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Erika van der Merwe (EM): The idea that the typical investment portfolio can be constructed with a 60% allocation to equities and a 40% exposure to bonds has paid off for a number of decades, with very few exceptions. Well, last year happened to be one of those exceptions. The diversification effect broke down spectacularly and the so called 60-40 portfolio generated losses. So we ask, is it time to ditch the 60-40 concept altogether on the grounds that the global macro environment in which we operate calls for an entirely fresh approach to asset allocation? Or does it simply need a revamp? I'm Erika van der Merwe and joining me for an in-depth discussion on this are Martin van Vliet, Colin Graham and Arnout van Rijn. Martin is a fixed income strategist in Robeco’s Global Macro team and Arnout and Colin are portfolio managers in Robeco’s Sustainable Multi Asset capability. So good to have you around us on the special occasion.


Martin van Vliet (MV): Thank you.

Colin Graham (CG): Thank you.

EM: So before we get into the discussion on the relevance of the 60-40 portfolio, I'd like us to just set the scene, lay the foundation. What is it and why has it worked so well for such a long time? I believe it's been almost 40 decades. So, Colin, starting with you, what exactly is the 60-40 concept and what's its power?

CG: Well, the power is for long-term investors so that they don't suffer the big losses of equity markets in certain years – when there's a recession, when there's a drawdown in risk, when earnings disappoint from companies. So over the long term, you want to have returns generating from equities, because if you do 200 year history, equities have provided the best returns over that period. So you want to have that. But again, in the short term, equities aren't necessarily the best investment. So therefore, having a more stable part of your portfolio makes sense, so that you can basically ride out the storm; so you can stay invested for longer. But you know, 60-40 is a very narrow view on the spectrum and I'm sure we'll talk about that.

EM: Right. And so Arnout… So equity is supposed to do the heavy lifting, generating those returns over time. So presumably the idea is that you have a long-term horizon where bonds is really the safety mechanism bringing more stability?

Arnout van Rijn (AR): Yes, that's correct. I would say that why it has always worked very well is particularly because of fixed income has been in a very long-term bull market. Why it didn't work very well last year was obviously that they were hitting the zero barrier on interest rates. So there was nothing to be offset anymore. Well, you could go to -1% or -2% on your interest rate, but it seemed unlikely. So then you were in an environment where both equities were expensive and bonds were at the zero barrier, so it couldn't offer that offset. Now we're in a different environment where bonds are again creating a decent nominal yield, like 3% or 4%.

EM: Yeah. So good foretaste for the discussion that we're going to get into. But I think the concept of diversification underlies all of this, Colin. Right?


CG: Absolutely. It's the pretty much only free lunch we have left. And you know, we've had a reset of the 60-40, and we've had a reset of bond markets. So we’ve seen yields rise, we've seen inflation linked bonds get to positive real yields. So from that perspective, there are much more opportunities, not just at the headline equity, fixed income, but also below that within equities, within fixed income, but then in alternatives as well. And if I have to go back to when I first started multi asset back in the late nineties, lots of clients had cash in their benchmark. So their strategic benchmark had allocations to cash, which during the Great Moderation, zero interest rates all disappeared. So it's quite possible we'll go back to that. You might actually see it's a 60-30-10 type allocation that people make.

AR: With cash as high as 10 then.

CG: Yeah, cash alternatives. Yeah, that type of sort of diversification element.

MV: But I would add that obviously the weights do not necessarily have to be fixed rates over time. I mean, I think it was even Benjamin Graham, the father of value investing, who suggested it should be dynamic, right? Sometimes 25, sometimes 50, sometimes 75. Depends on your risk appetite, depends on your investment horizon. So I think one should be flexible and I think that's also what the what our approach is.

CG: Well, in the Multi-asset team that's one of our philosophies, that static allocations are inefficient through time and we use our 5-year Expected Returns framework in order to help guide us whether it should be closer to 25% or closer to 75% in equities.

