60/40 Portfolio Can Be Improved With Creative Use of Alternatives, Experts Say

The unreliability of the 60/40 portfolio in 2022 has brought to the forefront alternative courses of action for investors. For retirement savings plans, industry experts say there are very few institutional options, but savers can explore liquid alternatives, collective investment trusts and individual retirement accounts.

In a panel discussion on Wednesday at the New York Stock Exchange, industry experts spoke about “The Rise of Alternatives and the New 60/40 Portfolio.” Asset management and investment advisers discussed methods to diversify and target new sources of income for everyday retirement savers, both in and out of defined contribution plans.

Since the 1980s, the 60/40 strategy—allocating 60% of assets to stocks and 40% to bonds—has provided investors with risk-adjusted returns. A bond was a reliable diversifier, a “unicorn asset,” according to Nathan Shetty, head of multi-asset at Nuveen. However, the 60/40 approach has been seriously challenged in recent years by inflation and fears of a recession, reversing the consistent negative correlation between stocks and bonds, he said.

“[2022] was a bloodbath,” Shetty said. “It was a painful year,” 

Getting Creative

Kimberly Ann Flynn, the managing director of XA Investments, said an available alternative is a mutual fund wrap with added investments such as managed futures and commodity futures, which exist in the category of liquid alternatives.

“Even though … there were a lot of unhappy users of liquid alts back in 2014, 2015, I think with now this big push again looking at 60/40, it’s just diversification away from U.S. equity,” Flynn said. “I think some of these liquid alternatives are going to see a resurgence. In terms of performance, long-short equity performed well, on a relative basis and absolute basis. Some of the managed futures strategies performed really well. Because the guts of the portfolio are liquid, they fit into a mutual fund.”

While investing in interval funds, closed-end funds that house illiquid alternatives, might seem a natural next step, Flynn does not think they will be accessible any time soon in DC plans. 

“It’s more about an operational setup issue,” she said. “I think the SEC would love to see the average retiree or 401(k) investor [with access to interval funds]. I think there’s industry participants pushing for that, but not yet.”

CIT on the Scene

Brian Chiappinelli, a managing Director at Cambridge Associates, said another alternative gaining momentum is the collective investment trust, or CIT. Traditionally, the target-date fund was an asset-allocated fund managed by a professional and limited to the vehicle of a mutual fund. The last 10 years has seen the rise of CITs, which “do the same thing, but with a couple of differences.”

One significant difference is that CITs have more leeway to add alternatives that are customized to a particular employee demographic, Chiappinelli said. For example, a very large employer with thousands of employees might not think an “off-the-shelf” TDF from one of the larger asset managers matches the liabilities of its employees, but a collective trust could be a suitable alternative.

“What [employers] do is engage with those same managers and say, ‘Can you create me a custom target-date fund, just for my employee set?’” Chiappinelli said. “When they do that, they can start bringing in alternatives, because now you’re just bringing all the stuff in, wrapping it in a different vehicle and presenting it to your employees.”

Another growing way to invest in alternative assets is through self-directed IRAs, added Michael O’Malley, the executive-in-residence at the University of Notre Dame’s Fitzgerald Institute for Real Estate.

“You’re talking about your 401(k) from your previous company sitting in a Fidelity IRA, and they give you a laundry list of people,” O’Malley said. “There are about a half a dozen groups that allow you to move your money away from Fidelity, and you can actually self-direct your IRA so you can invest in rental property, you can invest in a business, private funds.”

However, O’Malley noted there are several self-dealing rules that an individual must abide by. According to XA Investments’ Flynn, many challenges exist in the way of diversifying the 60/40 portfolio. Ultimately, “There really are very, very few institutional alternative options,” she said.