The traditional 60/40 portfolio, combining the complementary roles of equities and bonds, remains a central reference point in institutional portfolio construction. Few investors have as much experience managing a portfolio around this framework as Folketrygdfondet, Norway’s Government Pension Fund Norway, which manages more than NOK 400 billion. Kjetil Houg, CEO of Folketrygdfondet, believes the framework remains well suited to the fund’s long-term investment horizon, particularly as higher interest rates improve the return potential of bonds.
A transparent and cost-efficient investment framework
Folketrygdfondet’s 60/40 allocation is set out in its mandate from the Norwegian Ministry of Finance. While the fund does not determine the strategic allocation independently, Houg says there has been no reason to recommend changing it. “There are several reasons why we have a 60/40 portfolio, but the main one is that it is mandated by the ministry. It is therefore not really our decision,” he says. “At the same time, we have not seen any reason to advise the ministry to change the mandate. We support the framework and believe it works well.”
“We have not seen any reason to advise the ministry to change the mandate. We support the framework and believe it works well.”
Kjetil Houg, CEO of Folketrygdfondet.
The framework also aligns with Folketrygdfondet’s emphasis on transparency. “As a sovereign wealth fund, we value the transparency of public markets. Markets are transparent, and shareholders and bondholders benefit from strong minority protections,” Houg explains. “That appeals to our stakeholders, whether they are politicians, the ministry or the public. A portfolio that is open and easy to understand helps build trust over time.”
“In terms of our fiduciary responsibilities, this is a very cost-efficient way of managing the portfolio. We manage the portfolio at a total cost of between six and seven basis points, all-inclusive.”
Kjetil Houg, CEO of Folketrygdfondet.
Cost efficiency is another important consideration. Folketrygdfondet’s predominantly public-market portfolio can be managed at a relatively low cost. “In terms of our fiduciary responsibilities, this is a very cost-efficient way of managing the portfolio,” says Houg. “We manage the portfolio at a total cost of between six and seven basis points, all-inclusive, compared with at least 50 basis points for comparable sovereign wealth funds.”
A more balanced outlook for equities and bonds
The case for the 60/40 model ultimately rests on its ability to deliver attractive risk-adjusted returns over the long term. Houg acknowledges that the experience of the past decade has tested the model, particularly as fixed income delivered relatively weak returns for much of the period.
“What we have seen over the past decade is a remarkable excess return from equities over fixed income,” Houg says. In the Nordic region, the equity risk premium, the return on equities relative to bonds, has been around 10 percentage points over the past ten years. “That is quite remarkable and much higher than the equity risk premium normally is,” he notes. “This was an atypical period.” In his view, investors should not extrapolate the unusually large equity premium of the past decade into the next ten years.
“What we have seen over the past decade is a remarkable excess return from equities over fixed income. This was an atypical period.”
Kjetil Houg, CEO of Folketrygdfondet.
The period was shaped by strong equity market performance and very low interest rates, particularly before the COVID-19 pandemic. The subsequent surge in inflation and the associated rise in interest rates altered the outlook for fixed income.
“We are now in a higher interest rate environment. That means you can expect higher returns from fixed income and greater protection from the income generated by the portfolio.”
Kjetil Houg, CEO of Folketrygdfondet.
“We are now in a higher interest rate environment. That means you can expect higher returns from fixed income and greater protection from the income generated by the portfolio,” he says. A more normal relationship between equity and bond returns could strengthen the role of fixed income in a balanced portfolio.
The lessons of 2022
The events of 2022 presented a more direct challenge to the diversification assumptions behind the 60/40 portfolio. “2022 was the worst year for a 60/40 portfolio in decades, perhaps even centuries, because the correlation between equities and bonds was high and both portfolios suffered negative returns,” says Houg. He describes 2022 as a “perfect storm” but acknowledges that investors must expect periods when the two asset classes move in the same direction.
