Tactical Asset Allocation — Long Live the 60/40
Additional content provided by John Lohse, Senior Analyst, Research
Much has been discussed regarding the 60/40 stock/bond portfolio recently. While it came under immense pressure in 2022, 2023 saw a resurgence of cornerstone asset allocation. LPL Research believes the 60/40 still more than holds its ground as a valuable tool in portfolio construction. Especially as interest rates normalize, and equity markets navigate potential economic slowdowns. Therefore, we believed it would be fitting to review the LPL Research Tactical Asset Allocation’s (TAA) 60/40 strategy, which aligns with our Growth with Income (GwI) Investment Objective (IO). We also examine one of our model portfolios, the Model Wealth Portfolio (MWP) Tactical Exchange Traded Products (ETP) model, that LPL clients can use to implement these views.
Equities
The GwI (60/40) TAA currently has an overall neutral view on equities, holding 60% stocks versus a benchmark of 60% stocks, 35% fixed income, and 5% cash. LPL Research’s Strategic and Tactical Asset Allocation Committee’s (STAAC) year-end fair value target (calculated using our estimates for earnings and market multiples) for the S&P 500 is right around current levels, indicating the belief that the risk-reward balance between stocks and bonds is relatively balanced at present, despite strong year-to-date gains given the improved economic backdrop.
On geographic equity exposures, the TAA favors an above-benchmark exposure to U.S. equities funded by an underweight to emerging markets. Within domestic equities there is an up-market-cap bias (although small cap value has become increasingly attractive) favoring large cap equities and within large caps favoring growth over value. Large cap growth is the current largest equity overweight based on favorable views on strong large cap balance sheets, and growth tailwinds including interest rate stability, solid fundamental footing, and momentum in technology-oriented names.
Outside of the TAA, the STAAC also has a favorable view on two equity sectors — communication services and energy. Communication services had a strong Q4 earnings season, a positive technical backdrop, and the advantageous positioning of digital media companies. The energy sector has seen improved profitability and attractive valuations. The STAAC is underweight in the consumer staples and real estate sectors, favoring cyclical over defensive sectors overall.
Fixed Income
Treasury yields were higher in January as interest rate cuts got priced out to the May Federal Reserve (Fed) meeting, at the earliest, due to the still resilient economy. The market got ahead of itself late last year in pricing in aggressive rate cuts, so a back-up in yields has been warranted, in our opinion. Still, starting yields for many fixed income markets are at levels last seen over a decade ago, so the return prospects for fixed income remain favorable, in our view. The TAA has been overweight bonds by 3% versus its benchmark since June of last year, funding this with an underweight to cash.
Within bond sectors, the STAAC favors mortgage-backed securities (MBS) and preferred securities over corporate bonds. MBS spreads (the difference in rates between the asset and a Treasury security of the same maturity) are at multi-year highs, while corporate credit spreads, particularly in lower-rated debt, are very tight. Preferred securities saw a sharp decline following last March’s sell-off in the banking sector. This provided an attractive entry point to buy, as the TAA launched a position in Q1 2023.
The chart below reflects the tactical asset allocation and benchmark weights in the GwI 60/40.
LPL Research Growth with Income (60/40) Tactical Asset Allocation
Source: LPL Research 02/16/24
Summary
We believe the demise of the 60/40 was greatly exaggerated, and it is still an important portfolio construction tool into 2024 and beyond. This investment environment, as with most, is fast-moving and comes with its challenges, however, those challenges bring opportunity, and the 60/40 (GwI IO) Tactical Asset Allocation lends itself to capturing those opportunities in both the equity and fixed income markets.
How to Implement in Model Portfolios
The LPL Research model portfolio that captures our TAA and equity sector views most closely is the MWP Tactical Exchange Traded Product (ETP) model. This model has over $2.9 billion in assets as of January 31, 2024, with over $1 billion in the GwI (60/40) IO and has an almost 15-year track record, following its inception in July 2009. The model’s investment approach is designed to adapt to changing market conditions, with a time horizon of 3–12 months, and it typically executes 5 to 10 trades per year. The model follows the TAA guidance provided by the STAAC, using mostly passive, cost-efficient ETPs to implement those views, as well as implementing sector views with sector-specific exchange-traded funds (ETFs).
IMPORTANT DISCLOSURES
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk.
Indexes are unmanaged and cannot be invested into directly. Index performance is not indicative of the performance of any investment and does not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.
This material was prepared by LPL Financial, LLC. All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.
Asset Class Disclosures –
International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.
Bonds are subject to market and interest rate risk if sold prior to maturity.
Municipal bonds are subject and market and interest rate risk and potentially capital gains tax if sold prior to maturity. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply.
Preferred stock dividends are paid at the discretion of the issuing company. Preferred stocks are subject to interest rate and credit risk. They may be subject to a call features.
Alternative investments may not be suitable for all investors and involve special risks such as leveraging the investment, potential adverse market forces, regulatory changes and potentially illiquidity. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses.
Mortgage backed securities are subject to credit, default, prepayment, extension, market and interest rate risk.
High yield/junk bonds (grade BB or below) are below investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.
Precious metal investing involves greater fluctuation and potential for losses.
The fast price swings of commodities will result in significant volatility in an investor's holdings.
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