UniSuper CIO John Pearce on why the 60/40 portfolio is far from dead

John Pearce: What do we know about these times? Everyone is talking about risk. It is at the forefront of everyone's thinking. We're all worried about what's happening in geopolitics. Bond markets are taking absolute fright because of inflation. So, I actually think that the world – the pricing of risk now is such that you're at least getting rewarded for taking that risk.

Graham Hand: So, the U.S. 10-year at 5% is better for investing than the U.S. 10-year at 0.5%.

Pearce: It absolutely is. The problem we've got though is the speed at which it's got here. Now, we can argue whether 5% or 4% is the right number. I think we'd all prefer close to 4%. I certainly do not want it back at 0.5% or 1% or the ludicrous situations we still have in Japan where you've still got negative yields. So, to me the world is getting back to some semblance of normality. The problem we've got is the magnitude and the speed at which it's happened. So, hopefully, we have a pause here and we can stabilize at these levels or slightly below, but the actual, whether it's 4%, 4.5%, that doesn't particularly concern me.

Hand: So, you made an interesting comment I'd like to draw out where you said that when rates were close to zero the optimal allocation for a retiree wasn't that much different in the accumulation stage and the decumulation or the spending stage, but that's now changed. What do you see as the changes there?

Pearce: Well, if you recall that we had that acronym, TINA. And it was kind of right.

Hand: And then, you had to be in equities.

Pearce: You had to be in equities or risk assets of some description, because 1% at a credit margin, it just doesn't really cut it for anyone. You're looking at annuities, et cetera. Why did Australians issue annuities for so long because rationally it just wasn't the right decision to make. But now, as a retiree, you can actually go pretty well down the risk spectrum. And we're not talking about just cash, just some sort of cash enhancement. You can get these bank bonds or top-quality corporate bonds, et cetera. You can get a decent return. So, this notion of 60-40 being dead, I think the opposite. I actually think if ever a 60-40 in Australia is more 70-30. I think the time has come. 60-40, 70-30 that was a stupid idea when bond yields were 1%. But why not now?

Hand: Yeah, true. So, a lot of your members go into the balanced option. It's sort of your default set and forget option. But that requires you to allocate across equities and properties. How do you do that sort of allocation process and do your allocations change very much?

Pearce: At the high level, we are not that dissimilar to most of the big funds. Your typical balanced option in Australia is 70% roughly growth assets, 30% roughly defensive assets or thereabouts. Where we differ from other funds is firstly our exposure to unlisted assets has traditionally been a lot lower than other large funds. Within our growth allocation we tend to take sector-specific bets such as we have large overweights on just the tech sector, we have overweights to Asia or Japan at the moment or India, country-specific bets. That's where we tend to differ. In defensive we probably have less in these what we call alternative defensives and more on what we –we like to pick up our yield, for example, via at the moment Tier-2 major bank bonds.

Hand: Right. Okay. Those big allocation decisions, they don't change that much?

Pearce: Look, we're pretty active.

Hand: Okay.

Pearce: Post-COVID and some sort of normality our biggest position, our biggest changes have actually been in these Tier-2 bonds. So, if you looked at our portfolio a couple of years ago, you've hardly seen any of them. In our unlisted because of Sydney Airport, because we've actually had more opportunities at the pricing we like, we've lifted our unlisted exposure from 6% to about 18% in our balanced option.

Hand: All right. Okay. I didn't realize you've gone that much.

Pearce: Yeah. There have been quite a few changes.

Hand: As an investor you have to study history. Are you finding any historical precedents that can guide us in the current market because there's a lot to worry about there?

Pearce: I think it's very dangerous to look at any period of history. Not only have you got so many variables in terms of just economic and financial variables, you've also got the political construct, the institutional construct around it. Why were we able to escape a depression after GFC? It's because the central bankers like Ben Bernanke studied The Great Depression. We avoided The Great Depression because we studied The Great Depression. So, the whole institutional construct…

Hand: So, we knew what to do by then.

Pearce: Exactly. I don't like the term, but the reaction function – I mean, it's these new terms that we have to learn – has changed. So, I think looking at history is problematic. If you look what's happened since 1978 when the Fed has paused its interest rate cycle, the bond market has always rallied.

Hand: And the reverse has just happened.

Pearce: What's just happened, right?

Hand: So, if you were waiting for a Fed pause to buy bonds because that's what's always happened, you've just been run over.

Pearce: Okay. So, your advice from that was you're really struggling to find guide from history.