Shuffling possible. For a long time, investors have achieved adequate returns by dividing their assets between 60 percent equities and 40 percent government bonds. In view of rising inflation rates and persistently low interest rates, this is now becoming increasingly difficult in real terms, i.e. adjusted for purchasing power. "It is high time to readjust this successful strategy," says Kristina Bambach, who is responsible for the Phaidros Funds Balanced mixed fund at asset manager Eyb & Wallwitz together with Georg von Wallwitz and Ernst Konrad.
It's the $7.5 trillion question. 7.5 trillion dollars are invested worldwide in so-called 60/40 custody accounts - 60 percent stocks and 40 percent bonds with very good credit ratings. But for some time now, this has no longer worked. Has this winning strategy had its day?
"In the zero-interest-rate era, the 40 per cent of the portfolio invested in safe bonds actually no longer yields a return. And now - with higher inflation rates, rising interest rates and falling bond prices - this problem is actually getting worse," explains Kristina Bambach, who is jointly responsible for the Phaidros Funds Balanced at asset manager Eyb & Wallwitz, and concludes: "It is indeed time to counteract."
That the 60/40 approach has been so successful for so long is due to its simplicity. "It just didn't need a highly complex structure to deliver adequate returns and a good balance between risk and return," Bambach explains. The coupons on the bonds provided a base rate of return. If the economy cooled, the stock markets struggled. But at the same time, interest rates fell and bond prices rose. When the economy was good, bonds lost some ground. But there were opportunities in the equity markets. In the long-term trend, five to six percent per annum were possible in a very relaxed manner and without drastic price fluctuations.
For some time now, however, the cards have been reshuffled. For some time now, the coupon on safe interest-bearing securities has no longer been sufficient to keep pace with the rate of inflation. In real terms - after deducting the inflation rate - these investments are delivering losses. The diversification argument alone still justifies an investment. "All providers of mixed funds are therefore considering how this situation could be improved. We have taken a closer look at the four adjusting screws," says Kristina Bambach.
Her most important message: "There is no easy way out. Either investors accept a significantly lower return in the 60/40 portfolio in future. Or they adjust the strategy - and pay the price that necessarily comes with it."
One possible approach is to replace safe interest rate securities with those offering higher yields. "Investors could choose longer maturities, for example. However, they then have to accept greater price fluctuations due to the higher duration risk. Or they buy securities from companies with poorer credit ratings. In this case, however, part of the diversification aspect is lost. This is because their price performance - like that of the equity market - is closely linked to the economy. When things get tough in the economy, the risk of insolvency increases. Only first-class government bonds then offer protection."
The second way to change is to add new sources of return. Gold and absolute return strategies are often mentioned. "Gold actually makes sense during periods of stress. But in normal times, the returns are low and the price fluctuations are extremely high. To be successful here, investors would have to be able to anticipate stress phases," Bambach makes clear. By adding absolute return strategies, which promise returns independent of market developments, a portfolio can gain stability. "But in return it loses the charm of simplicity. This is because these strategies are complex, difficult to understand and usually not liquid either."
A third option would be to be more aggressive in the interest rate part, but to reduce the price fluctuations in the equity part. "The idea here is to focus more on stocks with bond characteristics. In other words, stocks that deliver steady, reliable distributions," explains Bambach. These can be classic dividend stocks. Or shares in real estate companies (REITs) that generate a regular, calculable return through their rental income. Another option in this context are stocks whose prices have fluctuated comparatively little in the past - so-called "low-volatility stocks". "These stocks are actually more likely to fluctuate less than the market in the future as well," Bambach is convinced. The price? "During periods of crisis, interim book losses are smaller than in the broad stock market, but they are still significant. Investors need to be prepared for that when replacing bonds with equities."
That leaves a fourth option. Fund managers could change the ratios of stocks and bonds quickly and flexibly as market conditions dictate. To take as much upside as possible in upswings and lose as little as possible when things go down. "In theory, this sounds good. In practice, however, it turns out that hardly any managers manage to do this systematically. Timing often doesn't work."
