GenAI will change the 60/40 portfolio strategy
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Generative AI could change the 60/40 portfolio strategy, according to Morgan Stanley.
That’s because AI will boost productivity, changing the growth/inflation relationship and the stock/bond correlation.
“Technology diffusion acts like a supply shock, boosting growth and often reducing inflation in the short run.”
The latest corner of your life warped by generative AI? Your investment portfolio.
According to Morgan Stanley, the AI boom has the potential to change a core tenet of investing for the basic, moderate-risk investor: the 60/40 portfolio.
That strategy — allocate 60% of your portfolio in stocks, 40% in bonds — has been touted as the foundation for investing since the 1950s, but it’s come under increasing doubt in the past few years. And now, another wrinkle in the debate is AI.
That’s because the technology could to boost productivity so much that the correlations between growth and inflation as well as the one between stocks and bonds might flip.
“Technology diffusion acts like a supply shock, boosting growth and often reducing inflation in the short run,” Morgan Stanley analysts wrote last month.
As a result, prior assumptions about how to diversify risk may no longer apply as the AI boom will spell healthy returns on both stocks and bonds — breaking the negative correlation between the two.
That undermines a key piece of the 60/40 strategy.
“In other words, bonds — as was the case this year — will no longer be the good diversifier they have been over the last three decades,” analysts wrote.
Stock/bond correlations vs growth/inflation correlations
Morgan Stanley Research
The flipped correlation between equities and bonds happened in the 1990s, analysts wrote, during the dot-com boom.
The explosion in information and communication technology accelerated capital investment, reduced operating costs for companies, and raised wealth, leading to higher consumption.
“Similar to ICT, AI — especially generative AI — has the potential to improve productivity broadly across sectors,” analysts wrote.
The debate over the 60/40 portfolio has intensified after a historic meltdown in the bond market sent Treasury yields soaring. That’s after the Fed aggressively hiked interest rates to hose down spiraling inflation after the pandemic. As a result, the 60/40 portfolio didn’t see spectacular returns.
BlackRock called the 60/40 portfolio obsolete because of the new high-interest rate era, saying investors have to now be more “nimble” and “granular.” Meanwhile, Vanguard has said the strategy was poised to see big returns next year.
For its part, Morgan Stanley said generative AI’s impact on growth and inflation is just one of many factors that could affect asset correlations.
“But if we do see this play out, we think it may mean portfolios will tilt more toward equities versus bonds in the long run as fixed income becomes a less reliable diversifier. Related to this, we think investors could search for new portfolio diversifiers,” analysts wrote, later adding, “We also might see a further acceleration in asset allocators investing funds in private credit, which theoretically is less correlated with public equities and fixed income.”