Why investors are exploring alternatives to their 60/40 portfolio
Rising inflation figures, diminishing interest rates and the growing popularity of alternative investments have forced many investors to question the effectiveness of the 60:40 split of stocks to bonds in its traditional sense, instead raising the question of whether more emerging alternatives could be more effective for experienced investors.
The classic 60/40 split of stocks to bonds has long been a staple for private investors looking to marry the long term, limited volatility of bonds (40%) with the high growth, more risky nature of equities (60%), but recent macroeconomic pressures and growth in the popularity of alternative investments has put this trusted balance under the spotlight for some investors.
After UK inflation rates hit 40-year highs of 9.1% in May 2022 following further rises in the cost of food, transport and energy were recorded, investment professionals have been unsurprised to see a growth in the level of demand from investors keen to explore alternative routes when rebalancing their portfolio amidst an ever-shifting economic backdrop.
Rising inflation causing investors to question traditional bonds
Traditionally in a 60/40 portfolio split, 40% of investments are made up of low interest, long term bonds designed to act as a protective blanket against potential fluctuations in the remaining 60% equity, but recent fiscal pressures have made attaining the required returns from this 40% in traditional bonds increasingly challenging.
Last month as the UK consumer price index (CPI) hit 9.1% as the UK recorded the eight consecutive month that inflation had risen and the highest figure since 1982, statistics collected by the Office of National Statistics found.
Though accompanied by the slightly more positive news earlier this month that the Bank of England (BoE) would increase the base interest rate from 1.0% to 1.25% effective immediately, when compared to the 6.6% rise in the level of inflation the UK has witnessed over the past 12 months this disparity in growth has lead many investors to feel as though they are fighting an uphill battle to achieve positive returns and save for later life.
Effectively, this current rate of inflation now means investors must choose bonds - or investments with similar low risk levels - with interest rates closer to that 9.1% figure to ensure positive returns once inflation has been considered.
Consequently many investors have considered seeking alternatives - a piece published by The Times (before even the most recent rises in inflation) suggesting a number of investors have opted to ditch traditional bonds such as gilts and corporate bonds (often targeting interest rates below 1%) in favour of higher interest bonds or a greater focus on equity opportunities.
And whilst some investors may see a solution to this issue via a shift to equity dominant portfolios such as those with a split of 80:20 or 90:10, though such options can offer the potential for significant growth over short periods of time, they can often be accompanied by higher risk, more severe fluctuations and an absence of the “safety net” of capital that bonds can provide.
Other variations of bonds do still exist for more experienced investors of whom may not be comfortable with a complete portfolio remodel though, who instead may wish to plan for later life or continue to build on their investment pot with a more gradual, long term plan.
One alternative example highlighted in particular in recent months has been fixed term property bonds - their association with the rapid acceleration of the UK housing market, “hands off” property investment capabilities and often significantly higher target interest rates when compared to traditional bonds making them especially suited to the more experienced investor.
Facilitating peer-to-peer loans from private investors to property development companies, fixed term property bonds give investors the opportunity to target interest rates generally between 5% and 8%.
Not only has the higher target returns and property-focused purpose made this bond variation especially popular among investors looking for alternatives within their traditional 60/40 portfolio, but the range of tax benefits they offer when invested into via the Innovative Finance ISA (IFISA) have too - allowing investors to utilise their £20,000 tax-free ISA allowance when doing so
Just one example of a popular alternative to incorporate into the traditional 60/40, property bonds are one of a host of increasingly popular ways experienced investors are looking to negate the long term growth impacts of rising inflation in the UK and make more considerable gains when saving for later life.
And whilst it’s important to note such higher interest alternatives are often accompanied by higher risks comparatively, by re-assessing the volatility of equity investments that traditionally make up 60% of a portfolio an investor can help to negate these increases in risks.
Early stage venture capital providing an alternative to volatile stocks
As global stocks and bonds values continue to fluctuate considerably month-on-month, and venture capital investment into the UK’s early stage tech sector persists in its growth since the start of the pandemic, 2022 is proving an especially timely year for investors considering a change of tact within their 60/40 portfolio.
Following a start to June that saw US stocks drop in the worst week since January fuelling further uncertainty across global stock markets, and a record start to the year for UK scaleups which witnessed more than £7.6 billion of VC investment in Q1 2022 (up from £5.1 billion in Q1 2021), some investors have been left questioning whether it could be time to swap some of their traditional stocks for alternative investments.
For some investors adopting this traditional 60/40 portfolio split, the 60% majority is invested into such volatile, potentially high-growth stocks, often with short term exit in mind and a relatively high level of risk accepted.
But for the significant proportion that instead utilise stocks with long term growth goals in mind, early stage VC investments (although still high risk) could pose a welcome alternative - not just due to their emphasis on prolonged growth, but due to the considerable money-on-money returns they forecast and generous tax benefits they often offer.
From Durham-based global threat intelligence provider Intelligence Fusion to the UK’s first digital-only bank Atom Bank, an abundance of VC investment opportunities have witnessed rapid growth over the past decade and seen investor returns far outstrip many long term stock portfolios - a number which due to the help of the popular Enterprise Investment Scheme (EIS).
Introduced in 1994 to raise capital and support growth of the UK’s early stage startup sphere, the EIS was founded with the goal of strengthening Britain’s growing scaleups by offering investors the opportunity to claim a stake in some of the nation’s most promising young companies. alongside some of the most generous tax reliefs available in venture capital.
Having raised over £25bn for more than 36,000 early stage British businesses to date, the scheme has benefited generations of investors with tax reliefs such as 30% income tax relief, capital gains tax exemption and inheritance tax exemption for over two decades, comfortably cementing its legitimacy as a key player in UK venture capital in that period.
And whilst a host of alternatives to stocks may appeal to investors considering a change in their 60/40 portfolio (from VCTs to mature private equity deals to property investments) the EIS’s ambitious growth opportunities and generous tax efficiencies make it a particularly attractive prospect for those with capital preservation and saving for later life in mind.
Creating a balanced investment portfolio
In an ever-changing economic landscape intensified by a particularly anomalous past few years, it can seem difficult for even some of the most experienced investors to navigate their way through the innumerable opportunities and options the private investment sector is synonymous with.
Whether you adopt a traditional 60/40 portfolio set on the foundations of stocks and government bonds, or a portfolio of 100% equity and alternative investments, it can be crucial to remember that portfolios don’t follow a ‘one size fits all’ policy.
Where for experienced investors with long term growth and manageable risk as priorities may include a comfortable balance of regular, noticeable bond repayments and high growth, medium risk venture capital as alternatives in their traditional split, less risk averse investors may opt for a 90:10 split dominated by highly volatile investments such as cryptocurrency.
Whichever balance you find in your portfolio, all have the potential to be successful - even 100% equities portfolios, which some suggest are actually superior in the long run due to historical data that shows equities consistently outperform stocks and cash.
But regardless of the route you choose, analysing the macro and micro environmental factors surrounding your investment to the finest detail - whether that's inflation and interest rates or growth forecasts and personal goals - should play a key role in your financial planning among a current landscape shaped by shifts in external influence and internal motivation.