become even more attractive as of late, while developed ex-U.S. equities appear more attractive than U.S. large-caps, especially after the outperformance and extended rally in domestic equities.

Breaking down the various market sectors, Bartolini pointed out that momentum remains strong and valuations stretched for communication services and technology amid continued risk-on positioning. However, momentum and earnings sentiment are lackluster for both staples and materials, reflecting the uncertain market environment.

Additionally, Bartolini highlighted the value factor as the only factor to outperform broad equities across the U.S., developed international, and emerging markets across the past year, with EM leading in terms of excess return to the market. Meanwhile, the low volatility and momentum factors have underperformed over the trailing 12-month period.

Looking at the fixed income markets, Bartolini noted that with rates rising, credit segments that are not so rate-sensitive, such as high yield and senior loans, have outperformed this past quarter. Meanwhile, the overall core bond segment remains challenged. Bonds are having their worst year since 2005, but yields remain low — pushing the 60/40 real yield negative. Bartolini warned that core global bonds could post the worst return ever if rates keep rising, but investors may find opportunities in below investment-grade segments, which have shown better yield per unit of duration profiles than investment-grade bonds.

Jeffrey Megar, managing director of Julex Capital, warned that while U.S. equities were the place to be since the start of the recent bull market, bear markets in recent years have shown to be both more severe and longer-lasting. Looking ahead, Megar highlighted risks like a growing government deficit, inflation, rising interest rates, a weakening U.S. dollar, and politics as factors that could destabilize the markets.

Consequently, Megar questioned investors’ perception of the traditional 60/40 investment portfolio allocation to meet the potential challenges ahead. Traditionally, the 60/40 portfolio included bond allocations to partially offset stock losses during bear markets with a secondary role of generating income. The bond allocation would also benefit from falling interest that typically occurs in bear markets.

However, with bear markets digging even deeper, the bond allocations may not be enough to even slightly offset the steep losses on the equity side, and a portfolio could suffer even worse declines ahead if we are still in a near-zero rate environment with the Federal Reserve incapable of offering enough tools to loosen its monetary policy.

In this type of environment, Megar argued for tactical asset allocation strategies while strictly avoiding predicting market direction or turning points. Megar explained that tactical asset allocation is an active management strategy that dynamically adjusts a portfolio’s asset allocation to current market conditions with the objectives of minimizing the potential for large losses and maximizing opportunities to improve returns. Tactical asset allocation employs a mechanical approach to a selection of funds within a basket of low-cost index funds.

Naomi DePina, vice president of ETF sales at GTS Trading & Execution Services, underscored the tools now available for financial advisors to execute more efficient trades across the various markets. GTS Issuer Services is a lead market maker for services for ETFs delivering competitive and accurate bid/ask spreads and is currently the lead market maker on 260 ETFs. It can help list/basket trading — GTS can snap provisional orders and begin working baskets prior to clients routing fix orders.

GTS has partnered with SSGA as the lead market maker for new ETF launches, providing liquidity for ETF products. It works closely with capital markets teams to help consult end clients on trading and execution. Support teams provide market commentary and ETF liquidity updates.

Financial advisors who are interested in learning more about asset allocation strategies can register for the Tuesday, October 19 webcast here.