In recent years, the death of the 60/40 portfolio has been heralded with some regularity. To be honest, I understood that quite well for a long time, because bonds have had a rather tough time since the end of 2021. Yields were disappointing and stood in stark contrast to those of shares. Worse still, precisely at times when shares were correcting, bonds failed to offer anywhere near the protection investors had come to expect. The traditional benefit of diversification seemed to have vanished.

What should replace bonds?

What surprises me is that, particularly now, there are many articles appearing that write off the 60/40 portfolio, whilst conditions for bonds have now improved considerably. Moreover, I am not immediately convinced that the alternatives being put forward will improve a portfolio.

Take gold or bitcoin, for example. I do not rule out the possibility that these asset classes may rise further in the coming years. But I find the evidence that they can structurally take over the role of bonds in a portfolio to be very thin. In fact, that conclusion often seems to be based on the very same relatively short, upward-trending period during which the 60/40 portfolio failed to perform.

Private equity and private debt are also regularly cited as alternatives. They can certainly add value in terms of diversification, as they give you access to other parts of the market. But underneath the surface, they remain equity capital and corporate debt. I therefore see them more as a different way of utilising the building blocks within a portfolio than as a genuine alternative to the 60/40 approach.

Bonds are making a comeback

No, a convincing replacement for the classic combination of shares and bonds is not yet in place. The good news is that this is probably not necessary either. The starting point for bonds has, in fact, changed significantly. Interest rates have risen so much that bond investors are once again receiving a decent coupon. As a result, market interest rates can rise slightly before the total return turns negative. That buffer was virtually non-existent a few years ago.

Moreover, I believe that in turbulent markets, bonds can once again more frequently fulfil their traditional role as a counterbalance to shares. So far, the economy has coped well with the higher interest rates. But if investment in AI slows, consumers become more cautious, or the labour market cools, a slowdown in economic growth is likely. In such an environment, a fall in interest rates becomes more likely than another sharp rise. And it is precisely then that the characteristics of bonds – which have secured them a permanent place in portfolios for years – come to the fore once more. Not only do they generate income, but they can also offer protection when economic headwinds put pressure on share prices.

The exception became the new norm

Perhaps investors have allowed themselves to be guided too much by what has happened since 2021. That is understandable. The combination of falling share and bond prices has left a deep mark. But strategic asset allocation requires a longer-term perspective.

Periods in which both shares and bonds underperform at the same time are simply a fact of life. That does not automatically mean that the underlying principles of diversification no longer work. Circumstances change, and with them the expected returns and the role that different asset classes can play within a portfolio. That is why the reports proclaiming the death of the 60/40 portfolio strike me as too categorical, just as the belief that bonds would always protect investors proved to be too categorical.

After a few difficult years, many of the conditions that made the classic combination of shares and bonds so attractive have returned. Perhaps 60/40 wasn’t dead at all. Perhaps 60/40 was just out of shape for a while.

More columns by Bob Homan