Why the 60/40 portfolio isn’t dead. Plus, small-cap stock picks and a REIT due for a snapback

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Is the 60/40 portfolio dead? After what we’ve seen so far this year, it’s certainly tempting to write its obituary.

The idea that a 40 per cent holding in bonds will counteract a drubbing in the stock market has been a cornerstone of investment management for decades. And it has often worked quite brilliantly, with one asset class picking up the slack when the other is struggling – or at least softening the blows through the income generation of bonds.

But not 2022, a year in which skyrocketing inflation and interest rates have so far taken a sledgehammer to the COVID-era stock rally, while simultaneously hammering the price of bonds.

Consider that from Jan. 1 through June 30, a typical 60/40 portfolio of U.S. equities and bonds lost 16 per cent of its value, according to U.S. bank Morgan Stanley. That wipes out all of such a portfolio’s gains since September, 2020. The losses using Canadian stocks and bonds are only modestly better.

Yet Morgan Stanley’s global strategist Andrew Sheets thinks the 60/40 portfolio is simply resting. Over the long haul, the strategy he thinks will still provide reasonable returns.

For one reason, with today’s lower stock prices, Mr. Sheets’s return estimates have gone up for equities. And the higher bond yields we’re now seeing will boost fixed income payouts, too. He expects a 60/40 portfolio of U.S. equities and a broad selection of bonds to generate annualized returns of 6.2 per cent over the next decade – or 3.9 percentage points above the projected average annual inflation rate.

There’s another reason for optimism too: the smoother ride that diversification will bring. It’s simply based on mathematics, he points out in a new research report.

The last six months have seen the worst performance in bonds in 40 years and unusually high volatility. Even with that, their volatility has been only a third of that seen in U.S. equities over that time.

“For portfolio construction, that matters, as having 40 per cent of a portfolio in anything with one-third the volatility of the other 60 per cent will absolutely dampen overall fluctuations. Hence, despite recent struggles, the case for 60/40-type approaches endures, with higher estimated long-term returns in the U.S. and Europe over the next decade than at most points over the last 10 years,” he says.

Many will doubt Mr. Sheets’s conclusion given bonds woeful performance this year, and yes, there are certainly all sorts of assumptions built into his long-term forecasts.

But before ditching bonds as part of a balanced portfolio, consider that things have lately been looking up. In the past month, the BMO Aggregate Bond Index ETF has risen 3.4 per cent, well outpacing the 1.3 per cent rise in the TSX.

Investors tend to gravitate to the safer world of fixed income, and away from the growth-oriented stock market, at times when economic chills are in the air. At least for the moment, that diversification is starting to work again.

— Darcy Keith, Globe Investor editor

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Stocks to ponder

Minto Apartment Real Estate Investment Trust (MI-UN-T) REITs have been under pressure and this is one of the worst performing one in the S&P/TSX SmallCap Index, with its unit price down over 30 per cent this year. Rising interest rates and fears of a recession have put pressure on the unit price of Minto Apartment REIT, which owns a portfolio of 30 rental properties. But Jennifer Dowty suggests the unit price may have bottomed. Among positive signals: several insiders were buying units in May and June.

Loblaw Cos. Ltd. (L-T) The grocer and pharmacy giant, which is scheduled to drop its second-quarter earnings this coming Wednesday, was able to pass along price increases to its customers at the start of 2022. That helped make the stock a rare winner in this unusual economic environment. With gains of more than 15 per cent this year, Loblaw shares have outperformed the S&P/TSX Composite Index by about 26 percentage points. But are consumers reaching a breaking point? David Berman shares some thoughts.

The Rundown

Little-known smaller stocks that a $2.3-billion fund manager is buying and selling

While many money managers shy away from buying small cap and microcap companies, Alex Etsell seeks them out – believing some of these lower-profile names can provide the greatest growth potential. Mr. Etsell, who oversees about $2.3-billion of Hillsdale Investment Management’s $3.8-billion in assets, speaks to Brenda Bouw about his latest thoughts on the market and his portfolio moves.