EM: Martin, just for listeners, so it's clear from what you’re saying so far, Colin and Arnout are in the multi-asset team, it's their job to think in terms in terms of diversification and across all sort of mainstream asset classes. You're in the fixed income team. You also think about diversification, of course, within that broader asset class. But just tell us what you do know.

MV: I think it's a good point that Colin made on diversification within fixed income. I think everyone traditionally thinks about government bonds but there is so much more in fixed income. We mentioned inflation-linked bonds. Obviously, we have credits, investment grade credits, high yield credits. There's so much different flavors one can pick in fixed income. And I think one has. I mean, we talked about the poor returns in fixed income last year when the yields were very low and inflation jumped to very high levels. I think that also has made inflation-linked more popular, I think, and get under the spotlight. And that's if you're worried about the persistence of high inflation in the next decade, for example, that's definitely a fixed income asset one wants to include in your portfolio.

EM: Okay. So I think that's a good warm up. So let's now turn to this question. Hopefully a debate of whether the 60-40 portfolio is still relevant today. So today's world is an entirely different one from the 1950’s and 1960's when Harry Markowitz’ portfolio theory was being developed. And I think that the roots really lie in there. And so we going to tackle this question around the relevance of this portfolio in two steps.

Firstly, by looking at the structural and the cyclical changes that we’re seeing in the macro environment, you’re talking about inflation and growth, etc., and what that means for portfolio construction. And thereafter, we’ll look at the broader, more secular shifts that we’re experiencing in our world: geopolitical tensions and risk, and also just new steps around sustainability, what that might mean.

So to set the scene on this first aspect, the cyclical and structural changes. Let's set the scene by listening to this or having you look at this. Here is Adam Butler. He's from Resolve Asset Management.

Adam Butler: Both stocks and bonds benefited from this kind of relatively slow-growth environment. But were growth fairly persistently, just slightly exceeded expectations. We had benign inflation, which was good for both stocks and bonds. And we all know we've had abundant liquidity. At the moment, we're coming into kind of the reverse environment. We've got the, first of all, world central banks removing liquidity. So one leg of the stool is sort of being kicked out from under us. Inflation is no longer benign and there's some ambiguity about growth.

EM: Well, that was from the podcast Excess Return. Martin, a good entry now for you to tell us, though, where do you see inflation and growth right now? We saw what worked in the past. Things are changing.

CG: Yeah, I think he's referring to the past 10, 15 years when inflation was very low and growth was not very strong. So the perfect environment for equities and bonds to flourish. I think cyclically I would argue there's a little bit more ambiguity in growth. I think growth is pretty weak in Europe at the moment. It's stagnating. In the US it's weakening.

Certainly the financial channel means that the growth outlook is pretty poor, I would say, for the US economy. Inflation at the same time is very high, still. Headline inflation has peaked and has seemingly turned the corner, but core inflation is still at very high levels, even at a peak in Europe.

So that means that central banks (and Adam was talking about it), are putting their foot on the brake. They have hiked interest rate aggressively. Monetary policy is now in restrictive territory, so it's no longer helping. But it's putting a strong brake on the economy. And even in Japan inflation has arrived and that hasn't happened for the past 20, 30 years. So yeah, that's the cyclical backdrop.

You could say it's a bit stagflationary still. At the same time markets are forward-looking. I think if you look ahead, then growth will stay weak in Europe. Certainly now with banks becoming much more cautious in lending, not just in Europe, but also in the US, by the way. So in the US we also expect growth to weaken further and we can have a discussion about recession or not.

I think if there were no resilience in the labor market, resilience in the services sector and some fiscal support in Europe, we would already be in recession, I think, and that's what the markets also think, that headline inflation will drop further. Energy inflation will fall out of the equation and core inflation should lag, but central banks can't be sure. They still haven't won the fight against inflation.

So yeah, the short-term interest rate will still remain high in the next couple of months. In Europe we can see even further rate increases. But the fixed income market is forward-looking and if the economy indeed slows and if headline inflation indeed falls back, then at some point you can go back to a neutral monetary policy setting in the next few years.

And that means there's value in government bonds. But we’ll come to that later.

