Building portfolio resilience: why today’s approach needs to be different

Structural changes in financial markets mean we need a different mix of asset classes to deliver dependable returns.

For decades, diversification strategies focused on the two traditional asset classes: stocks and bonds. The use of these assets evolved significantly, but they remained core building blocks. Two critical factors had to remain in place, however, for this strategy to keep working: a low correlation between the two asset classes and limited volatility for bonds, given the reliance on them as a source of stability. Among other structural market changes, these two factors are no longer in place.

As a result, an era of simplistic portfolio construction – with its reliance upon asset class assumptions that no longer hold true – is over. Creating resilience within portfolios requires a new approach and a new asset mix.

Asset allocation: what worked in the past, and why it’s not working now
In the “safety first” period after World War II, investors considered capital preservation their top priority, and portfolios were weighted heavily toward fixed income.

As the long-term growth that equities could deliver became increasingly apparent in subsequent decades, the 60/40 approach to diversification emerged. Even as investors pursued the higher long-term gains stocks offered with a 60% allocation, keeping portfolios 40% invested in fixed income proved a reliable means to achieve stability. Some investors even sought exposures beyond 100% limits of their portfolios by deploying leverage.

By the late 1980s, many large institutions began to add alternative investments, including private markets, to their allocations. By the early 2000s, the allocation to “alts” among large institutional investors often reached 15%-20%.

But for most individual investors, small institutional investors, and many defined contribution retirement plans, the 60/40 portfolio remained the trusted approach to diversification. Markets helped: from the mid-1990s to 2021, a low, often negative, correlation between stocks and bonds contributed to the effectiveness of the 60/40 approach.

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