Are Canadians behind by sticking to a traditional 60/40 portfolio?
While some swear by their 60-per-cent equities/40-per-cent fixed income investments, some experts suggest a different way of looking at asset mix
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The traditional 60/40 portfolio – with an allocation of 60-per-cent stocks and 40-per-cent bonds – is not the best way to balance assets under current conditions, according to some experts, and risk diversification may hold the answer.
With bonds only slowly gaining steam as interest rates inch higher, after years of low yields, and public markets vulnerable to economic and geopolitical uncertainty, some financial advisors are urging investors to diversify. This is especially the case for high-net-worth investors with access to alternative investments.
And while there are different ways to look at diversification, from geographic to asset class, some financial advisors suggest diversifying a portfolio through risk allocation.
How to diversify investment portfolios?
“Given the heightened volatility we have seen in public markets over the last few years, one would naturally look for ways to mitigate this impact in their portfolio, explains Greg Gipson, chief investment officer at Grayhawk Investment Strategies Inc.
The idea is to have an allocation that reduces the potential for lower returns or losses in a portfolio, he says.
“The enhancement of a traditional portfolio to include alternative investments can serve to potentially enhance returns, reduce volatility, and provide diversification against public markets.”
He adds, “As an example, an asset class such as private equity may have lower volatility or variability of returns than its public market comparison, but I would argue that it can carry a higher level of risk of capital loss.”
From a numbers perspective, a 60/40 portfolio would typically capture roughly 85 per cent of equity market returns with two-thirds the level of volatility, explains Gipson.
He says that a “new” version of the 60/40 portfolio would potentially look similar to its traditional counterpart, when it comes to its risk and return profile, “but leverage a broader set of building blocks to do so.”
What risk profile do alternative assets have?
“The income generation component could look to add exposure to investments such as private credit or real estate along with certain types of hedge funds focused on total return, which can act as a ballast to equity market volatility,” he explains.
“On the capital appreciation side, investments in asset classes such as private equity and venture capital may serve to enhance return while reducing volatility, though prudent allocations to the risk of these investments must be at the forefront of investors’ minds.”
Adding alternative assets to one’s investment portfolio isn’t a new move, but is still one that comes with unwarranted hesitation, explains Robert Janson, co-chief executive officer and chief investment officer at Westcourt Capital Corp.
“Alternative doesn’t mean risky. We reject that notion [of] ‘60/40 until we die and alts are risky,’” he says. “That is patently false because the greatest investors, and the biggest investors, and the most sophisticated, brightest minds in investing are embracing the only free lunch that is in investing, which is diversification.”
How do large investment portfolios allocate assets?
Janson points out that public markets are making up about 30 per cent of some of the largest investment portfolios in the world, including Canada Pension Plan (32 per cent), Yale University endowment (27 per cent) and Tiger 21 ultra-high-net-worth peer network’s aggregate allocations (24 per cent).
But this conversation over the “traditional” 60/40 portfolio still creeps up, explains Janson, despite it being outdated.
“Canada, as a whole, is 20 years behind the times. The concept of a 60/40 portfolio, I believe, is the Canadian construct, or at least it has been continually adopted by the Canadian marketplace when everybody else has abandoned that years ago,” says Janson.
“It has been a head-scratching endeavour for me over the past 10 years to see the landscape shift so slowly away [from] the 60/40 portfolios because there are so many other opportunities out there,” he adds.
But with these other investment areas, such as private equity, private debt and real estate, knowing the risk means doing the research. Indeed, failures in due diligence are among the biggest issue when a private equity deal falls apart, particularly when commercial real estate is concerned.
Due diligence on private equity, private debt and real estate
According to a 2021 study by the Family Office Real Estate Institute, more than 90 per cent of family offices undertake their own due diligence in real estate deals, despite the fact that “a majority of family offices do not have a specialist in house or a platform to perform the level of due diligence that is not only needed for real estate, but also for private equity deals, portfolio analysis, for hedge funds or venture capital.”
But investors who want to build a portfolio that offers higher risk – with the potential for higher reward – then due diligence is not something to approach half-heartedly.
“The world of alternatives requires that you’re willing to do the work,” says Janson. “A high-net-worth family or a family office should be able to do the work to be able to understand what the risks are.”
Whether the family office decides to take on the task of due diligence in-house or decides to look to a third party to take this on, the level of due diligence increases with the increase of risk.
“You don’t need to be able to fly the plane, you need to understand what the risks are when you get on that plane to go to your next destination. You have to discharge your duty that if you want access to sophisticated products, you have to be able to do sophisticated work on a due diligence front,” says Janson.
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