CG: Yeah. Martin, you raised a very good point there, especially around inflation, because people say, well, why is inflation important? Why is everybody focusing on this? And I think one of these things is the money illusion, where today you feel fine, but actually the goods you're going to purchase tomorrow, the next day, the next day after that, are going up faster than your wages.

So therefore, you actually will be poorer in the future than you are today. And that's why we think it's important that we need to focus on this, because that has been one of the tenants of the growth of the last 30 years, that actually you've been able to afford more goods in the future. And, again, if you're saving for retirement, that's the sort of environment you want to have when you come to retire.

MV: Yeah. And I think more people are aware of the loss of purchasing power, When inflation is very low, you hardly notice. But if inflation is very high, like 5 to 10%, then people really start to notice that prices have gone up sharply and they also react on the back of debt. Now with interest rates in Europe also positive again and on the rise, you see also people looking at their saving rates and say, hey, inflation is still pretty elevated .I want to be partly compensated by having a positive interest rate.

AR: What surprises me is that in financial markets so far the pricing has been such that they don't expect inflation to stay high for very long. Right? All you see in those forwards curves is that inflation will go back to 2,5% fairly soon. And so there's still a lot of belief in that central banks will get this under control quite quickly.

MV: So in that sense, you could argue that there's credibility, that the central banks will win this fight against inflation. I think there's a subtle difference. because over the past ten, 15 years, if you look at the inflation markets, inflation compensation was hovering at 2% or lower in longer tenners in Europe. But now, if you look at for example the five-year inflation rate, five-year forward, it's at 2,5%.

So, the market prices in a positive inflation-risk premium and they think that inflation will go back to 2%, rather than below like it was in the past 10, 15 years. So the market is pricing in not a return to the lowflation era, but just a return to target inflation. So that's what this experience over the past two years has brought us. There is a change in view.

EM: Yeah. So a change in view and perhaps a shift, a seismic change in the macro environment. Perhaps not as dramatic, and that's up to debate. So does it indeed then call for a new approach in asset allocation? And what have we learned from history in this regard? So here's a perspective to get you going on that.

It's Jean Boivin. He's head of the BlackRock Investment Institute. He was speaking on CNN.

Jean Boivin, CNN: We need a new playbook in this environment. We don't think that the last 40 years prior to 2020 will be a good guide for what's ahead of us. That said, it doesn't mean that the 40 allocation to bonds and 60 is broadly wrong. What we really mean by this is that the simplistic approach of simply getting your allocation broadly to a broad index of bonds and a broad index of equities, and sitting there, you know, setting and forgetting, will likely not be working as much as well as it has in the past. So we need to approach that differently going forward.


EM: So the media made a lot of BlackRock's report, implying and there was an article on FT on this also, implying that BlackRock has ditched it and pitching against Vanguard on this, Colin?

CG: As with most headlines, you actually have to scratch below the surface and go down and actually look at the report and you find that what they're saying is you should have an extra allocation to alternatives. So it goes to the 60-30-10 approach and that 10% should be made up of other assets. That could include cash, and other assets that have a different return and risk profile to the 60 and the 40.

EM: As well as the agility, right, the flexibility?

CG: Exactly. And one of the things that we're talking about this year and why it's been so resilient is the earnings. And I think this is why in the past, equities have been seen as a good inflation hedge because they've been able to raise prices and maintain margins. In terms of what you saw in Asia or indeed when you've been back here, Arnout, how do companies cope with that?

AR: Yeah, they’re finding it very tough in general in Japan, as Martin mentioned, to raise prices. But there there’s been really a noticeable change that once some of them cross that the boundary and said: ‘no, we really have to raise prices here. Sorry about it, but we have to do it’. And that's when all the other started to follow and hence why you're starting to see inflation in Japan now as well.
What's been very remarkable is that in a country like China, there has not been much of that. There has been no need to actually pass on price increases because they haven't seen much of that input price inflation, but they've always had wages growth of 5-6% or so. So they've been used to having that annual cost-cutting exercise and therefore have been able to maintain prices relatively stable.

