Is the traditional 60/40 portfolio dead? Morgan Stanley's Jim Caron has a theory about that

Published Wed, Mar 1 20237:20 PM EST

2022 was the worst year the "60/40 portfolio" had since 1926 . But the traditional investment model, in which investors put 60% of their money in stocks and 40% in bonds, has enjoyed a strong rebound in 2023 — at least so far. Such portfolios gained 6.2% in January — a performance at the 96th percentile of all months since 1921, according to Bank of America . The gain was just below the 6.3% total return of the S & P 500 in the same timeframe, recouping losses from December. But Morgan Stanley 's Jim Caron is unconvinced by the rally, calling the 60/40 strategy "a thing of the past." No longer a reliable hedge? Creating a profile in which an investor can compound returns in a stable manner over time was the main idea behind the 60/40 portfolio, the co-chief investment officer of global balanced funds at Morgan Stanley Investment Management told CNBC's " Street Signs Asia " on Tuesday. And that approach worked for investors in the past, according to Caron, as bond returns remained consistently positive in 36 of the last 40 years. "But that was when interest rates were falling from 1980 to 2021. But if interest rates just move sideways or even have a little bit of a drift higher, then the concept of a 60/40 balance in a portfolio to generate stable returns over time like it did over the past 40 years — that's really missing the point," Caron said. "One has to think of different and more dynamic portions of equities and bonds to balance risks and produce more stable returns," Caron said. That's why the 60/40 approach may no longer be an optimal strategy for investors, he added. Bank of America strategist Jared Woodard shares that view. The logic of holding a 60/40 portfolio for the long term appears "broken," he wrote in a Feb. 13 note. "The deflationary environment of recent decades seems to be ending amid the reversal of globalization, rise of ESG policies, inflationary demographics, and exhausted tech disruption. The shift from a 2% [average fed funds rate] world to a 5% world means structurally higher inflation and interest rates," he said. That implies that the era in which bonds functioned as a reliable hedge appears to be over, with stock and bonds now enjoying a positive correlation, he added. Returns from stocks and bonds have typically been negatively correlated; when one goes up, the other goes down. That reduces portfolio risks and limits losses in periods of market volatility. What should investors do? Despite his reservations about the 60/40 investing strategy, Caron believes fixed income is now a "good opportunity" for investors. "Bond yields have gone back higher. It's almost like we're getting a second bite at the apple at this point. We have high yield [bond] yields at near 9%. You've got emerging market yields, broadly speaking, at around 8.75%. Investment grade yields are about 5% as well," he said. Caron said that's "reasonably good news" for investors looking to invest or re-allocate into fixed income. Yields on U.S. government debt have been soaring on expectations that the Federal Reserve will keep interest rates higher for longer. The yield on the benchmark 10-year Treasury touched a high of 3.983% on Tuesday. And a day earlier on Monday, the 2-year yield hit its highest level since November. As for stocks, Carson said their recent pullback after a strong start to the year also present near-term opportunities for investors. — CNBC's Michael Bloom contributed to reporting