The 40/60 portfolio has 'paid off' this year and should boost future returns, says Vanguard

Vanguard's 40/60 strategy, overweight in fixed income with a 62% allocation, has outperformed due to elevated bond yields and a tactical shift away from richly valued U.S. large-cap growth stocks towards value and developed international markets; the strategy's time-varying asset allocation, based on Vanguard's 10-year return forecasts, aims for reduced volatility, with a predicted drawdown of -4.2% compared to -8.3% for a standard 60/40 benchmark, offering a better risk-adjusted return despite only a slight increase in expected returns.

Analysis

Vanguard's 40/60 investment strategy, allocating 38% to equities and 62% to fixed income, has demonstrated favorable performance year-to-date, primarily attributed to its overweight position in fixed income amidst elevated bond yields, with the 10-year Treasury yield recently trading around 4.46%. The strategy's equity component deliberately avoids U.S. large-cap growth stocks, which Vanguard estimates are trading 37% above fair value, and instead tilts towards value stocks and developed markets outside the U.S.; this positioning proved advantageous in April, when developed ex-U.S. markets returned 4.7% compared to a -0.7% return for the U.S. market, especially as U.S. growth stocks experienced a challenging start to 2025 including a significant decline during April's tariff-induced sell-off. Within its fixed income allocation, the strategy has shifted from U.S. intermediate credit bonds to U.S. aggregate bonds, favoring a slightly longer duration to enhance diversification and performance during periods of uncertainty, aligning with expectations of a gradual fall in interest rates impacting shorter-term bonds. Vanguard's time-varying asset allocation, based on 10-year return forecasts, aims to deliver superior risk-adjusted returns, projecting a decrease in volatility by over 200 basis points and a significantly lower drawdown of -4.2% compared to -8.3% for a traditional 60/40 benchmark, despite an anticipated modest increase in expected returns of approximately 10 basis points. This approach is positioned for investors seeking more active portfolio management responsive to current market conditions and valuation disparities.

Key Decisions for Investors

• Investors concerned about high valuations in U.S. large-cap growth stocks and seeking reduced portfolio volatility should evaluate strategies with a greater allocation to fixed income and developed international equities, similar to Vanguard's 40/60 model.
• The reported success of tilting towards value, developed ex-U.S. markets, and longer-duration bonds suggests a review of current asset allocations may be warranted to capitalize on these trends and manage potential U.S. market volatility.
• For those utilizing static asset allocations, the potential for enhanced risk-adjusted returns through dynamic, forecast-driven strategies like time-varying asset allocation merits consideration, particularly in the current market environment characterized by uncertainty and significant valuation concerns.