So that's a different environment there from an inflationary point of view. And one of the reasons why we also believe there are still a lot of potential in those markets in Asia and in emerging markets in general, that they've been more used to inflation in the past. They've learned how to deal with it. The people are not as afraid or anxious or angry even about inflation as they are here.
So they're just taking it in stride and eventually it will go back down. Which also means that the environment for the central banks there will be much more easy, that they can relax at some point and don't need to be worried about this this spiral that we are afraid of here in Europe in particular, that once inflation goes up, wage increase or wage demands will go up, etc.

So that makes them stand out from that point of view. They've been used to it and they dealt with it before and they have largely left it behind already.

EM: Martin, what does history tell us from the developed world, from the high-inflation regimes of previous decades?

MV: Yeah, I would add that on the inflation-hedge characteristics of equity, I think if you study the ‘70s and the ‘80s, that was the last decade where we had very high inflation in Europe and in the US, that was not particularly favorable for equity returns. On the observation that earnings growth is still relatively okay… I mean, at the moment we are seeing wage growth picking up in Europe. We see still pretty elevated wage growth in the US. So the only conclusion I draw from this is that if earnings are still stay okay, then there's still pricing power of companies. And that's bad news for inflation over the next couple of months. Something's got to give. If wages are going up sharply and you still manage to have positive earnings growth, then you have pricing power.
And then the central banks can't relax and they can't deliver the rate cuts that are currently priced in. in the US. at the moment. So from that perspective, I only see rate cuts materializing if there's going to be a huge financial market crisis. We had a bit of a taste of that earlier this year surrounding US. regional banks. Or f there's going to be a clear and noticeable recession later this year in the US. So…

EM: That's one to drive home a point then about whether we need a different approach in this environment. We can say inflation is going to do this or that, but we don't know. So is it important then to, as Jean Boivin said, to have an agile approach?

CG: Definitely. And you can go round the world and look at different assets within equities and bonds, and there's different characteristics. When you're in a period of deflation, where the only thing that was important was what the US Federal Reserve was doing, then yes, everything moves together. But you're beginning to see some diversification here. As Arnout says, emerging markets have been dealing with inflation pressure for longer than Europe or the US. And so they've already gone through their rate cycle and actually are more likely to cut than the ECB or indeed the Fed.

So they're sort of further along this journey already. And then we've already talked about inflation-linked bonds. And there's various other asset classes you can look at and then you come to currencies from multi-asset perspective and that's been a pretty dead water. You can either be long dollar or short dollar, but you are beginning to see that different currencies are moving to different stimula.

EM: Right. And then a provocative question, what could possibly go wrong in this environment?

CG: Where do we start?

MV: With the equity guys, because I'm from the fixed income side, so it’s quite an easy one for me.

AR: What could go wrong is also what was discussed by one of the speakers on the video, that we've had this wonderful area of liquidity and indeed were slamming on the brakes now. If we slam too fast, accidents will happen. And we've seen some accidents happen already. At the same time, there’s the Main street versus Wall Street argument.

Central banks are really thinking back to the ‘70s when Arthur Burns decided to no longer hike interest rates in an early stage and then inflation came straight back up again. So that’s what’s on Jerome Powell’s mind now that he doesn't want to make that same mistake because he read the history books. So he's going to be overly tight.

And that's potentially the risk that at some point will mean that markets will run out of liquidity and that could cause a nasty correction.

CG: There's also another example of Greenspan cutting rates after LTCM in ’98 that where it was obvious they didn't require – the economy was still running hot - it didn't require interest rates to be cut. And so that led to the TMT bubble ‘99, 2000 just because they cut rates too early. So I think history is telling you that actually you have to make sure that inflation is beaten before you can cut rates.

EM: So the risk of policy error, Martin?

MV: If they stay very tight for quite long, then US banks have a problem. Certainly the banks… We see a lot of competition for money markets. It's quite simple. If you have to pay your floating rate or your liabilities, which is 5% or higher and you're locked in a lot of assets at a yield of 2 or 3%, then you don't have to be a scientist to understand that's bad for future profitability.

