Campbell Harvey, a professor of finance at Duke University, is best known for developing the yield curve recession indicator, known for his excellent record in predicting the downturn.
In a new paper he co-wrote with Edward Hoyle, Sandy Rattray and Otto van Hemert’s defense fund giant Man Group, Harvey points out a 60/40 portfolio – 60% in stocks, 40% in bonds – is not just a strategy passive.
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“We argued that rebalancing is an active strategy, as assets are sold as they rise in value and are bought when they fall in value. Buying (rebalancing) when stocks are falling leads to greater losses,”; they say.
As a rule, the authors have previously defended rebalancing calls only if the 1-month, 3-month, or 12-month trend in the relative return on equity bonds is above its long-term historical average. Moreover, move only half the distance back to the 60/40 mix, they advise.
Following the rebalancing rule would limit the 60/40 portfolio decline in the first quarter to 7.2% or 7.4%, versus an 8% decline in automatic rebalancing.
“The impact of the rule is not as great as during the 2007-2009 financial crisis (about 5 percentage points then), when stocks underwent a more gradual and larger underperformance. But the strategic rebalancing rule lowered the 2020Q1 hurdle, despite the unexpected crisis, “they say.
See also:Vanguard comes to 60/40 portfolio defense as it predicts stock returns for the next decade
The same paper also examines which strategies worked best during withdrawal. They have previously argued that buying established options was expensive during normal time and gold was not reliable.
Current strategies, those that Man Group EMG,
is known for, best performed during sales.
Another interesting finding was that so-called security strategies – those aimed at companies whose shares are less volatile or non-indebted – did not work well.
“This is similar to the Financial Crisis episode in 2007-09. We argue that this is due to tightening credit conditions. For example, if leverage is used to increase the return on low-risk stocks, then an increase in “Borrowing costs can be detrimental, both additional and indirect costs by forcing unlocking positions,” the authors say.