Investors are ‘walking the plank’ in pursuit of attractive yields, embracing risks that could significantly compromise the performance of their portfolios, according to Rob Perrone, investment counsellor at Orbis Investments (Orbis).

Speaking exclusively to fundeye, Mr Perrone outlined the issues facing the 60-40 portfolio composition, and expressed concern about the lack of stability provided by former investment staples such as cash and government bonds. 

However, he was also worried about how much risk investors seemed prepared to take on chasing yields.

Mr Perrone said: "In response to the kind of challenges 60-40 investors are facing, investors are kind of walking the plank when it comes to risk and going further and further out the risk curve in pursuit of yield. We don't think that's a sustainable or healthy approach."

In particular, he questioned why some investors were pivoting to broad passive strategies and corporate bonds.

He said: “We think broad passive exposure to stocks and bonds looks pretty risky, because the risk that we're always worried about is permanent loss of capital."

He also observed that corporate bonds were also failing to perform to expected standards.

He said: “Today, if you look at the yield, particularly with investment grade corporate bonds, you're getting about two percent. Even if you were willing to go to BBB, just one rung away from junk, you're only getting a hair over two percent right before inflation. If you were a loan officer at a bank, you would care about these credit fundamentals, and the credit fundamentals of BBB bonds today are about where they were for junk bonds five years ago.”

The investment counsellor did not believe Covid-19 had created or catalysed any factors and trends in the 60-40 split, instead the decline of yields and returns among established risk-off assets and the fixed income space had been a gradual process over decades.

Mr Perrone said: "For the last 30 years, generating good risk adjusted returns has been really easy. All you had to do was just buy the stock market and buy the bond market and you would get good risk adjusted returns, or more technically beta was kind of all you need."

The developing situation did not mean investors needed to shift the percentages of their portfolio and push for a 90/10 portfolio, of the kind that Warren Buffet suggested earlier this year. Instead, Orbis’ investment counsellor recommended active investing, alongside on gold and inflation linked bonds, alongside hedging and value shares.

He explained: "If we look forward today at the combined valuation of 60-40, with the risk characteristics bonds and equities, we think beta can't do the job anymore. So, we think part of the solution needs to be more active investing rather than passive.:

He also argued that unlike passive investments tracking US indexes, the returns of hedged equity were less dependent on the overall direction of stock markets. He also argued that gold and inflation linked bonds can be more attractive than government bonds on a risk-return basis.

Elaborating on this perspective, Mr Perrone said: “We think they can do well in a lot of the same environments where government bonds can do well, and that they can hold their value against inflation. Central banks can't print gold, so it is kind of a nice risk angle to have…They should also think about value shares, many of which are pretty good businesses. They have just been utterly neglected for the last four years, and as a result are now pretty cheap.”

He concluded: “Combining active stock picking with hedging reduces risk, reduces volatility, and reduces beta.”