And I think that's where we are in the US. In Europe, it's slightly different because there's less competition for money market funds. So if central bank stay tight for long, like the Fed, then we can have a new flare up or even a bit broader banking crisis in the US later this year. So that could go wrong.

I mean, in Europe we've had an energy crisis, which is obviously related also to the to the war in Ukraine. It's easy to paint a scenario where we're going to see a new spike in in energy prices next winter. I mean, it's great that energy prices have come down sharply. That's great news for inflation and for purchasing power of consumers.

But I think many experts are warning that that we're not safe and there could be a new energy price spike. And on top of that, we've had a small flavor of a sovereign debt crisis in the UK last year. So this is also still a different environment for many sovereigns. They are heavily indebted due to the support they've provided during the pandemic, but also more recently on the energy front in Europe. Who knows? Something can happen there.

CG: Martin makes a great point here. What we've seen from the LDI crisis in the UK, also the regional banks in the US, is not really a solvency issue, it’s a liquidity issue. And if they could have held those assets to maturity, it would have been fine. But what happened is that they had to sell them today at those particular losses and that was what's caused the issue.

So again, it's a liquidity issue rather than necessarily a solvency issue. And same with the LDI, last year.

EM: Then looking to the broader, more secular shifts and changes in the world in which we live in. Martin, you spoke about being safe in the energy crisis and that touches on some of the geopolitical conflict that we've seen. And this is typical of our lives. It's always been there. It's a constant, but it does seem as though we are witnessing a shift.

What are you what are your views on potential shifts and what does that mean for portfolio allocation, Arnout?

AR: Well, I see it particularly from the US-China point of view. One of the reasons why pricing in overseas listed Chinese shares is so cheap is still that there is that tail risk that the market senses that the US may also sanction China and that we're all going to be told: you can no longer invest in China. And that would lead to a further polarization of this conflict.

I’m vehemently opposed to that and say: come on guys let's please not go there and continue to have those discussions with a country where. Yeah, there are human rights violations, etc., but it's also a country that wants to learn from the West, as far as I know, after having lived there for such a long time. So we should continue to have that discussion.

But if we don't, then you may indeed see this separation of markets. And then it's down to who has the strongest home market demands. And then you would say, in China there is not much of an equity culture. Equity is just something that you buy for the short run and you buy property for the long run. And bonds are somewhere for the intermediate term.

Here for us, of course, it's different. Equity is for the real long term and property may be too. And bonds are also for the intermediate term, but the position of equity flips around. So in the US you really have a very strong equity culture. So if that…, and I'd love to hear your thoughts around that to, Colin and Martin, if you're going to see that polarization continue, then you would indeed see that US markets are better supported because they have a strong equity culture. European markets probably don't have much of that yet, but there's a strong pension fund sector that may support it. And Asia doesn't have too much of that. So then there is a risk for equities in Asia.

Clearly, we don't believe that because we actually do like Asian stocks here. So we maybe we're hoping, but we're also thinking that sense will prevail. And we continue to talk with China in particular.

EM: Well, good point there. Martin?

MV: Yeah, I would comment on the equity perspective here on the Chinese markets, but I think Arnout touches on a broader topic of geopolitical and yeah, you see obviously in many countries a tendency towards populist nationalism. I mean, we can highlight a number of countries there. And if you study history, then you see that that means pretty loose fiscal policies – again I’m giving a fixed income perspective here - and I think that we also already saw a taste of that during the pandemic.

But I think that political development across many countries in the world means that… I mentioned the sovereign debt crisis…, I'm worried about the long-term fate of fiscal policy and what it could mean for sovereign indebtedness, but also maybe for inflation.

Because I do acknowledge that a loose fiscal regime, loose fiscal policy, eventually implies inflationary risks. So that's something what I have clearly on the radar for the longer term.

EM: Colin, I know you have something to add.

