James Sullivan of Tyndall Investment Management
James Sullivan, head of partnerships at Tyndall Investment Management, dives into fixed income.
When I started out in this industry in 1999, I recall there was a broad rule of thumb within the investment community that one should hold one's own age in bonds as a percentage of one's portfolio. For example, a 40-year-old would be guided towards a 60% equity, 40% bond portfolio split. At the time I understood the thinking behind this concept, but times change, and the pricing of asset classes certainly changes.
All one must do is type '60/40 portfolio' into Google to see what the view is among many commentators on this subject:
Time to rethink the classic 60/40 portfolio? (Forbes, March 2021)
Traditional 60/40 portfolio has actually reached its expiration date
(CNBC, September 2021)
The 60/40 portfolio is dead
(Barrons, November 2021)
Do I agree with these articles, that the 60/40 model is dead? No.
But as with all investment considerations, one must remain open-minded and be willing and able to adapt to a new environment while staying within the objectives of any given investment mandate.
A 60/40 split of equity to bonds in 1999 would have looked far more attractive then than it would today, with the US 10-year yielding around 6% and inflation around the 2% mark. Those two numbers are almost perfectly inverted today with US inflation at 7% and the 10-year yielding 1.7%.
Death of the 60/40 portfolio is greatly exaggerated, but we recognise it is not in the best health.
While acknowledging the value of bonds today we should also recognise the evolution of the so-called ‘alternatives' sector which goes some way to offering investors a perceived escape chute from the fixed income panic room.
This sector has evolved dramatically in the past decade as bond yields fell. This is no coincidence. Fund groups have been falling over themselves to offer the investment community something to replace their bond allocation. Something to replace that 4% yield and low volatility.
Examples include: aircraft leasing, battery storage, ship leasing, music royalties, peer-to-peer lending, ground rents, infrastructure, to name just a handful.
There may be nothing inherently flawed with any of the above, and in isolation they may wonderful investments, but the truth is there is no asset class that sits pari-passu with fixed income. It does not exist, no matter how hard we try and convince ourselves we have found a solution to this headache. For better or worse, we change the risk and reward dynamics of a portfolio when substituting out of bonds into the alternatives sector.
In our model portfolios which have a limit on the minimum and maximum equity component dictated by the risk profile, we need to fill the rest of the portfolio with assets we believe provide our clients with the optimum risk adjusted portfolio.
First, we must ask ourselves three questions:
- What should our fixed income exposure be?
- Where on the duration spectrum should we be?
- What quality of fixed income do we desire?
Currently, our stance has been to adopt neutral-to-overweight equity exposure based on our appraisal of bottom-up valuation (neutral) and top-down influences (positive). This means that we can afford to be a little less stimulating within the rest of the portfolio as we have absorbed some of the opportunity cost by our equity weighting.
So, to answer our own questions:
- We are tactically underweight fixed income partially as a consequence of adopting an overweight equity position
- We have a bias towards shorter duration bonds to defend against volatility at the longer end of the curve
- We favour credit over government paper to pick up a modestly enhanced yield as we do not expect spreads to gap out in the short term
By adopting this stance and harbouring shorter-dated credit within the portfolio, it also frees up our risk budget to accommodate one or two of our preferred alternative investments. When (and it is when, not if) markets normalise and we approach a positive real yield we can revisit our allocation and once again demonstrate a fluid approach to portfolio construction.
James Sullivan is head of partnerships at Tyndall Investment Management
