The 60/40 Portfolio: Robert Michaud on "Money Life with Chuck Jaffe" Podcast
On March 26, 2021, New Frontier Chief Investment Officer Robert Michaud sat down with Money Life host Chuck Jaffe to discuss how New Frontier approaches the construction of a modern 60/40 portfolio. Below is a partial transcript of the conversation.*
Recording
New Frontier has a very distinctive methodology. We have been living through a market that is anything but normal. How has that been for you? Has it at all tested the basic theories and tenets that you believe in?
New Frontier’s new concept of an efficient frontier is based on modern portfolio theory to come up with an intelligent scientific portfolio to maximize return and minimize risk under the assumption that we live in an uncertain future— that there is no way that you can accurately predict what the risk, return, and the correlations between all the asset classes are… This environment has been a great test of our process. Things now are starting to look a bit more socially certain while still perhaps economically uncertain.
A year ago, we were at a very uncertain place both economically and financially. How to invest during that point in time required a great amount of introspection, questioning what you're thinking, and questioning some of the relationships between major asset classes— China and technology, which had been some of the riskiest places to invest, suddenly became almost safe havens- because the country was dealing with the virus better, or one knew that a particular sector was well positioned to survive, or even thrive, in a pandemic.
I noticed on your website a piece that was talking about 60/40 portfolios. Could you explain how they work, and why this particular market we're seeing now has you more convinced about 60/40 rather than less?
The 60/40 portfolio is widely misunderstood. It is fundamentally important to investing and is the most common portfolio for most investors. On a conceptual level, if you add up all of the stocks, bonds, and investable securities around the world and put them all together, you'll get something that, on average, over time, looks pretty close to a 60/40 portfolio. A 60/40 portfolio has exposure to everything— it's often called a balanced portfolio. In addition to doing a good job of balancing the risks of stocks and bonds— executed well— it also lets you balance risks across all asset classes.
Our philosophy of investing over time is to consider all currently available investment opportunities and to build a portfolio that combines all these opportunities in the best way at each point in time. For example, China and tech stocks had very different characteristics post-pandemic than they did pre-pandemic. Some parts of the world are looking more like they're becoming a value type of investment as their prices go down, and of course the interest rate environment is changing dramatically. So, you do need a dynamic approach to building a balanced portfolio, but it is still likely to be the right type of portfolio for a lot of investors out there.
At a time like now, some investors are scared about bonds because interest rates have gone up. They are extrapolating into the future and think bonds may go up more. That's certainly a possibility. Then there are others who are concerned about stocks because stock prices have risen quite dramatically over the last year. But what we've seen time and time again is that a consistent approach to investing is likely to lead to the best outcomes. Stocks beat cash two thirds of the time, but a diversified portfolio is likely to beat being out of the market about four fifths of the time. But if one went with their gut, they may be out of the market more than half the time. So clearly, an optimized and balanced approach is generally better for investors in an evolving market.
Optimization is a term that is tossed around a lot. A lot of investors hear it and think it sounds good, but don't understand it. Since it is something that you believe in so strongly, would you talk about optimization?
Optimization, at its core, is simply trying to make the most informed, most efficient, and most intensive type of decision about everything. It could be agonizing over your whole family's choices at a dinner table, or it could be building a sophisticated portfolio with many different ETFs representing different asset classes. If you're not optimizing, then by definition, you're leaving inefficiencies in your portfolio— you are not getting every bit of return possible out of your portfolio and taking risks that you don't need to. So why would you ever invest in an unoptimized portfolio?
If one had known a year ago exactly where we would be today— that we would still be sitting in a pandemic, largely working from home, and socially distancing— they may have completely stayed out of the market. Yet markets have had historic returns over the last year, and so many investors would have been wrong. This is yet another time where we have to go back to good fundamentals and think about how investors get rewarded over time. They get rewarded for investing in risky assets and lending money to markets, and they don't know which are going to pay off and which are not. So, the way to do it is to always be thinking about the long-term picture, staying consistent, staying invested, not panicking, and not getting greedy, but also paying attention to what's going on right now. The 60/40 of the past is not the 60/40 for right now. We’re an optimization company, we can optimize anything, whether it's an aggressive portfolio or a conservative portfolio, but for most people, the 60/40 is the middle of the road portfolio that ends up being the most comfortable for what they're trying to achieve.
You need to find a portfolio that fits with your investment objectives and think about why you're investing and what your investment goal is before you decide how to invest.
You talk about how you're still doing 60/40 but changing the components. You also point out that you don't want to go with your gut, but it's hard to overcome your gut, especially in a market like this. How do you suggest people deal with it?
Countries like China, which have dealt with the pandemic relatively well, have prospered, and their stock markets have prospered along with them. Places like Europe, which have endured a lot of confusion, have also seen their stock markets suffer. In fact, you almost don't have to read COVID news- you can just look at international market news and to a large extent, see how each country has been doing. What that means for the future is always trickier. Where there is risk, there is also often return. Places like Europe, where markets have been hit hard, now, for some types of investors, are seen as a risk premia. Other markets which have done well may be viewed as overvalued. I try hard not to make predictions and to always step back, stay rational, and stay diversified. Don’t be entirely exposed to those places with the most risk because… they have a lot of risk! You don't want to put too much risk into your portfolio. That just never ends well… Risk is the biggest danger to long-term wealth.
*The transcript has been edited for clarity and may contain paraphrased, rather than original quotations/ text.
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