CG: Definitely. So just thinking about the China-US dynamics and even if there isn't the political… well, there are political risks… But even if that's not what blows up, you have to remember that China has gone from being the world's manufacturing base, with cheap labor force, etc., etc., growing very fast. And you know, we’re not going to see another China come online in the next 20 years.

Therefore, the implications for the price of goods going forward has to be higher. You have to think inflation’s going to be higher, because you haven't got this deflationary shock that we've experienced from China over the last 20 years. So that's going to change going forward. And the great thing about having a sort of 60-40 portfolio is that you have these extremes in markets. You have the bond vigilantes; Arnout mentioned the equity culture that you should only buy equities.

These will always have their time in the sun, but they generally are not good for long-term investing. If you invest on the back of the bond vigilantes, you probably have no cash left now, even if you are right. In terms of that, I think, that's again why you want to have a portfolio that can be agile, move around the asset classes when you see the opportunities.

EM: What about sustainable investing? It might seem like a shift, but I'm bringing it in here as a secular shift because I think it's changed the rules of the game. It's extended the investment horizon. Colin, how do you feel that the considerations for investors and institutional investors to think about the long term, the ESG, that changing portfolio allocation and the approach.

CG: Yeah, I think you can go back 100 years or 200 years, and think about what was it all about back then? Before you had unions, before you had labor rights, it was all about the capital. So people who could provide capital could get returns. And then you sort of the movement of the labor. So protecting the rights of the workers; unions.

And you saw that shift between capital and labor become more aligned. And we're now into the third piece, which is the natural capital. So what impact are you having on the environment by running your business? So before we say, that was for free, and now you have to think about what is their cost to your business?

You have to make disclosures about your carbon footprint, you know, these type of things. This is only going to grow as people really take into consideration what is the cost of using natural resources. So this is something that we're looking at in terms of what we do, in terms of longer-term strategic allocation and how we incorporate that.

AR: And it would also then mean the likelihood of higher inflation for longer, because you basically have another factor into your costs that you need to price onto your customers.

MV: Yeah, we actually looked at the inflationary aspect of the energy transition, for example. It is true that certainly in Europe, which is obviously an energy importer, inflation will be lifted on a secular horizon due to the energy transition. And it's true that if externalities get priced, carbon taxes, for example, that it has an inflationary impact. But I would also point out the volatility of inflation, because due to climate change, which we obviously hope to address, there will be also more climate disasters and shocks to food prices.

So the volatility of inflation will also be higher.

AR: That is comparable to the supply chain shocks that we had after Covid.

MV: Indeed, but it's slightly different. But it means that there should be a risk premium in the bond market and in the inflation market, which I talked about, that there is now a positive inflation risk premium embedded in government bonds. So that makes it makes sense.

CG: But again, it's is one of these topics that technology will fix. So I'm very…

EM: You believe that?

CG: I believe that, absolutely. Because I think that if you look at the five year plan, I think it's 2017 or 2016 in China, they put a huge amount of money into high-voltage, long-range cables to transmit electricity from where they can generate electricity, where the coalfields were to where it was needed on the coasts.

And now you look at actually around the world, you know, we've got the North Sea economy here, which is all the wind farms around UK, Netherlands, Germany, Belgium. You wouldn't have been able to do that ten years ago because you couldn't you couldn't take the electricity from which it generated and deliver onto your grid. And that's a very much a step forward.
And I believe that technology will come to our rescue.

MV: Definitely. I fully agree. I think also that there's a lot of CapEx needs on that front. If you want to take a positive perspective also on the future of economic growth across Europe or the developed world, that you can highlight the need for CapEx on that front – what it will do to interest rate, well, that's another matter – but I fully agree, I take a positive perspective here. And I think coming back to your earlier question on sustainability, I think as investors, obviously, you have to have a strong opinion. And we have that opinion at Robeco. Not just on the ESG side, but also increasingly on the SDG side. And my view is that it will be even more tailor-made investment products for clients with various clients having different needs of different perspectives.

EM: Indeed.

