Splitting portfolios 60/40 between equities and bonds might have worked for decades but the current market backdrop suggests this classic structure might be heading for more difficult times, according to 7IM’s Matthew Yeates. 
The 60/40 portfolio is intended to offer investors a balance between the growth potential of higher-risk equities and the relative security of bonds.
While this has worked during two decades of falling bond yields, Yeates – head of alternatives and quantitative strategy at 7IM – argued that the risk yields might climb from here, combined with lofty valuations in equities, suggests investors should start looking further afield than mainstream assets.
“The 60/40 portfolio has been a great place to be over the last decade but looking forward, and with an eye on what’s happened in 2020 in particular, we think investors should be looking for more now from their portfolios,” he said.
“For a balanced portfolio, we would currently expect to see an allocation of circa 15 per cent in alternatives, a split which will likely only increase over time when you consider where bonds yields and equity markets are currently.
“Be it diversification through proper strategic asset allocation, looking at regions like emerging markets or diversification through alternatives, these should all be differentiating parts of robust multi-asset investing going forward, which should replace the increasingly flawed 60/40 approach.”
Below, Yeates offers up five funds that he thinks could be used to diversify a portfolio with a conventional split between stocks and bonds.
BBGI
Yeates’ first pick is BBGI, which is a UK-listed infrastructure investment trust that targets public-private partnerships (PPP) and private finance initiatives (PFI).
“The appeal of investing in infrastructure assets is secure, long-term, inflation-linked revenues,” he said.
“BBGI owns a diversified international portfolio of equity and debt in PFI/PPP projects. This delivers a highly visible stream of cashflows over the long term, backed by government counterparts with a significant degree of inflation linkage.”
Performance of trust vs sector over 5yrs
Source: FE Analytics
The portfolio is exposed to “stable developed countries” with 36 per cent in Canadian assets, 30 per cent in the UK and 13 per cent in Australia. Half of the portfolio is in transport infrastructure such as roads and bridges, with 23 per cent exposed to the health sector, 14 per cent to justice and 11 per cent to education.
Over the past five years, the £1bn trust has posted a 59.91 per cent total return – which ranks it in second place out of the six members of the IT Infrastructure sector.
BBGI has ongoing charges of 0.87 per cent, is trading on a 30.4 per cent premium to net asset value and yields 4.4 per cent.
AQR Managed Futures
For his second choice, Yeates opted for the $693m AQR Managed Futures fund, which is run by AQR chief investment officer Cliff Asness, global asset allocation team head John Liew and five other co-managers.
The fund trades futures contracts (agreements to buy or sell a particular asset in the future at a price set in advance) in equity indices, fixed income, currencies and commodities, with the aim of capitalising on investor under- and over-reaction to market trends.
AQR said the strategy works best in conditions that see markets go from good to great or bad to worse, as it relies on the presence of sustained price trends. This means it can struggle over the short term, when markets are choppy, range-bound or undergoing a reversal in trends.
Performance of fund vs sector since launch
Source: FE Analytics
“This strategy can take advantage of trends in both rising and falling markets to make profits – this can be helpful for the portfolio when other return-seeking assets are not performing well. It takes advantage of the fact that rising markets tend to continue to rise, and conversely that falling markets tend to continue to fall (i.e. they ‘trend’). These funds will use systematic signals of asset performance over various time horizons to identify when specific asset classes are trending higher or lower,” Yeates explained.
“AQR are one of the longest players in the space and currently the positioning is short interest rate exposure, as well as being long commodities and as such is especially well placed to benefit from a continuation of the inflationary environment of recent weeks.”
AQR Managed Futures has an ongoing charges figure (OCF) of 0.80 per cent.
BlackRock SF Global Event Driven
Next up is the $5.1bn BlackRock SF Global Event Driven fund, which aims to generate a positive absolute return by taking synthetic long and synthetic short investment exposures on a global basis.
Yeates explained: “This strategy has the flexibility to invest across a mix of (mainly) equity-based opportunities arising from M&A activity. There’s high opportunity for alpha in the space, with an associated insurance-type premia for taking on merger risk.
“The strategy is largely US focused (60-80 per cent) but will also invest in merger deals and opportunities elsewhere in the world. The strategy has been a consistent performer since we added in May last year.”
Performance of fund vs sector over 5yrs
Source: FE Analytics
BlackRock SF Global Event Driven is led by Mark McKenna, who is supported by a wide team – many of whom he has worked with in the past. While the focus is on M&A, other ‘catalyst events’ that could prompt the fund to invest include company offers, spin-offs and split-offs, financial and strategic restructuring, and management changes.
Over the past five years, the fund has made a total return of 32.12 per cent. This compares with a gain of just 17.44 per cent from the average member of the FO Hedge/Structured Product - Equity sector.
It has an OCF of 1.36 per cent, which includes a 20 per cent performance fee on returns above the BofA ML 3 Month US Treasury Bill index.
Fulcrum Equity Dispersion
Yeates’ fourth pick for a fund to diversify a 60/40 balanced portfolio is Fulcrum Equity Dispersion, which he described as a relatively new fund that looks to profit from volatile company performance relative to more stable index performance.
“We would expect the fund to perform well in heavy risk-off periods, as well as those with high degrees of sector rotation. As such it has defensive characteristics but is also well placed to benefit from inflation leading to divergent stock prices,” he explained.
“The fund invests in this volatility rather than the direction of any movement and is led by Steve Crewe, a highly respected and experienced name in the area.”
Performance of fund vs sector since launch
Source: FE Analytics
The fund invests in a range of derivative strategies to gain exposure to the volatility of global equity markets. The strategy was run ‘live’ for three years in Fulcrum’s Diversified Absolute Return fund before being launched separately in July 2020.
Since inception, it has made a 3.85 per cent total return and outperformed the average member of the FO Hedge/Structured Product - Equity sector.
Fulcrum Equity Dispersion has a 1.25 per cent OCF and levies a 10 per cent performance fee.
MontLake Angel Oak Multi Strategy Income
The final pick from 7IM’s Yeates is the $939m MontLake Angel Oak Multi Strategy Income fund. It invests in US residential mortgage backed securities (RMBS), with a focus on those issued before the financial crisis.
“US RMBS brings back memories of 2008 but with around 15 years’ worth of payments on these mortgages, as well house price appreciation over the period, many of these are very good credits as it stands today,” Yeates said.
“Despite this backdrop, these assets trade on a yield of close to 4 per cent, whilst being floating rate. They are a core part of our different thinking in credit markets.”
Performance of fund vs sector over 5yrs
Source: FE Analytics
Over the past five years, the fund has outperformed its average peer in the FO Fixed Interest – Global sector with a total return of 25.31 per cent.
MontLake Angel Oaks Multi Strategy Income has an OCF of 1.19 per cent.