The traditional 60/40 portfolio allocation has worked for years for advisors and investors, but with new pressures on the bond space in the last several months and looking forward, advisors are seeking income opportunities and strategies in a variety of places to keep portfolios afloat. Dave Nadig, CIO and director of research for ETF Trends and ETF Database, was joined by several industry experts to discuss the potential of stacking diversified returns on top of the traditional 60/40 to potentially generate income on a recent webcast.

Corey Hoffstein, co-founder and CIO at Newfound Research, discusses that advisor and investor concern regarding a traditional 60/40 portfolio composition really began around 2015 when the combined yield of portfolios hit historic lows for the time. Today’s yields are drastically lower than they were in 2015.

“The going concern is both the combination of low forward nominal returns plus inflation, which has the risk of turning those low nominal returns into negative real returns,” Hoffstein explains.

On the equity side, valuations are very important, and indeed were a top concern for advisors on the call, but valuations really only play out on a 10-15 year timeline, according to Hoffstein, whereas short-term equity investment is driven mostly by sentiment. This is something that doesn’t necessarily hold true within fixed income, however; instead, starting yield is generally one of the best predictors for forward returns.

Jeremy Schwartz, CFA and global CIO at WisdomTree Asset Management, discusses the idea of stacking returns and leveraging. The WisdomTree U.S. Efficient Core Fund (NTSX) is an ETF that focuses on capital efficiency and utilizes a 90/60 approach to allow investors the potential to allocate less money while getting back more for what was invested. The fund utilizes laddered treasury futures between two and 30 years to mimic the Aggregate Bond Index without carrying the credit risk. NTSX is active in that it triggers for rebalancing at plus or minus 5% on the stock side.

“Our suggestion is to use the efficient core to reduce both stocks and bonds and add diversifiers. For the inflationary environment I see, I think that’s the most important conversation,” explains Schwartz.

A managed futures overlay on top of a 60/40 traditional portfolio can help diversify and also protect in environments in which a traditional portfolio might be at higher risk, says Hoffstein. He gives the example of allocating two-thirds of capital into NTSX, which, with its 90/60 strategy, ends up providing the beta of a full 60/40 portfolio, minus fees, all while freeing up a third of the investor’s capital for alternatives.

“We can have that 60/40 S&P and bond exposure and then try and layer these alternatives on top,” Hoffstein says. “When we think about the fact that we’re entering into a low expected return environment, any incremental return on top, particularly if we can choose strategies that might actually diversify our 60/40 exposure, I think can be really powerful going forward.”

Commodities generally run inverse to equities and bonds during inflationary times, typically performing well, and Rodrigo Gordillo, president and portfolio manager at Resolve Asset Management Global, believes that a commodity sleeve can be stacked on top of the portfolio to bring diversification and balance. A global macro approach has typically performed very well in inflationary times like those being experienced today.

Hoffstein goes on to explain that through utilizing a mixture of ETFs and mutual funds, a stacking approach that would potentially best benefit an investor would include one that has exposures of 60% equities, 40% bonds, 30% managed futures, and 30% global macro, with some tail risk added in for 160% notional exposure.

“Leverage isn’t necessarily a bad thing if you’re using it to introduce further diversification,” Hoffstein says. “To me, this isn’t something that necessarily means you’re taking on more risk; in fact, in a market like this year so far, it’s actually helped reduce drawdown because we’re specifically using exposures to help combat problems like runaway inflation that hurt both stocks and bonds. So again, I think this can be a really beneficial diversifier.”

For more news, information, and strategy, visit the Modern Alpha Channel.

 Financial advisors who are interested in learning more about stacking return strategies can watch the webcast here on demand.