Vanguard said investors looking to boost returns over the next few years might consider increasing their bond allocations. The asset manager’s model portfolio is weighted toward fixed income, with about 40% allocated to stocks and 60% to bonds. In particular, it is overweight U.S. credit and U.S. long-term bonds compared with a benchmark that is 60% equities and 40% fixed income. This reflects Vanguard’s belief that higher bond yields can provide some buffer against modest increases in interest rates. This bias toward bonds is particularly important because the 10-year yield has been on an upward trend recently, briefly topping the 4.8% level on Tuesday. Traders have been reducing expectations for a rate cut from the Federal Reserve. Bond yields and prices move in opposite directions. The portfolio uses an approach called time-varying asset allocation, which is based on asset managers’ forecasts of 10-year returns. “Based on our expectations for the next decade, that means the equity risk premium is very low,” said Todd Schlanger, senior investment strategist at Vanguard Group. The exact portfolio breakdown is 38% in stocks and 62% in fixed income. . Breaking down the portfolio Schlanger said the 40/60 model portfolio does not have a large allocation to large-cap growth stocks, which are already trading at very high valuations. “We found through research that there is a relationship between stock valuations and their future returns over the next ten years,” he said. He added that valuations for large-cap growth stocks imply returns ranging from slightly negative to 2% over the next decade, based on research. In contrast, Vanguard’s 40/60 portfolio is tilted toward value and small-cap stocks. In addition, it also allocates to equities in developed markets (excluding the U.S.), which it prefers over emerging market equities because the latter asset class has rallied strongly, Schlanger said. The fixed income portion has 22% allocated to U.S. investment grade intermediate corporate bonds. “In most of our simulations, corporate bonds, credit bonds end up outperforming government bonds over a 10-year period,” Schlanger said. About 6% of the fixed-income portfolio is long-dated U.S. Treasuries, with maturities of about 15 years. Duration is a measure of a bond’s price sensitivity to interest rate fluctuations. Bonds with longer maturities tend to have longer durations. “Year to year, you may have volatility, but in most of our simulations over the ten-year period, you see a premium for investing in long-dated bonds, what’s called a term premium,” he explained. “So, the The model favors extending the duration of a portfolio. “The term premium is the excess return investors require over time for the risk of holding bonds with longer maturities. A more active approach Schlanger said investors don’t have to abandon their 60/40 portfolios. Vanguard’s 40/60 portfolio is just one of 13 different strategies the company offers. “For example, if someone invests in a classic 60/40 portfolio, they will think that returns are really unpredictable and that it’s better to just hold a static portfolio,” Schlanger said. “There’s certainly a lot of evidence that this is a good way to invest.” The 40/60 strategy is a more active approach, he said. “By doing this, they’re aiming to achieve a similar level of return with less risk,” he said. “So that’s really the demographic it’s targeting – people who may have more risk tolerance and are willing to take that on They hope to be compensated by better risk-adjusted returns over the next decade.