Kristina Bambach's interim conclusion: "If you want a portfolio with a balanced risk-reward profile, you can't avoid mixing equities and bonds in the future either. But the 60/40 portfolio should be readjusted by adding bonds with higher yields."
How is this specifically implemented in Phaidros Funds Balanced?
"Our ambition is, after all, to generate a positive real return in all asset classes. We therefore focus on the high-yield sector in the interest rate area, concentrating on the niche theme of 'Fallen Angels'," explains Kristina Bambach. If bonds that used to have a good rating are downgraded to high-yield level, opportunities arise because many investors are forced to sell at that moment. This is because they are not allowed to hold these securities in their portfolios for regulatory reasons. The resulting price reductions can be exploited (private wealth reported on this strategy in issue 02/20). You can find the article on the homepage under "The Catcher").
Especially in the current situation, this seems promising. "In the second half of 2021, the global economy will pick up significantly. Then the insolvency risk for these issuers should decrease and the interest rate spread to government bonds should tend to decline," Bambach reflects. "So these interest-bearing securities not only have the higher coupons, but also the better price prospects." Because inflation risks also increase in such an economic environment, the fund manager also cautiously mixes in REITs and gold - "the classic inflation winners" - as a second step.
Kristina Bambach accepts that the Phaidros Funds Balanced fluctuates more than other mixed funds as a result. "We define risk differently than many players on the capital market. In view of our long-term investment horizon, we are not concerned with temporary price fluctuations of an asset. For us, risk means the danger of a permanent or at least long-lasting loss."
In equities, therefore, the quality of the business model and - especially now in times of rising inflation rates - market power as well as price rollover margins are the decisive selection criteria, not price volatility. "We look at a company and consider whether or not we want to be a shareholder there over the next five to ten years."
Specifically, stock selection follows the Schumpeter approach. As a young man, Austrian economist Joseph Schumpeter described the benefits of so-called challenger companies - they completely turn industries upside down and grow strongly as a result. Today we call this process disruption. "We invest a third of our equity allocation in such challengers as MercadoLibre, Shopify or Teladoc," says the fund manager.
Later, the Austrian national economist then described the advantage of oligopolists with strong market positions, high margins and steady growth in a stagnant economy. "Because this is in line with our view of the world after the 2021 recovery boom, we are also betting on companies such as Microsoft, Novartis and Mastercard. This combination provides diversification and reduces the risk of the equity portion of the portfolio," Bambach explains.
Her answer to the $7.5 trillion question is then also very clear: don't throw the tried-and-tested strategy overboard in a hectic manner. Readjust in the interest area. And simply accept the inevitable higher price fluctuations. "A good mixed fund is like a good ship," explains Kristina Bambach, "it shouldn't bother us if it fluctuates. We as managers just have to make sure it stays on course by selecting investments. And we manage to do that." ®
// How to invest - the Phaidros Funds Balanced.
The mixed fund Phaidros Funds Balanced (LU0295585748) is the flagship fund from Eyb & Wallwitz. It was launched in 2007 and then redesigned in 2010. The basic strategy defined at that time still applies today. According to this strategy, the split between equities and bonds should generally be 50/50. Theoretically, the share of equities may fluctuate between 25 and 75 percent. In the last ten years, however, it has generally been between 40 and 60 percent.
This approach has proven successful. If long-term rolling three-year returns are used for comparisons with similar funds, the Phaidros Funds Balanced has been in the top quarter of the reference group in 122 out of 131 months since 2010 (Morningstar Category EUR Flexible Allocation Global). The ten-year return was 6.57 per cent per annum.
Of particular interest, the fund has consistently been in the top ten percent of its category since October 2018.
Typical of the fund was also its price performance in the challenging year 2020. It initially lost around 20 percent in the Corona crash, but did not seriously change its investment behavior - "short-term price fluctuations are not a risk for us" - and then recovered the book losses by August. The fund ended 2020 as a whole with a gain of 13.3 percent, according to Eyb & Wallwitz.
Eyb & Wallwitz; www.eybwallwitz.de