Investors who rely on a traditional portfolio of 60% stocks and 40% bonds may want to switch their strategy in this environment, according to Jim Caron, Morgan Stanley Investment Management’s chief investment officer in the portfolio solutions group. The market has been dealing with bouts of volatility all year, as traders assess the state of the United States economy and the potential impact of the Trump administration’s trade policy and increased tariffs . The 60/40 portfolio has mostly worked for the past 10 to 15 years because it is a passive strategy — and one that performs well when bonds have a low correlation to equities, Caron explained. But that has now changed, he said. “Based on a three year rolling correlation between equities and bonds, correlations for returns are as high as they’ve ever been in 115 years,” Caron said. When the correlation is high, bond returns and equity returns move down or up at the same time, he noted. “What you should be trying to do is match off the volatility of bonds with the volatility of equities,” he said. “You should think of that as an active process where it’s not ’60/40 is the golden ratio.’ It could vary.” That could mean 40% bonds and 60% equities , 80/20 or even a 20/80 portfolio, depending on the current environment. By sticking with a passive 60/40, investors could be missing out on returns, Caron warned. For instance, the strategy gave investors about a 7.5% annual return, on average, from about 1981 to 2021, he said. However, if rates move sideways, a bond’s return is largely due to the coupon payment rather than price improvement from the duration, he noted. If equities make an estimated 7% return on average, the 60/40 will give you a total return closer to 5%, he said. “If you compound that over time, if you make a 7% return pretty consistently over time, then by compounding, you would double your money every 10 years,” Caron explained. “If you make a 5% return, then you would double your money every 15 years.” How Caron is invested now Right now, Caron’s preferred portfolio allocation is 55% stocks and 45% fixed income — but what is in those buckets is just as important. Equities are primarily in the equal-weighted S & P 500, an outlook available to individual investors through the equal-weighted S & P 500 ETF (RSP). “By definition, we are taking an underweight to large-cap tech, and we’re putting an overweight to large-cap value, to mid caps, to the broader segments of the market,” he said. RSP YTD mountain Invesco S & P 500 Equal Weight ETF in 2025. Mega-cap tech stocks have been battered this year, with the Nasdaq down about 12% from its December record high. Caron also likes European equities right now, which are roughly a large-cap value play. He moved into an overweight position in February after he saw indications of pro-growth policies and deregulation coming from European political leaders. That aggressive rhetoric from politicians is a “major game changer,” he said. “The reindustrialization of Europe is what I see,” Caron said. “If you have a reindustrialization, you need energy and you need energy security.” In fixed income, he is taking a barbell approach with high-quality, short-duration bonds and some high-yield exposure. Net/net, the firm is investment grade, he said. Caron sticks with Treasurys, short-term investment-grade corporate bonds and agency mortgage-backed securities (MBS) in his high quality bucket. He also likes non-agency MBS and bank loans.
Source: cnbc.com