Now, for a change of tempo. So I have some remaining burning questions for you, but we’re going to do it in rapid fire formats. I'm going to put the questions to you. We don't have to go too deep. But do give me your initial thoughts on these. I don't when always know to whom to put the question.

So just feel free to jump in and give us your answers. So first question, are you ready?

AR: Yes!

EM: Will the search for yields still be a winning strategy in the coming years or can investors not afford the risk that that would invoke?

MV: Well, the search for yield, I think we don't need to search anymore.

EM: Says the fixed income man?

MV: Yields are strongly positive: European high yields are 8% German T-bills are 3% US T-bills are 5%. So the search is over. That doesn't mean that we can't return to a world of slightly lower interest rates.

AR: That's exactly what I think. At some point we will go back to those 2.5%, 3% interest rate environments. And is that enough then? It's better than the 1% or 0.5% or -0.5% that we had. But I think there will still be a search for yield. But in an environment with much less liquidity. So these excesses that we've seen in some of these alternative assets, which we haven't really talked about, these alternative assets that are often not yielding, they're just whatever the next guy wants to pay for you, right? If you buy fine wines or cigars or something as an investment, you can put that in your 60-30-10 portfolio. But I wouldn't recommend it. Because they're all relying on plentiful liquidity. And if that's not around, then you would still like to go for the ones that are yielding real returns.

EM: Well, my second question I think is redundant, but here it is though:

Will fixed income finally be a returns driver this year and next. Or will it simply be a way to balance risk?

MV: Well, year to date, it has been a driver of positive returns. And my personal view is there's more in store for the second half of the year. But apart from the returns, I think what we learned this year is that the safety value of government bonds is back. Look at what happened in March, for example…

EM: To the regional banks for instance.

MV: No, I mean, look what happened to government bond yields. They dropped like a stone. So the safety value of government bonds really worked this year, unlike last year.

EM: Colin is nodding?

CG: I think that some fixed income assets will be safe, but I think there's other fixed income assets that aren't safe. You know, we saw with the Credit Suisse takeover: it was all there in, the black and white, in terms of the legal documentation. You’re seeing it with the preference shares in the US as well where they could be written to zero in on some occasions.

There is still some concern about certain parts of the market. We should be aware of those. But in terms of the broad picture diversification, then your bonds and your equity should give you that diversification this year.

EM: Okay, next question.

What happens if inflation stays high? None of these scenarios of it coming back to more moderate levels. What would be the best approach then from an asset allocation perspective.

CG: From a returns perspective, cash.

AR: Yeah, and you could find some defense in equities here and there in those that have pricing power and we've talked about that a lot, but we do see some pricing power in semiconductors, for instance, that are also needed for the energy transition.

MV: Yeah, and indeed we talked about inflation-linked bonds. Maybe you need to allocate some of your money to that in that scenario. And I also would highlight that the lesson from the ‘70s, where we had a long decade of high inflation, was that you want to be hiding in shorter dated bonds or cash if you will. Returns were actually quite okay when you were reinvesting your money in T-bills during that debt decade.

So that's would definitely be a strategy.

EM: Picking up on an earlier point. Next question. How creative and adventurous should investors be with a selection of asset classes? We've mentioned alternatives. Is that it? Or are there mainstream or far less mainstream asset classes we should be considering?

AR: The point there is indeed that a lot of those have been driven up by high liquidity. So even the ones that are generally seen as the alternatives-to-go-for like private equity, for instance… a lot of that is either it's not invested and it's just laying around waiting for the right opportunity, or it is in what can be considered relatively low-yielding assets.

So for instance, the money that's going into the wind farms and solar parks now makes them, to me as an equity investor, look rather expensive versus what you can buy in the equity market directly, where you often get a discount. So yeah, I've been looking for alternatives, but I haven't found anything that's really better yet.

CG: Commodities would be another one where we would look at and we can argue and we have argued constantly about the worth and what's gold worth. But some investors like gold because it's a store of value. But given where interest rates are, some of the shine has probably come off gold a little bit, but it's a store of value.

