Ask the Manager: Pierre Debru on Rethinking the 60/40 Portfolio

Pierre Debru, Head of Research, Europe, at WisdomTree, joins our Ask the Manager series to discuss the evolution of the 60/40 portfolio, the role of leverage in improving diversification, and how WisdomTree’s Efficient Core ETFs offer a more capital-efficient approach to investing.

Many believe that the 60/40 portfolio is "dead" because traditional market conditions that made it a reliable investment strategy have shifted. How do you view the 60/40 portfolio?

Whether saving for retirement or a future home, investors are typically looking for strong returns without taking on too much risk. Traditionally, investors have balanced stocks with bonds to manage risk creating, for example, a 60/40 portfolio i.e. 60% in equity and 40% in fixed income.

While this tends to improve the risk return profile thanks to the diversification between the two assets, it also limits the growth potential as the overall risk taken is lowered. So, the 60/40 portfolio has always been somewhat flawed.

One of the biggest drawbacks of the 60/40 portfolio is the lack of exposure to other asset classes and the reduced long-term growth potential. Is there an approach that facilitates better diversification, while balancing the risk and return characteristics inherent in a 60/40 portfolio?

The solution to many of the drawbacks of the 60/40 can be found in academic literature, and in particular, in Markowitz’s Modern Portfolio Theory and Sharpe’s Capital Asset Pricing Model. The key is leverage.

By leveraging a well-diversified portfolio, such as the 60/40 portfolio, investors can maintain the benefits of diversification while targeting a level of risk, and therefore of long-term growth, similar to equities.

Also, by delivering a leveraged 60/40 exposure, this approach also frees up space for diversifiers and return enhancers.

WisdomTree’s innovative Efficient Core ETFs do not fall into any existing category. Can you explain where the idea for those ETFs comes from?

WisdomTree has developed a unique range of Efficient Core exchange-traded funds (ETFs) that allocate 90% to stocks for growth and 60% to bond futures for balance. In other words, Efficient Core ETFs deliver a leveraged 60/40.

The initial idea comes from a research paper by AQR’s Clif Asness called “Better than 100% equities” published in 1990s. Basically, Asness demonstrated that a levered equity and bond portfolio historically outperformed an all-equity portfolio with a matching level of volatility.

This essentially shows that leverage allows you to benefit from diversification without compromising returns. We decided to adopt this approach and deliver a one-stop solution that would improve upon the traditional 60/40 and correct its flaws.

What is the investment process behind these ETFs that makes them so efficient?

The strategy basically invests 90% of its assets in physical equity. For US Efficient Core strategy that would be a portfolio of around 500 large cap US equities while for the global Efficient Core strategy that would be global developed large cap stocks.

The remaining 10% is kept in cash and used as margin for a 60% exposure in government bond futures contracts. The fixed income exposure is built to be diversified maturity wise (by using multiple contracts) and to match the currency split of the equity basket.

So, leverage is the element that makes the strategy efficient. What makes leverage appropriate for this strategy, and do investors need to be concerned about incurring loses exceeding the amount invested?

Leverage is the key to the efficiency. Academic research is clear that for investors preferring higher return than the market portfolio, it is usually more efficient to borrow at a risk-free rate and invest in the market portfolio rather than simply allocating to riskier assets. Leverage allows you to benefit from diversification without compromising returns and is in fact a key piece of the puzzle when it comes to long term investing.

It is important to note, as well, that in a UCITS ETF it is not possible to lose more than the amount invested. So, using leverage doesn’t increase the level of risk.

At the end of the day, the volatility of efficient core strategies is slightly lower than that of equities. Furthermore, the weight between equity and bond future is rebalanced on a quarterly basis and also when the weights have changed by more than 5%.

So, assuming that, for example, equities are doing badly and the portfolio weights become 85%/65% instead of 90/60, then the portfolio would sell some bond futures to control the risk.

It looks like investors could use this strategy in many different ways in their portfolios. What are the options you would highlight?

Efficient Core ETFs are a versatile tool that can be used in many places in the portfolio.

• Since they tend to exhibit a higher Sharpe ratio than an allocation to only equities, they can be used as a replacement or a complement to core equities
• Thanks to the use of leverage, it creates space for diversifiers and can, therefore, be used as a capital efficiency tool
• It also serves as a low-cost, one-stop solution for investors looking for a multi-asset portfolio with equity-like risk and, consequently, equity-like growth prospects.

Digging further into this equity replacement idea, what makes Efficient Core a good replacement for core equity strategies and how does it compare to active strategies or equity factor strategies?

Efficient Core ETFs have historically delivered a Sharpe ratio that is improved versus equities thanks to the diversification of the bond future. With volatility that is similar to equities this translates into an historical outperformance versus equities. This makes them strong replacements or complements to core equity exposures.

Numerically speaking, a backtest of the US Efficient Core Strategy would show an outperformance of 0.8% per annum and an improvement of the Sharpe ratio by 0.1 versus the S&P 500 net TR Index since December 1981¹.

It also performed in line with the top quartile when considering all 921 active funds and ETFs in the Morningstar US Large Cap Value peer group, the Morningstar US Large Cap Blend peer group, the Morningstar US Large Cap Growth peer group, and the Morningstar US Equity Income peer group².

A last word on the capital efficiency, what would be a good example of a portfolio that uses Efficient Core to improve capital efficiency and create space for diversifiers?

By delivering a capital efficient 60/40 exposure in a single solution, Efficient Core ETFs also free up space for additional diversifiers and return enhancers.

Just to take a simple example, by investing 67$ out of a 100$ capital in a Global Efficient Core UCITS ETF, an investor would create an exposure of $60 to global equities and $40 to Government bond futures contracts, effectively investing in a 60/40 portfolio.

However, the investor would be left with $33 of capital to invest in Broad Commodities, Gold, Real Estate or crypto assets without having to reduce their investment to equities.

About Pierre Debru

Pierre Debru leads WisdomTree’s European research team and plays a pivotal role in the strategic direction of our European research efforts. His key areas of expertise extend across equity factors and quantitative strategies, portfolio construction and model portfolios, and thematic and crypto investments.  

Before joining the company in 2019, Pierre worked in investment research for DWS and the Xtrackers range for over five years. During this period, he focused on smart beta investments, model portfolio construction and thought leadership. Pierre has over 20 years of experience in investments and structured asset management. He graduated from Ecole Central Paris and obtained a Master of Science in Mathematics applied to Finance. 

[1] Source: Bloomberg, WisdomTree. From 31st December 1998 to 31st January 2025. Daily data in USD. Includes backtested returns. You cannot invest directly in an index. Historical performance is not an indication of future performance and any investments may go down in value.

[2] Source: Morningstar, WisdomTree. December 1998 to January 2025. in USD. Includes backtested returns. You cannot invest directly in an index. Historical performance is not an indication of future performance and any investments may go down in value.

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