The End Of The 60/40 Portfolio

The End Of The 60/40 Portfolio 

For years, a common investing approach was the 60/40 portfolio: 60% in stocks, and 40% in bonds. The idea behind it was simple: bonds were expected to outperform when stocks underperformed, and vice-versa. But as Tatiana Darie of Bloomberg pointed out yesterday (“Shifting Correlations Unleash Market Havoc“), that is no longer the case:

Whether good or bad, shifting correlations are poised to wreak havoc on cross-asset strategies, and hedging assumptions will likely need to change. In the current environment, bonds are no longer proving to be a shield from stock losses. Jim Bianco of Bianco Research says the reason to hold bonds is changing, calling the days of the 60/40 portfolio "over."

It also means that trading might require a more creative and active approach that goes beyond traditional (and stale) assumptions.

Moving Beyond Traditional (And Stale) Assumptions

As it happens, we developed an approach that moves beyond traditional assumptions. Specifically, it moves beyond the assumption that asset allocation is useful at all. The 60/40 portfolio, and other forms of asset allocation, deliberately put you in asset classes expected to perform badly. Why not put your money in assets you expect will do well? If you’re worried about downside risk, you can hedge with options. That’s essentially our approach, The Hedged Portfolio Method. 

The Hedged Portfolio Method 

Here’s how our method works, in a nutshell: 

1. Our system estimates 6-month returns for each security with options traded on it in the U.S. In addition to stocks, this universe of securities includes bond and commodity ETFs and even inverse ETFs. Our system is completely agnostic when it comes to asset class. 
2. Next, our system finds optimal hedges for each security, and calculates their cost. 
3. We subtract the hedging costs in 2. from the estimated returns in 1. and rank the securities by expected return, net of hedging cost. 
4. The names that come to the top of the list in 3. are our top names. We buy and hedge a handful of them. 

There are some additional steps, such as using a tightly collared “cash substitute” to minimize cash and boost returns, but that’s the gist of it. 

Precisely Limiting Your Risk

One advantage of our approach is that you can precisely limit your risk. Don’t want to risk a decline of more than 17% over the next 6 months? Our system will hedge it so you don’t. Much different from putting 40% of your money in bonds and hoping for the best. 

A Real World Example 

Here’s a portfolio our system created for an investor in July of last year. This was for an investor unwilling to risk a decline of more than 20% over the next 6 months. This one included American Superconductor Corporation AMSC, Abercrombie & Fitch Co. ANF, Constellation Energy Corporation CEG, Dell Technologies, Inc. DELL, Navios Maritime Partners LP NMM, Natera, Inc. NTRA, and Powell Industries, Inc. POWL.

Here is how that portfolio performed over the next six months: 

You can find an interactive version of that chart here. And you can see how hundreds of other hedged portfolios have done here. 

If you’d like to stay in touch

You can scan for optimal hedges for individual securities, find our current top ten names, and create hedged portfolios on our website. You can also follow Portfolio Armor on X here, or become a free subscriber to our trading Substack using the link below (we’re using that for our occasional emails now).