So then the other commodities, even if you go into recession or inflation stays high, people will still demand soft commodities. You know, to eat, to heat themselves. So, from that perspective, I think that commodities can provide that diversification at the moment as well.

EM: Next question.

Is sustainable investing being embraced more broadly by multi-asset investors?

CG: Yes and no. I think is the correct answer. I think that asset owners and very large insurance companies: yes. If you go and talk to the private wealth managers of the banks platforms, then we get very much more mixed feedback on sustainable products that we're creating for that.

EM: Next question. How should investors think about their regional exposure?

AR: Clearly we are thinking that Asia is a good place to be for the time being. The US is expensive, but always is expensive. And we talked about the equity culture there. So it still requires a decent allocation. But to think of the global being 65% US, that seems to me a very unbalanced allocation.

EM: Yeah.

MV: And from a fixed income point of view, I would highlight that we talked about inflation in Asia, which is less of a problem than in the US and in Europe. I think in Japan, there is this expectation that the yield curve-control policy will at some point be abandoned. So that's a place where you want you don't want to be too overweight government bonds, I reckon. And I would also highlight emerging markets. Colin touched upon it that what we clearly see in this cycle is that countries like Brazil, Mexico have hiked policy rates quite early and aggressively. And there they are quite further advance in the fight against inflation. So if you're overweight EM local bonds, then that could also be a nice cyclical return, we reckon.

CG: One of the things about this cycle, which is good and nice and different from previous cycles, is that the dollar is so expensive. If you look at any measure of the dollar, it's very expensive. So if you're investing in non-dollar assets, whether it be emerging market debt, whether it be European equities, Asian equities, then you have a margin of safety here where the dollar is likely to weaken over the next five years.

So you have a little bit of a safety net and you're also getting higher yields. You got better expected returns and lower valuations. As an investor, if you ticked off everything you wanted to be investing in, then, you know, there are parts of the world, emerging markets, debt and equity, where you think actually, this is where we want to be.

EM: Good point is, let's bring it all together. So what are your final views? So we put the question right up front. Is the 60-40 portfolio dead or does it just need a revamp tweaking; a more nuanced approach?

CG: I think you go back to the way we used to run 60:40 before it became very narrow and to the point the speaker made that it's just this Great Moderation (low inflation, low growth, but not too fast) has caused that it's very much narrow and you can see that in the US stock market at the moment where two stocks make up 14%, 15% of the of the index.
So, you know, for me this is just a concept.

EM: Big word.

CG: Yeah.

… where actually it's just narrowed down to 60-40. What we need to do now is expand it back out. And say we need to reintroduce other asset classes.

EM: Okay. Martin?

MV: I would argue that I haven't changed my view that there's definitely value in having fixed income in a multi-asset portfolio. I think your sharp ratio is just better. I haven't changed my view there. If you look at the longer run, you can have a discussion about the exact weights, if it should be 40% or more or less. That depends on your situation, your horizon, your risk appetite.

But certainly this year I think there's cyclical value in fixed income and you definitely need to diversify there. I fully agree that it's not just government bonds. There's so much more out there which can also help you protect against persistent inflation.

EM: Final word from you, Arnout.

AR: Well, I'm much more of an 80-20 guy myself as an equity investor.

But recently, indeed, the case for bonds has definitely improved. So therefore there's good reasons to be back in bonds again. And that hasn't been the case for me in the past five years. And I always find solace in value equity investing from the point of view that it does bring a certain downside-risk protection and whatever our quants are showing is that the gap between value and growth equity in terms of the different valuation multiples is still at record high levels. So as much as this year, there does seem to be some return to growth investing, I still think that in the long-term equity portfolio, value should be preferred.

EM: Arnout, Martin, Colin, thank you so much for your time.
Great insights.

I so thoroughly enjoyed the conversation.

CG, AR, MV: Thanks, Erika.

EM:
And to our audience, thank you so much for joining us. If you've enjoyed the show, please subscribe and rate the Robeco podcast. All our podcasts are available on your favorite podcast platform as well as on the Robeco website.

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