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I often tie the market and economy into pop culture or current events because it’s more fun for me to write and hopefully it’s more enjoyable to read.
However, pop culture has been dominated by Taylor Swift. Her tour is literally impacting GDP, she has the most popular movie in theatres and now she’s all over our televisions on NFL Sundays. I respect her but enough is enough.
Current events have been devastating and have left me reflecting more than usual. With all that’s been going on, I’ve been thinking more and more about family. I am truly blessed in that department. My mother and father are still here, and they’ve been happily married for 42 years. My wife is an angel who I’m thankful for every day and even my in-laws are an absolute pleasure to spend time with – and we’ve all heard our fair share of in-law horror stories.
The human element is why I love what I do. Sure, the markets are interesting, and I take great pleasure in evaluating different investments, but I enjoy meeting people and getting to know them. Last week I had lunch with a client who just turned 80, and he lifts heavier weights than I do. It was the highlight of my week. He updated me on his family, his health, told me countless stories about growing up in Brooklyn. We laughed a lot, learned a bunch and enjoyed a veal Milanese before going halvsies on a tiramisu - the client is always right, even when it affects my waistline. We talked about the current state of the world, fears, concerns and how that translates into investing. The care that I have when managing portfolios comes from knowing that there is a person or a family that the assets belong to. There are goals and hopes and dreams attached to the allocation. I never lose sight of that.
We try to reflect all this by adding a degree of customization to our portfolios. There is no one-size-fits-all solution. Advisors that go this route tend to have very low handicaps in their golf game and consider themselves salesmen rather than advisors.
For years now we’ve been advising against a 60-40 stocks & bond mix. Traditionally, the idea behind the 60-40 is that it’s supposed to smooth the investment highs and lows. Stocks, on average, return 9-10% per year while fixed income delivers 3-4% with about 1/3 of the risk. Historically, including fixed income dings performance but adds portfolio protection against large drawdowns.
The only problem is, the economy is different this time. The 60-40 portfolio was down -16% last year. Equities were down over -18% and Fixed Income was down about -14%. During the last three-year period, stocks and bonds have had a higher correlation than any other time since 1997. They are moving together! That tends to happen during periods of higher interest rates. The velocity at which rates increased didn’t help either. We’ve seen 3 negative years of fixed income in a row and the annual average over the last 3 years is -5.7% from the Barclays Aggregate Bond Index.
Why are so many investors in 60-40 allocations? This style of investing is frankly more convenient for the advisor. There’s little thought that goes into this type of strategy, but it is certainly more scalable for them. It’s so common for a client to tell their advisor that they are worried about the economy and the advisor reacts by recommending a 50-50 portfolio to appease them. Or if a client feels like they can take on a bit more risk then….boom, “how about a 70-30?” This happens all the time and this approach is pretty careless. We just experienced the most telegraphed hiking cycles on record, it didn’t make any sense to invest in fixed income until recently.
So, what’s the recommendation going forward?
Well first, you deserve a portfolio that’s tailored to YOU and to what you’re trying to accomplish. Do you want or need income? Great, one of the few positives about this rate environment is that at least you can generate 6 or even 7% cash flow rather easily. Private Credit is yielding 9-10%, as they provide loans to middle-market companies that banks stopped lending to after the Dodd-Frank Act was introduced post 2008.
A 60-40 mix of stocks and bonds is missing a very powerful asset class in alternative investments. This includes farmland, private real estate, commodities, venture capital, private equity and YES hedge funds. Some people hear hedge funds and think that means dialing up risk. I think this is because of the dramatization we are exposed to in movies like the Big Short and shows like Billions. The reality is that most hedge funds are aiming to mitigate or remove risk. The word “hedge” is right in the name. Long/Short strategies aren’t only betting on stocks to go up but they are also betting that certain stocks will go down. Multi Strat hedge funds are looking to generate positive returns even in down markets and have been diversifiers against risk assets. Hedge funds tend to thrive when volatility picks up in the equity market and the VIX Volatility index has jumped from 12 to over 20 in the last two months.
Let’s look at what we’ve seen in the last 3 years. A global pandemic, the largest amount of stimulus the world has ever seen, the fastest rate hiking cycle on record, a war between Russia and the Ukraine and now one in Middle East.
There are current headwinds as well. We have credit card delinquencies rising, car owners missing payments at record highs, over 43 million Americans paying over $1.6 trillion in student loan debt again after a 3 year hiatus and for the first time Americans need to earn more than 6 figures to afford a median priced home. The problem is the average American doesn’t make 6 figures. We are also headed toward an election year. More and more uncertainty.
Relying on passive, plain vanilla, 60-40 allocation in this environment just doesn’t make a ton of sense.
Alternative investments that have little or negative correlation to stocks and bonds are creating greater diversification in portfolios and have had positive performance during negative periods of the S&P. US Farmland, for example, has had a negative correlation to stocks and bonds over the last 20 years and has outperformed the S&P 500 with 1/3 of the risk. Don’t take my word for it, Bill Gates is the largest farmland owner in the US.
Asset Class Returns During Equity Drawdown Periods
Over the last 20 years, private real estate has had a correlation of 0.1 to equities and a negative correlation to fixed income. In turn, it generates income while performing in line with the S&P 500 with less than half the risk.
There are ways to protect and even capitalize on the volatility in the market, but this goes beyond a 60-40 allocation. Make sure to ask your advisor questions if you have concerns about your allocation or financial plan. Sadly, you must advocate for yourself sometimes.
We take pride in always having both hands firmly on the wheel and never take for granted that there are people and families behind these portfolios.
Disclosure
The information contained in this presentation is provided for informational purposes only and should not be construed as investment advice or a recommendation to purchase or sell a security. Investing involves the risk of loss that clients must be prepared to bear. This document contains forward-looking statements of opinion, belief, and expectation about the future. Actual results could differ materially from such statements and our opinions are subject to change without notice. Connectus Wealth, LLC d/b/a Connectus Private is an SEC-registered investment adviser. Investment does not imply government endorsement or that the adviser has attained a level of skill or training.