The 60/40 portfolio has been suffering all year, but there are opportunities for long-term investors

Published Wed, Oct 19 20223:17 PM EDTUpdated Wed, Oct 19 20224:40 PM EDT

The classic diversified portfolio of 60% stocks and 40% bonds is having a terrible year. The 60/40 strategy, known as a balanced portfolio, has been hit by rising bond yields — which means falling fixed income prices, as well as a sinking stock market. The portfolio's annualized decline of 32% for 2022, as of Oct. 18, is the worst in the past 100 years, according to Bank of America. Yet, amid that devastation there may be opportunities for long-term investors. "The future is brighter for the 60/40," said Omar Aguilar, CEO and chief investment officer of Schwab Asset Management. "When we compare the opportunities we see in a 60/40 today to what we had in the middle of the pandemic, clearly there are more opportunities now than back then," he added. One measure of the portfolio's performance is the iShares Core Growth Allocation ETF , which has a target fixed allocation of 60/40. The ETF is down more than 19% this year, as of Tuesday's close. Aguilar's optimism is rooted in his expectation that there will be a decoupling of stocks and bonds, whose prices have been falling. Typically, these two asset classes have an inverse relationship. "The correlation will come back to the normal levels, or the historical levels that you normally have between equities and fixed income," Aguilar said. "We hope this will be a result of yields stabilizing and getting to the terminal rate, which hopefully will happen by the first part of 2023." For Bank of America Global Research's chief investment strategist Michael Hartnett, "long 60/40" is one of the most contrarian trades at the 2023 lows, thanks to its performance, past history and anticipated volatility ahead. "If in 2023 either the inflation becomes more accepted, anticipated and/or it drops because of the unemployment rate, then you have a case for saying actually maybe the Fed can ease up — who knows, maybe even cut rates over the following 12 months," Hartnett said. "If that is the case, then just as everyone is abandoning 60/40, the great contrarian trade next year would be 60/40," he said. Harnett isn't advocating a massive outperformance of the 60/40 portfolio and is not convinced the stock market has made its ultimate low yet, or that bond yields have reached their peak. However, when that turning point occurs, he advises selling the dollar and buying the 30-year Treasury . In equities, he would buy small cap, cyclicals, value, European and emerging markets. "You are long the new leadership," he said. Schwab's Aguilar advises against chasing yields in fixed income, but instead maintaining a balanced approach between credit and duration. He also believes valuation in stocks is starting to become attractive. Thinking outside 60/40 There are also those who aren't necessarily buying back into the 60/40 strategy. Michael Dow, chief investment officer at Beacon Pointe Advisors, shifted to a 55% stocks, 25% fixed income and 15% alternative investments split — and he's not looking back. He's overweight value stocks. His alternative investments are primarily in private equity, private credit and private real estate, as well as in real assets and hedge funds. In fixed income, the firm currently has a bond duration of four years, down from its previous seven-year duration. However, it is contemplating shifting back to around six years in anticipation of a recession. He suggests not straying too far from your strategic allocations. "Volatility is the price you pay for building wealth," Dow said. 'Once in a generation opportunity' Nancy Tengler, CEO and chief investment officer of Laffer Tengler Investments, fashions her clients' portfolios based on their needs and risk profiles, and has recently been making some changes. After moving into alternatives and convertible securities from bonds in the summer of 2020, she is now shifting back into bonds. However, she's sticking with short-duration assets in corporate, municipal and Treasury bonds and laddering them. A bond ladder involves purchasing issues with different maturities and then reinvesting the proceeds as near-dated bonds mature. By doing this, you're spreading interest rate risk. "Our duration is two to three years. You will have the ability to generate a decent yield … but you will mitigate risk so you are laddering your holdings," Tengler said. "The best thing to do in this environment is to ladder because you don't know how far the Fed is going to go." While she's not predicting a bottom in equities, she doesn't think investors should sit on the sidelines. "This is a once in a generation opportunity to buy really high quality companies at reasonable multiples," Tengler said. "You have to be willing to step in against the sentiment," she added. "Three years from now, will I be happy I bought at this time? Yes, absolutely." She likes names including Lululemon , Home Depot , McDonald's and Chipotle . In tech, her picks include Adobe , Amazon , ServiceNow , Palo Alto Networks , Microsoft , Broadcom and Texas Instruments . — CNBC's Michael Bloom contributed reporting.