Is the 60% Equity 40% Bond Portfolio Obsolete?

Traditional methods of having a balanced pension or investment portfolio to cater for rises in equities (company shares) when bonds (debt – i.e., government bonds, gilts, corporate bonds, index linked and fixed interest stock) fall is to have a balance similar to the following:

• 60% in equities and 40% in bonds
• 55% equities, 40% in bonds and 5% in cash
• 40% in equities and 60% in bonds

This has worked well for many years.  When equities are falling, investors move to bonds that rise and vice versa.  We are currently in a market period where both equities and bonds are falling.  Does this make the 60% equity 40% bond balanced portfolio obsolete?

What’s the problem with Covid-19 and Russia/Ukraine?

High inflation means central banks will increase interest rates to try and curb inflation.  What’s the problem?

• When you hold fixed rate bonds and gilts, you have bought say a £100 at fixed rate of return e.g.  2%pa for the lifetime of the bond e.g., for 20 years and then you get the £100 back.  Think of it like the government having an interest only mortgage.  Inflation, over that period devalues your bond as £100 today, will not be worth the same in 20 years.  Any interest rate increases also mean that your real return over cash is also devalued. 
• High inflation and interest rate increases devalue fixed rate bonds.

Economic pressure, recession and higher taxes reduce company profits mean equities (share) prices fall.  What’s the problem?

• Pressure is mounting with prices rising, energy prices surging on Russian oil and gas sanctions.  In UK and US there are workforce shortages which hurt companies.   In addition, corporate taxes are rising to pay for covid-19 debt and NHS funding as are perosnal taxes.  China, the world’s manufacturer, is slowing down with lockdowns in place that the rest of the world has already suffered over the last two years.  A slow China will hurt global economies with a lack of supply of materials, parts and goods.
• Undertainty, recession, higher taxation and lower economic activity means demand for western equities is falling driving share prices back down. 

This is the ‘perfect storm’ for traditional balanced portfolios with both bonds and equities falling.

What is the solution to the potential storm?

For two years now we have told you that the only way for governments’ to repay covid-19 borrowing is to devalue the debt with inflation.  Indexed linked gilts and global index linked bonds would seem a natural replacement in a bond portfolio for fixed rate bonds. 

• To balance your bond portfolio, we suggest more exposure to index linked bonds and gilts rather than fixed rate.

Use Commodity Rich Country Bonds

For fixed rate bonds, look to countries that are rich in commodities.  China is the biggest producer of rice and grain and manufacturing.  India is huge with natural resources and quickly catching China up to be a power house with huge exports of minerals, pharmaceuticals, engineering goods – including iron and steel products, industrial machinery, and automobiles.  Brazil also has similarly huge commodity resources.  Venezuala has the largest and Canada the third largest oil reserves in the world.  Australia is commodity rich in minerals with its biggest export being iron ore, followed by natural coal and gold.  New Zealand is commodity rich with exports in dairy, eggs, honey, meat, wood, fruits and nuts.  Both Germany and France are virtually self sufficient when it comes to food production, so some expsoure here may be acceptable.

• To balance your bond portfolio, we suggest moving away from fixed rate western bond exposure but consider more exposure to global bond funds that lend your money to the above the above countries.

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