60/40 may be ‘flipped around’ as fixed income appeal rises

After more than a decade of high-priced bonds, fixed income is now compensating investors more than many asset classes, argued Raymond Sagayam, chief investment officer, fixed income at Pictet Asset Management in the United Kingdom.

Speaking in a panel session titled ‘The renaissance in fixed income’ at Conexus Financial’s Fiduciary Investors Symposium in Singapore, Sagayam said markets had priced in unrealistic expectations that there will be a “ladder of de-escalation” in interest rates, arguing rates are likely to plateau at a high level for some time.

He also pointed to equity earnings yields contrasted with 10-year bond yields and argued investors are “not getting compensated” for the high price of equities, and “the last time we saw the equity earnings yield down at these levels was back at the GFC.”

Predicting a lot of pain still to come in equity markets, he said he was an advocate of shifting “from equities into fixed income assets in general.”

But he is not blindly advocating investors lap up everything in the fixed income universe, he said, noting he was concerned about full maturity credit funds and felt “there will be a much better opportunity to gain exposure towards the end of this year, maybe early next year.”

But two areas he is very bullish are short duration funds and cash, which is “now an asset class in its own right” with different options investors need to understand.

He also pointed to emerging markets where interest rate differentials are wider than in developed markets.

“The emerging central banks have been far more aggressive at hiking interest rates, they’ve been doing it early, it’s at a much higher magnitude, so you’re getting compensated,” Sagayam said.

Emerging currencies are also the cheapest they have been in 40 years relative to the US dollar, he said.

INFLECTION POINTS

Farouki Majeed, chief investment officer at Ohio School Employees Retirement System in the United States, said the last two years saw inflection points where investors could take advantage of macro changes.

It was “unusual” that his fund made the decision to be underweight equities and fixed income over this period, but it was a “fairly easy call to say both of these assets are going to face very strong headwinds,” Majeed said.

The fund ultimately saw a return of negative 5.6% in 2022, which was better than a lot of peers.

“If you were a 60/40 investor in 2022, 60/40 would have given you a return of negative 16%,” he said. “Many of my peers had double digit negative returns in 2022. This was a period where making some bold macro calls could have benefited value addition in a portfolio quite a bit.”

The fund is still holding to those positions but “the ones that I would first probably want to think about correcting is fixed income,” he said.

Majeed said he agreed with Sagayam that terminal interest rates could go higher still and remain high for longer than some expect, and that the short duration end of the fixed income market is attractive, while reserving judgement on longer duration plays.

“As far as equities are concerned, I am more cautious about equities at this point in time than fixed income, so we might be more underweight equities for a longer period of time,” he said, arguing financial assets will have a “pretty challenging time” for the next one to three years and the 60/40 portfolio “may have to be flipped the other way around” for the near term.