TLDR - Key Takeaways

  • A portfolio that is composed of 60% Stocks and 40% Bonds (hence the ‘60/40 portfolio’) has performed relatively well in the US and Globally over a longer period of time. However, over the last decade its returns have diminished as bond yields remained low and therefore dragging down portfolio returns, among other macroeconomic factors. In this time, investors would have been better off investing in riskier assets, like Stocks.
  • The 60/40 portfolio has performed poorly in Indonesia. Indonesian stocks have trended relatively flat even when certain sectors such as Commodities and Banks have done well. Meanwhile, bond yields are relatively high which contributes to portfolio performance. 
  • Past performance is not indicative of future performance. The macroeconomic reality as we head into 2023 looks very different from last year, and the past decade. Key themes include: higher inflation, geopolitical uncertainty, and higher interest rates.
  • The idea of a 60/40 portfolio remains defensible. However, it needs to be tweaked and contextualised to the macroeconomic environment. Understanding what the environment for investing looks like 2023 and beyond for Indonesia, an actively managed approach to portfolio management is needed to make it work. Portfolio managers need to be quick on their feet to tilt across asset classes and sectors to capture the best opportunities, diversify and generate returns. ‍
  • Relying solely on the inverse relationship between stocks and bonds for diversification is not enough. This calls for better portfolio construction and diversification within the types of stocks and bonds that are included in the portfolio.

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What is a 60/40 portfolio?

The 60/40 portfolio is an investment portfolio that is composed of 60% Stocks and 40% Bonds. For decades this portfolio has been the benchmark portfolio for retail investors. Developed by nobel-prize winner Harry Markowitz in the 1950s, it has become the baseline portfolio that financial planners recommend for investors like you and me over the long term. 

Theoretically, the 60/40 portfolio is a well-diversified portfolio that generates equity-like returns but with lower volatility to keep for a long time. Investors get upside from exposure to stocks, but are protected when stocks go down through its exposure to bonds. (Note: This is because historically there has been an inverse relationship between stocks and bonds - meaning when stocks go down, bond prices typically go up). Not to mention, bonds pay out coupons, so ideally the portfolio benefits from a steady stream of income from bonds.

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Secrets Behind Its Success

The 60/40 portfolio has ndone well over a longer period of time, averaging 8% returns per year for almost a century in the US. The past success of the 60/40 portfolio was driven by favorable macroeconomic factors, but more importantly a negative correlation between stocks and bonds. Bonds are supposed to do the opposite of stocks. By definition of negative correlation, when stock prices go down, bond prices tend to go up. Even as returns of the 60/40 portfolio are lower due to decline caused by low bond yields (due to systemically low interest rates set by global Central Banks after the 2008 Financial Crisis), bonds have been reliable to act as a counterbalance when stocks decline, and therefore, providing diversification benefits. 

However, in 2022 the relationship between stocks and bonds shifted to a positive correlation, meaning that as stocks fell, bond prices also fell. While the macroeconomic conditions that led to this have been brewing for a few years, the catalyst for this shift is high inflation which prompted Global Central Banks to rapidly raise interest rates to slow down economic activity. As interest rates abruptly rose, stocks and bond prices fell. 

Note: Rising interest rates hasn’t always prompted a positive correlation of stocks and bonds, but the pace of the rate hikes, uncertainty driven by geopolitical events last year, and the rapid transition from a ‘low-yield, low inflationary’ environment to a 'higher-yield, higher inflationary’ environment all contributed to shifting correlation between stocks and bonds.

The consensus today is that the correlations between stocks and bonds will revert to an inverse relationship now that asset prices have reset, with inflation looking under control, and that interest rate hikes have stabilised. 

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How Has a 60/40 Portfolio Performed Lately?

While the 60/40 portfolio has done well over a longer period of time, the average returns over the last seven years have declined to less than 5% per year. In fact, 2022 was the worst year for the 60/40 portfolio since 2008, losing ~20% of its value as both stocks and bonds went down. This is because when interest rates rise rapidly, stocks and bond prices tend to go down.

Below, we highlight the annual performance of two 60/40 portfolios: one consisting of Global stocks and bonds, and the other consisting of US stocks and bonds. Kindly note that these portfolios assume passive management and no rebalancing. As we can see, the portfolio has performed five out of the eight years observed, but returns have been volatile on a year-on-year basis. As a frame of reference, we’ve added how the S&P 500 (US Stock Index) did each year. 

Source: Bloomberg. As of Jan 2023. For illustrative purposes only. Assumes passive management and no rebalancing. Global 60/40 constituents: MSCI All Country World Index and Bloomberg Barclays Global Aggregate Index. US 60/40 constituents: Vanguard Total Stock Market ETF and Vanguard Total Bond Market ETF.

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How Did the 60/40 Portfolio Do In Indonesia?

The short answer is: not too bad. The portfolio generated positive returns 6 out of the 8 years observed, and averaged ~6% in returns per year since 2015, where the Jakarta Composite Index (Indonesia Stock Index) averaged 4% a year.

Source: Bloomberg. As of Jan 2023. For illustrative purposes only. Assumes passive management and no rebalancing. Indo 60/40 constituents: Jakarta Composite Index and Indonesia Bond Pricing Agency Composite Index. IDR Deposits: Average 3 Month Time Deposits.

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However, when we compare these returns against Indonesian Bank Deposits, the performance of the 60/40 portfolio looks less compelling. Over the same timespan, Bank Deposits averaged ~5.5% in returns every year - or 0.5% less than the 60/40 portfolio.

Returns as a measure of success alone is not enough. As we have written previously, applying risk metrics such as standard deviation and Sharpe ratio, among others, helps us better understand how well the portfolio did.

Source: Bloomberg. As of Jan 2023. For illustrative purposes only. Volatility is measured through Standard Deviation. Sharpe Ratio determines risk-adjusted returns, or the portfolio’s ability to generate returns over risk. Indo 60/40 constituents: Jakarta Composite Index and Indonesia Bond Pricing Agency Composite Index. IDR Deposits: Average 3mo Time Deposits. Indo Stocks: Jakarta Composite Index.

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Was it worth investing in the 60/40 portfolio vs. Bank Deposits over the last 7 years? Maybe not. Investing in Bank Deposits would have delivered similar returns, with seemingly lower volatility and risk.

Conclusion: The idea of a 60/40 portfolio remains defensible. However, it needs to be tweaked and contextualized to the macroeconomic environment. Understanding what the environment for investing looks like 2023 and beyond for Indonesia, an actively managed approach to portfolio management, by expert investors, is needed to make it work. As a prudent investor, it becomes very important for you to choose the right investment manager that can capture the best opportunities and generate returns meaningfully.