Why I’m losing my faith in international diversification

Emerging markets have taken a horrific beating over the past year. Maybe that spells opportunity. Just as likely, though, it means more problems ahead as interest rates rise and global growth slows, says Ian McGugan, who is now reassessing the case for venturing abroad.

GM, Ford confront Wall Street’s recession fears

General Motors Co and Ford Motor Co are about to replay a script they have played out many times before – trying to convince investors they can get through a recession without skidding into the red. Joseph White of Reuters reports.

Others (for subscribers)

Monday’s analyst upgrades and downgrades

Globe Advisor

Global market tumult slows growth in ETF industry

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Ask Globe Investor

Question: I am aware that investments held by a brokerage firm are covered up to $1-million by the Canadian Investor Protection Fund in the event of a bankruptcy. Recently, our account has gone considerably over this amount and I am concerned that if the brokerage does go bankrupt we could lose everything over the $1-million threshold. Should we transfer some of our securities to a different brokerage company? If so, what would the tax consequences be? Would we be considered to have sold the shares on transfer and have to claim the capital gains at that time?

Answer: I don’t think it’s necessary to transfer any assets. Before I explain why, some background is in order.

The Canadian Investor Protection Fund (CIPF) is funded by investment dealers that belong to the Investment Industry Regulatory Organization of Canada, ranging from the big, bank-owned brokers to small, independent firms. (View a list of CIPF’s members here. by going to CIPF.ca and clicking on “member directory.”) In the event that a firm becomes insolvent, CIPF will cover up to $1-million in cash, stocks, bonds or other assets that are missing from a client’s account.

The dollar limit applies to each of several different account categories at the same financial institution – namely, $1-million for all non-registered accounts and tax-free savings accounts combined, $1-million for all registered retirement accounts and $1-million for all registered education savings plans. If you have accounts at other financial institutions, they receive their own coverage up to the same $1-million limits.

Now, before you move any assets around, it’s important to understand a couple of things. First, insolvencies of investment dealers are rare. Second, even if your firm were to go bankrupt, it’s likely that only a small portion – if any – of the firm’s assets would be lost. Once the bankruptcy trustee has distributed all of the available assets to clients, the odds of a single customer being out by more than the covered $1-million are vanishingly small.

In the past 25 years, there have been just eight CIPF member insolvencies. The total payout, net of recoveries, in those eight cases averaged just $2.27-million, Jane Yoo, a senior adviser with CIPF, said in an e-mail. To be clear, that’s the average combined payout to all customers of the insolvent firm; the payout to each individual client would have been a small fraction of that number – far under the $1-million limit.

What’s more, it sounds like you have a joint account with a spouse, in which case you would each qualify for $1-million of CIPF protection, or $2-million in total. So there’s even less reason to worry.

The bottom line is that you have a great deal of protection for an extremely unlikely event that, even if it were to happen, would almost certainly not leave you out of pocket. So I see no reason to move a portion of your assets to a different broker. Moreover, doing so would entail a lot of paperwork – brokers love paperwork – and add another layer of complexity to managing your assets.

Now, in some cases it may make sense to move assets. Perhaps you don’t like the service at your current broker; or you already have two brokers and you want to consolidate your accounts under one roof for simplicity; or you want to take advantage of a cash incentive a broker is offering to move your assets. As for the tax consequences, transferring non-registered securities from one broker to another is not considered a deemed disposition, so no capital gains taxes would apply in such cases.

Capital gains taxes do come into play, however, if you do an in-kind transfer of assets with unrealized gains from a non-registered account to a registered account such as an RRSP or TFSA.

–John Heinzl

What’s up in the days ahead

Gordon Pape looks at three stocks that are bucking the trend in this year’s market correction.

Click here to see the Globe Investor earnings and economic news calendar.

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Compiled by Globe Investor Staff