Over the longer term, CIO remains convinced that a diversified portfolio of equities, bonds, and alternatives is the best way for investors to balance growth and preservation. (UBS)

CIO continues to believe that holding a core position in a balanced portfolio is the most effective way for investors to preserve and grow wealth over time.

What are the merits of a balanced portfolio today?

First, we continue to expect further downside for bond yields and upside for equity markets, and see upside over the next year for balanced portfolios in both our base case and upside scenarios. While parts of the US equity market are expensive, most global markets are not overpriced, in our view, and we expect earnings growth to be positive in all regions.

In our base case scenario, we expect a 60-40 portfolio of global equities and 10-year US Treasuries to potentially deliver a return of 8.1%. In an upside scenario, returns could rise to 10.7%. In a downside scenario, we would expect strong returns from bonds to partially offset equity market declines, potentially limiting portfolio downside to –3.4%.

Second, holding a disciplined and balanced allocation to a broad range of companies, sectors, and asset classes can facilitate steady upward progress, even as market narratives chop and change. By contrast, investors with concentrated exposure in individual asset classes are at risk of experiencing higher volatility, and investors trying to trade between asset classes are at risk of being “whipsawed.”

Third, the sharp fall in interest rate expectations in the past couple of months has made the potential reinvestment risk of holding too much cash very clear. With rates likely to fall in the next year, and potentially sharply, investors will need to find a way to get invested in longer-duration assets. But trying to time entry can be challenging. Balanced portfolios, and phased approaches to market entry, can help reduce market timing risk relative to trying to go “all in” either in equities or bonds.

Fourth, after a sharp rally in traditional equity and bond market indexes, the need for investors to earn alternative sources of return is greater. A balanced portfolio, including a mix of passive and active funds, and an allocation to alternative investments (including hedge funds, private markets funds, and risk parity) can enable investors to tap into a broader range of returns.

Fifth, amid sharp moves in equity and bond markets, and the potential for additional volatility in the months ahead as markets trade around potential scenarios, the potential for a disciplined rebalancing process to add to portfolio performance is greater. For example, Vanguard research estimates that rebalancing can add about 14bps to annualized returns (for a 60% stock, 40% bond portfolio), as well as reducing the portfolio’s expected risk.

Finally, over the longer term, we remain convinced that a diversified portfolio of equities, bonds, and alternatives is the best way for investors to balance growth and preservation. In our capital market assumptions, using equilibrium return assumptions, we estimate that a portfolio of 45% stocks, 35% bonds, and 20% alternatives could deliver a return of around 5% in excess of cash annually over the longer term, with an annualized standard deviation of around 9%. That translates into an expected return of 2.7–4.3x versus cash over a 20–30-year timeframe.

Main contributors – Mark Haefele, Mark Andersen, Jason Draho, Kiran Ganesh, David Lefkowitz, Frederick Mellors, Dominic Schnider, Dirk Effenberger

Read the original report : Year Ahead 2024: Scenario update, 5 January 2024.