The traditional 60/40 fund, which dates back to the 1950s, no longer works in the current economic climate, argues Ashley Lynn, analyst at Orbis Investments.
Sixty percent equities and forty percent bonds - the "60/40" fund. It has become such a standard for "moderate risk" that any other allocation raises eyebrows.
The idea behind the 60/40 goes back to the 1950s, when economists like Harry Markowitz and William Sharpe proposed that imperfect correlation between equities and bonds meant that combining the two would reduce risk.
When equities went down, bonds would go up, so the stocks could provide long-term upside while the bonds protected against a market crash.
That theory remains popular, but the facts have changed. Since the global financial crisis, central banks have been buying up bonds, increasing their prices.
By effectively printing currency to complete the purchases, the government added more money to the economy, which was supposed to promote bank lending.
At the same time, since higher bond prices result in lower yields, investors were incentivised to put their money into stocks in search of returns.
So as governments added money into the economy in an attempt to promote growth, investors used this money to buy up equities - at the same time that central bankers were themselves pushing bond prices to record highs.
In other words, the financial wizards have broken the historically negative correlation between bonds and equities. They may well have (at least temporarily) broken the old method of risk protection along with it. Bonds and equities have run up together, and they could crash together.
Equities look expensive
Stockmarkets are entering the ninth year of a bull market and look expensive. At the top of an equity market cycle, it is typically the "cyclical" stocks that look overvalued. This time, however, it is "defensive" names that have driven the market upwards.
This makes sense: central banks suppressed the prospective returns on bonds by bidding up their prices, so investors who had previously held bonds were forced into equities.
As reluctant equity investors, they went for the most bond-like stocks they could find, at a time when other equity investors lacked confidence in growth.
Amid continued uncertainty, cyclicals like banks, industrials, and energy remained cheap.
So not only do we have a situation where bond and equity markets have run together, we also have a situation where the market, particularly the US, looks expensive, and yet cyclicals look attractive.