Houg considers the episode an important reminder that correlations can change, but does not believe it invalidates the model. “We have to expect correlations to rise from time to time. However, they will very rarely reach one, if ever. As long as correlations remain below one, fixed income provides some degree of diversification.”
“We can handle fluctuations in the portfolio’s market value, so we are not afraid of another 2022.”
Kjetil Houg, CEO of Folketrygdfondet.
Folketrygdfondet’s long-term horizon and limited liquidity requirements also reduce the pressure to respond to short-term market fluctuations. “We have substantial risk capacity. Our liability is very limited: we deliver three percent every year to the ministry, and that is it,” Houg explains. “We can handle fluctuations in the portfolio’s market value, so we are not afraid of another 2022.”
Active management within a 60/40 framework
Although Folketrygdfondet operates within a defined strategic allocation and invests primarily in Norwegian equities and bonds, the mandate leaves room for active management. The fund seeks to generate returns above its benchmarks through security selection, portfolio construction and rebalancing.
In equities, the scope for differentiation is relatively limited because the portfolio invests in public markets and remains closely aligned with its benchmark. “In the equity portfolio, things are relatively straightforward. We invest in public markets, and there are only so many ways to do things differently,” Houg says. “We generally stay very close to the index, with some enhancements.” Even so, Folketrygdfondet has managed to generate excess returns over its equity benchmark over time. “That is meaningful, particularly when the scope for deviating substantially from the benchmark is limited.”
Credit as a key source of excess returns
The fixed-income portfolio offers greater flexibility. “In fixed income, the situation is different. We have considerably more room to deviate from the benchmark,” Houg says. Credit exposure is a central component of Folketrygdfondet’s active fixed-income strategy, with the fund typically investing in smaller issuers and maintaining a significant allocation to high-yield bonds. “The portfolio is more diversified, and we typically invest in smaller names than those in the benchmark. We also have a significant allocation to high yield,” he says. Houg identifies these positions as the main drivers of the portfolio’s long-term excess return.
“The portfolio is more diversified, and we typically invest in smaller names than those in the benchmark. We also have a significant allocation to high yield.”
Kjetil Houg, CEO of Folketrygdfondet.
Historically, the fund has placed less emphasis on generating returns through duration positioning or trading different parts of the yield curve. More recently, however, the team has started taking somewhat larger positions on curve movements, while keeping the overall interest-rate exposure close to that of the benchmark. “We do not take a specific duration bet, and we do not take a currency bet either.”
Rebalancing as a source of value
Beyond security selection and credit allocation, rebalancing is another important element of Folketrygdfondet’s approach. The fund’s strategic allocation requires it to adjust its equity and fixed-income exposures as markets move. “Where you rebalance and how frequently you do it can make quite a significant difference,” Houg explains. “Whether you rebalance every day, every month, or only when certain thresholds are reached matters. We tend to buy equities when they are cheap and sell them when they are expensive, and vice versa.”
“Where you rebalance and how frequently you do it can make quite a significant difference.”
Kjetil Houg, CEO of Folketrygdfondet.
For a large investor concentrated in relatively small domestic markets, however, the execution of rebalancing is as important. Folketrygdfondet therefore takes a gradual approach, seeking to limit its market impact and avoid disrupting prices when adjusting its exposures. “We try to move slowly and avoid breaking any eggs,” Houg says. “We have managed that quite well over time, and the results are encouraging. We have typically gained rather than lost from our rebalancing operations.”
A constructive outlook for the 60/40 model
For Houg, the combination of higher bond yields, a long-term investment horizon, active credit management and disciplined rebalancing support the continued relevance of the 60/40 framework. “We are now seeing quite attractive yield levels, which make fixed income more compelling,” Houg concludes. “You can also expect greater protection from the fixed-income portfolio because the return profile is less asymmetric. The normalization of interest rates has therefore strengthened the case for the 60/40 approach.”
This article is part of HedgeNordic’s “Rethinking the 60/40 Portfolio” publication.
