The Singapore-based bank sets out its views for 2023. It argues that after the market falls of last year, the stars are in alignment for a return to the 60/40 equity/bond approach to asset allocation.

As interest rates rise to curb the highest inflation rates in four decades, traditional asset allocation concepts that were torn up in the aftermath of the 2008 financial crash might, like an ageing rock group, be making a comeback tour.

One traditional notion is that a 60/40 per cent split between equities and bonds, respectively, confers a degree of upside exposure to risk assets with a “ballast” of bonds to guard the downside. 

Over the past year, however, anyone hoping for protection in this way was disappointed. Equities and government bonds fell in tandem as rates rose as a result of the Russian invasion of Ukraine, China’s zero-Covid policy and other forces hurting the stock market.

But maybe the time is approaching when the 60/40 model will work again, according to Hou Wey Fook, chief investment officer, DBS Bank, in a report examining themes for this year. 

“With bond yields at above 5 per cent today and equity valuations having been reverted, we believe the window is now open to be engaged for the long term, in a multi-asset portfolio of equities and bonds,” Hou said. “What is critical is for investors to build resilient portfolios that comprise securities of high-quality companies that demonstrate traits of being income generators, growth enhancers, and risk diversifiers.”

Hou expects risks of recession to slow the pace of further rate rises at the US Federal Reserve and other central banks. He predicts that rates will peak at around 5 per cent; inflation will slow down but not to the degree that will make the US Fed, for example, cut rates.

“For investors who bemoaned the lack of `value opportunities’ in risk assets previously, the time has come. As painful as 2022’s sell down has been, it has also surfaced fresh opportunities for investors to construct a traditional 60/40 portfolio with a great starting point,” Hou said. 

DBS looked at the US S&P 500 Index as proxy for equities and the Bloomberg US Corporate Bond Index for bonds, arguing that on data stretching back to 1974, there is an attractive risk-reward for a traditional 60/40 portfolio strategy now.

Source: DBS, Bloomberg

Is there a shift coming?
Some wealth management investment chiefs think clients must prepare for a shift when it appears that the rate-rise cycle has topped out. For example, UBS global wealth management’s chief investment officer, Mark Haefele, has argued that rising bond yields make fixed income assets more attractive as a source of income.

He also thinks that this year is a good one in which to deploy more capital into private markets, because investing in vintages after public markets peak has historically generated outsize returns. In the final month of 2022, meanwhile, data on the actual buying and selling behaviour of investors showed that they took risk off the table. 

DBS’s Hou has upgraded bonds to “overweight,” justified by the wide bond-equity yield gap. Investment-grade credit, for example, with yields rising above 5 per cent, gives a “blend of income and safety,” he said.

The CIO also argues that clients should stay with “high-quality” equities and those with plenty of protection against adverse events, known in the Warren Buffett sense as having a wide “moat.”