For decades, the 60/40 portfolio has served as one of the defining frameworks for portfolio construction. While few institutional investors adhere strictly to that allocation today, it remains a useful lens through which to evaluate the role different asset classes play within a portfolio. Discussing this framework, Kari Vatanen, Head of Allocation and Alternatives at Finnish pension insurer Elo, offers a perspective on how institutional investors assess the role and attractiveness of different asset classes in today’s market.

“When talking about a 60/40 portfolio, one first needs to think about what the function of the 60 is and what the function of the 40 is,” says Vatanen. “The solution depends entirely on what you’re trying to achieve.” For Vatanen, the equity side is the easier part of the equation. Despite concerns over elevated valuations, market concentration, and geopolitical uncertainty, he argues that listed equities continue to serve the same fundamental purpose they always have.

“When talking about a 60/40 portfolio, one first needs to think about what the function of the 60 is and what the function of the 40 is. The solution depends entirely on what you’re trying to achieve.”

Kari Vatanen, Head of Allocation and Alternatives at Elo.

Institutional investors still require a meaningful allocation to equities to generate the long-term returns needed to meet pension liabilities and other investment objectives. “The function of the 60 percent is to seek returns over the long run and help meet return objectives,” explains Vatanen. “Nothing has really changed. We still need equities to generate those long-term returns, and I don’t think any other risky asset class can replace them.”

“The function of the 60 percent is to seek returns over the long run and help meet return objectives. Nothing has really changed. We still need equities to generate those long-term returns.”

Kari Vatanen, Head of Allocation and Alternatives at Elo.

Although some investors worry that equity markets have become excessively concentrated, particularly in the U.S., where a handful of mega-cap technology companies account for a growing share of index performance, Vatanen cautions against letting those concerns dictate portfolio construction. “There are certainly reasons to be concerned about market concentration,” acknowledges Vatanen. “But it’s a double-edged sword. If investors had become too worried about those companies three years ago, they would have missed most of the market’s returns.”

Rather than retreating from equities, Vatanen believes investors should recognize that the beneficiaries of artificial intelligence will broaden as the technology matures. While software developers and large technology platforms have led the first phase of the AI cycle, he expects the next stages to benefit a wider range of industries. “I see three phases,” says Vatanen. “First comes software and data centers, then the infrastructure build-out, which benefits industrial companies and equipment suppliers. The final phase is when companies integrate AI into their own operations, creating productivity gains. Every phase will have different winners and losers.”

The Challenge of the 40

The more difficult question is how to build the other side of the portfolio. Bonds have traditionally provided the counterweight to equities, offering income, capital preservation and diversification. But with today’s broader opportunity set, institutional investors can no longer assume that government and corporate bonds are the obvious answer. Cash, private credit, infrastructure, hedge funds and alternative risk premia can all play a role, depending on the specific role investors expect that allocation to fulfil within the broader portfolio.

“The important question is: what is the function of the 40 percent?” says Vatanen. “There can be several different answers. If the purpose is simply to lower equity risk, then the most straightforward solution may be to invest in money market instruments and earn the risk-free return available on cash,” he argues. “But if you want higher returns, or a different return stream that genuinely diversifies equities, then you have to do something else. The solution depends entirely on what you’re trying to achieve.”

“The important question is: what is the function of the 40 percent? There can be several different answers.”

Kari Vatanen, Head of Allocation and Alternatives at Elo.

The return of positive interest rates has undoubtedly improved the attractiveness of cash compared with the previous decade, when investors were effectively penalized for holding liquidity. Yet Vatanen does not believe higher policy rates have automatically restored the appeal of traditional fixed income. Looking at government bonds, he questions whether investors are being adequately compensated for assuming duration risk when cash offers only slightly lower yields without the same exposure to rising long-term interest rates.

“If long-term German government bonds yield around three percent, is that enough?” asks Vatanen. “I don’t think so. I can earn around two percent from cash without taking duration risk. If we remain in a more inflationary environment, longer-term interest rates could still move higher. In that scenario, I don’t think long-duration government bonds offer an attractive risk-reward profile.”

Corporate credit presents a different challenge. Although higher base rates have lifted headline yields, Vatanen argues that compressed spreads have eroded the compensation for taking credit risk. In his view, credit markets offer little margin for error if economic conditions deteriorate or inflation remains elevated, making expected returns less compelling than headline yields suggest. “The risk premium for taking credit risk is too low at the moment,” he says. “That means I’m not particularly happy with the expected returns from a traditional bond portfolio. If inflation stays higher for longer and longer-term rates continue rising, yield curves also look too flat for that kind of environment.”

“The risk premium for taking credit risk is too low at the moment. That means I’m not particularly happy with the expected returns from a traditional bond portfolio.”

Kari Vatanen, Head of Allocation and Alternatives at Elo.

With government bonds and corporate credit offering limited appeal, investors are increasingly looking beyond traditional fixed income for income and diversification. Private markets, including private credit, real estate and infrastructure, have become natural alternatives. “If you’re looking for cash-flow returns from that 40 percent of the portfolio, there are more attractive opportunities,” says Vatanen.

“Directly owned real estate, for example, provides rental income that can be higher than bond cash flows.” He also points to selected infrastructure assets as sources of resilient cash flows, although valuation concerns make parts of the real estate market less attractive than in previous years. Vatanen remains more cautious on private equity, where the return profile is less compelling in the current environment.

In Vatanen’s view, private equity valuations have yet to fully adjust to the new market environment, while subdued transaction activity has slowed exits and capital deployment. Many institutional investors remain locked into existing portfolios, waiting for distributions. “Most investors are stuck in the private equity market,” says Vatanen. “Activity has been low, there haven’t been many distributions, and at the same time there haven’t been many capital calls either. When the market is stuck, returns become relatively modest.” 

With interest rates likely to remain elevated, Vatanen sees little reason for private equity to regain its role from the low-rate era. “That kind of environment doesn’t help private equity markets, which means I don’t see private equity as the best diversifier in portfolios at the moment.”

Hedge Funds More Appealing

With parts of private markets offering less compelling opportunities, Vatanen sees a more favorable environment for hedge funds. Higher rates, greater macroeconomic uncertainty and wider market dispersion have created more opportunities for active strategies than during the ultra-low-volatility regime of much of the 2010s. But before selecting strategies, he argues that investors should first determine what role they want hedge funds to play in the portfolio. 

“The first question is what function I want the hedge fund portfolio to provide,” says Vatanen. “If I’m looking for diversification, then I would focus on market-neutral strategies, global macro, quantitative strategies or relative-value managers,” he explains. “If I want higher returns and I’m prepared to accept more market exposure, then long-short equity or event-driven strategies may be more appropriate.”

“Demand for hedge funds has already increased because many of the other alternatives don’t look particularly attractive today.”

Kari Vatanen, Head of Allocation and Alternatives at Elo.

“Demand for hedge funds has already increased because many of the other alternatives don’t look particularly attractive today,” concludes Vatanen. “Most hedge funds have still been able to deliver solid returns, and today’s market offers many more opportunities than we had during the years of zero interest rates and very low macro volatility,” he adds. Compared with some private asset classes, particularly private equity, he continues to see “a very important place” for hedge funds in institutional portfolios.

This article is part of HedgeNordic’s “Rethinking the 60/40 Portfolio” publication.