The return of volatility to markets at the start of the year and the increasing correlation of traditional asset classes such as equities and bonds have posed questions over whether existing models are outdated.
Asset allocation has become more nuanced in recent years with unprecedented central bank policymaking having a significant impact on markets.
As such, multi-asset funds have become more popular with advisers and investors looking to spread risk over several asset classes.
More traditional portfolio construction theories recommend a 60/40 equity-bond split; however, in the post-financial crisis era, many market commentators have questioned whether this is still relevant.
To compare different allocation models, FE Trustnet constructed five portfolios with varying allocations to the MSCI AC World – an equal-weighted index of global equities – and the Bloomberg Barclays Global Aggregate index – an index of global investment-grade debt from a range of issuers.
These portfolios were then weighted in different proportions to try to build a picture of how each one would have performed over the past decade.
The five portfolios were rebalanced on a monthly basis in the following ratios to the MSCI AC World and Bloomberg Barclays Global Aggregate: 20/80, 40/60, 50/50, 60/40 and 80/20.
From a performance perspective, portfolios with a greater allocation to equities unsurprisingly did the best over the long term.
Performance of portfolios over 10yrs
Source: FE Analytics
The 80/20 portfolio generated the best performance over 10 years with a total return of 97.18 per cent, followed by the 60/40 portfolio with a gain of 96.50 per cent.
Portfolios with a greater allocation to bonds performed the worst as equities embarked on a bull run following the global financial crisis.
In comparison, the MSCI AC World index delivered a total return of 96.02 per cent while the Bloomberg Barclays Global Aggregate index recorded a gain of 84.10 per cent.
During the 10 years under review, the 50/50 portfolio recorded the highest number of positive months – 24 more than the next best.
The 20/80 and 40/60 portfolios saw the fewest positive periods, only outnumbering the negative ones by 10.
The lowest annualised volatility seen over the 10-year period was the 20/80 portfolio, which had a score of 9.01 per cent.
Those with a greater proportion of equities were among the most volatile, with the 80/20 portfolio recording the highest score of 11.83 per cent over the decade.
The largest maximum drawdown figure – which measures the return made if investors bought and sold at the worst possible moments – was recorded by the 80/20 portfolio, which lost 22.76 per cent.
The best maximum drawdown figure was recorded by the 40/60 portfolio, at 9.70 per cent.
Downside risk was generally lower for portfolios with a lower exposure to the MSCI AC World index over the 10-year period.
While a case could be made for the traditional 60/40 model based on long-term performance, questions have been raised over whether it is still fit for purpose.
GAM’s group chief economist Larry Hathaway noted towards the end of last year that investors needed to “guard against complacency” of established asset allocation practices in the post-crisis era, warning that an uptick in inflation would be “ruinous to the simple 60/40 index-tracking portfolio”.
“Equity risk premiums would almost certainly jump, given increased cyclical uncertainty as monetary policy makes an abrupt u-turn. Stock and bond prices would plunge simultaneously,” he explained.
Such a scenario has been seen this year with concerns over inflation and faster-than-anticipated interest rate hikes causing greater volatility in markets and a sell-off in the early part of 2018.
Performance of portfolio vs constituents YTD
Source: FE Analytics
The MSCI AC World index is down by 6.04 per cent this year, while the Bloomberg Barclays Global Aggregate index has fallen by 3.38 per cent.
As such, the 60/40 model has also struggled since the start of the year, losing 4.93 per cent, but has displayed less volatility than the two constituent indices and a lower drawdown than the MSCI AC World index.
However, the model remains divisive among some industry commentators.
Jason Hollands (pictured), managing director at Tilney, said: “Given the artificial distortions we've had in recent years – [low] bond yields, QE and ultra-low interest rates – it's questionable whether a higher bond weighting is appropriate. 
“These funds were often aimed at more cautious investors working towards retirement and looking to cash in their pensions so they needed that money to purchase an annuity.
“Obviously, far more individuals are now going into [pension] drawdown and should probably be running with bigger equity weightings than they have done in the past.”
Andrew Merricks, head of investments at Skerritts Wealth Consultants, said the shortcomings of the 60/40 mix were revealed during the financial crisis.
“Bonds and equities are far too closely correlated for my liking and when one goes, the other tends to go as well,” he explained.
“There’s nothing in the bond market that looks attractive to my mind, so why have them if you’re not expecting them to do anything?”
The increasing correlation of asset classes since the onset of quantitative easing and rock-bottom interest rates in the post-crisis environment was evident earlier this year as markets slid, according to the Skerritts investment director.
“I think we sort of saw that in the run-up to February’s sell-off,” said Merricks. “We set a red-flag warning of yield of [10-year] US Treasuries at 3 per cent and they actually got to 2.88 per cent before equity markets sold off.
“Because yields have been going up, bonds have been going down and then equities slide: disaster.”
Investors should instead look for more genuinely diversified strategies to prevent overexposure to more correlated assets and to guard against negative market sentiment.
“We don't use any of those types of funds, we run portfolios on a genuine multi-asset basis which would include a much wider range of asset classes than just equities and bonds,” said Tilney’s Hollands. “In my view, that type of structure is a bit outdated.”
Merricks said he prefers to use physical gold or cash to help diversify portfolios: assets that are uncorrelated to market movements.
“Cash is boring, it doesn’t give you a return, but it is the one thing you do know isn’t correlated to anything and if markets go down you don’t lose, unless you get a financial crisis like 2008 and all the banks go bust, but I can’t see that coming back again in the short term,” he said.
“I think people can overcomplicate things a bit. If you don’t like market conditions sit in cash because you have the opportunity to go back in and pick up the bounce if you want to.”