Finance

The 60-40 Portfolio – Really ? Again ?

The Basic

In this first blog post, we'll delve into Financial Node with an easy and understandable portfolio: the 60 % stock and 40 % bond portfolio. The idea is to get you familiar with our "Workspace" with a simple example. We won't bore you with the why of such portfolios, or whether you should indeed invest in this type of portfolio. Your decision is yours alone and we hope Financial Node can help you make a more informed decision in the end. Nevertheless, to put it in a nutshell, stocks are usually decorrelated with bonds, which creates nice diversified portfolios.

At the heart of Financial Node is backesting, so let’s start off by heading over to the Workspace to create a portfolio and add two tickers : SPY and IEF.

SPY is the SPDR S&P500 ETF and IEF the iShares 7-10 Year Treasury Bond ETF. Click on the + Instrument button, and search for those tickers to add them.

Drag and drop each node on your Portfolio node. This will result in having an equi-weighted portfolio by default. In order to adjust the weights, we first have to click on the Portfolio node and change a specific setting under the Instrument tab: Child Weights. Change the setting from EQUI to FIXED. Now you can modify the weights of the SPY and IEF as below :

Figure 1: 60% SPY + 40% IEF Portfolio

Once done, on the right handside under the portfolio tab,  feel free to configure your portfolio's settings to your liking : initial capital, currency, minimum cash, etc... Here we’ll leave everything by default: 100,000.00 USD with 3% minimum cash. You can also change your rebalancing frequency if you wish, here we’ll leave it to quarterly.

The Backtest

Now onto the backesting and analysis ! Click on the Backtest button and let’s view the results:

Figure 2: 60/40 Portfolio vs S&P500 benchmark

To get in-depth metrics, select the Portfolio node and under the Node section, click on the Metrics tab. This simple portfolio shows quite good results: a Sharpe ratio of 1.42, an annualized return of 8.73%, 70% of monthly returns are positive with an average monthly profit of 1.6% and an average monthly loss of -1.37%.

Figure 3: Main Statistics of 60/40 Portfolio

You can also check the contributions by asset class in the Portfolio section :

Figure 4: Respective weights and returns of each asset class

As we can see our equity asset class (which is only the SPY ETF here) accounts for more than 75% of the returns. We can verify this in detail within the TreeView tab, where among other metrics, is the total return of each node:

Figure 5 : Returns of each node of our 60/40 Portfolio

Below the dividends (or coupons) received :

Figure 6 : Dividends (and coupons) received within each node

And even the Value-At-Risk (95% 1-month) to identify risky nodes :

Figure 7: VaR (95% 1-month) of each node

Under the correlation tab you can also view a correlation matrix:

Figure 8 : Correlation matrix of 60/40 portfolio

We can see our portfolio is extremely correlated to the SPY which could cause us harm. As the S&P500 has been extremely bullish for the last 10 years, our analysis is a bit biased as we haven’t included bear trends such as the dot com crash and the 2007-2008 subprime crisis. Any harsh negative return on the S&P 500 could heavily affect our portfolio, so let’s try to spice things up a bit.

Spicing up the portfolio

Let's add a slight tilt on semi-conductors, invert the weights, (40% on equity and 60% on bonds), and split the bonds into two groups 7-10Y maturities and 20+Y maturities as below:

Figure 9 : A new portfolio setup

Here's the equity curve we get:

Figure 10: Spiced Portfolio results

Looking at our main statistics and correlation matrics below, we managed to increase our Sharpe ratio to 1.7, while reducing our correlation to the S&P500 to 0.54 !

Figure 11: Spiced Portfolio main metrics
Figure 12: Spiced Portfolio correlation matrix

There are of course many more criteria to take into account to suit your risk profile : maximum drawdown, average length of drawdowns, Value-At-Risk, geographic exposure, etc... Feel free to tinker with the app by adding, removing more nodes and instruments to suit your needs !

If you have any comments, let us know below, or email us directly at contact@financialnode.com!

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