This article first appeared in Forum, The Edge Malaysia Weekly on September 7, 2026 - September 13, 2026

One of the truths about investing is that no asset allocation strategy or algorithm lasts forever. Times change, the context changes and what worked in the past is not only failing, but sometimes downright dangerous to use.

When I first learnt the investment trade as I had to oversee reserves management in Hong Kong, we had a brilliant young secondee from the Bank of England who worked on tested central banking investment strategy. It was mostly AAA bonds, no equity, and he did not like gold. As we had to take over the Land portfolio, which comprised mostly equity in Hong Kong stocks and some bonds, I had to apply the standard benchmark of 60% equities/40% bonds to our portfolio, which was standard asset allocation that had worked well for decades.

In 2022, this formula delivered its worst performance in generations, for a number of reasons. First, in 2022, the 60/40 portfolio suffered a catastrophic return of -17.3% to -17.5%, its worst performance since 1937. The immediate cause was not just a fall in global equities of -18.1%, but the Bloomberg US Aggregate Bond Index falling 13%, its worst year in history.

With both equities and bonds suffering losses, there was no “diversifying” effect. The core reason was the violation of the critical assumption that stocks and bonds are negatively correlated, meaning that if one rose, the other may rally. But in the post-pandemic period, central banks decided to raise interest rates, so both stocks and bonds were affected simultaneously by higher interest rates.

The immediate reason for higher interest rates was higher inflation. Traditionally, when the central bank raises interest rates to tame inflation, stocks react negatively, while bond prices rally.

However, when inflation begins to rise, it becomes the enemy of both stock and bond asset classes. Higher interest rates compress real estate values and also the stock market, even as higher inflation erodes corporate margins. Central bank hikes in interest rates cause bonds to suffer, because existing long-bond prices fall.

The four decades between 1980 and 2021 was a period of falling interest rates and low inflation, namely the golden age for the 60/40 formula. The US Federal Reserve chairman introduced high interest rates in the beginning of the 1980s to squeeze out inflation and the G7 economies enjoyed a period of declining interest rates and low inflation. However, when interest rates are near zero, the expectation is that we are entering a period of higher interest rates. When the European Central Bank (ECB) and Bank of Japan began experimenting with negative interest rates, they ventured into uncharted monetary territory, pushing policy rates below zero to stimulate economic growth and raise inflation expectations.

With near zero interest rates, the 40% bond part offered negligible income (around 1% to 2% per annum) and huge risks if inflation and interest rates rose. This was particularly true for long-term bonds, since the longer the duration, the more prices fall.

In essence, the period when Japan and ECB had low interest rate policies was a period of a long bond bull market. From 1981 to 2021, 10-year US Treasury yields fell from 15.8% to 0.5% per annum, so over this period, some bond funds delivered stock-like returns of around 9% annually.

The reason the bond market is suffering higher yield rates (and a decline in bond prices) can be attributed to the Trump effect. After he came into office in 2016, he launched tariffs and sanctions against American foes and allies alike. From a dollar discount because the dollar was always a hedge against other countries’ credit or political risks, higher US interest rates reflect a “dedollarisation” premium — you hold dollars because there are certain risks of US excessive debt and potential sanctions that would hurt surplus economies and wealth holders who may be subject to US sanctions.

We have shifted from a “disinflationary, falling-rate regime” to a potentially “higher-for-longer, inflation-prone regime” driven by:

● Demographic shifts (ageing populations, shrinking labour forces)

● Deglobalisation and supply chain reshoring

● Geopolitical fragmentation and defence spending

● Energy transition costs

● Massive fiscal deficits and government debt

While 2023-2025 delivered solid positive returns, the “diversification benefit” of bonds has not fully returned. Stocks have done most of the heavy lifting.

Is 60/40 permanently dead or just temporarily impaired?

The debate is ongoing. Arguments that it is structurally broken:

● International Monetary Fund analysis suggests the shift in stock-bond correlation may be “structural”, not temporary, in a world of recurring inflation shocks.

● The “40-year bond tailwind” cannot repeat — mathematically impossible from current yield levels.

● “Higher-for-longer” rates mean duration risk remains elevated.

Arguments that it is adapting, not dying:

● Morgan Stanley argues 60/40 is “back” — with inflation falling and yields now at 4%+, bonds provide genuine income and better diversification potential.

● The “2023-2025 recovery” (~40%+ from the 2022 bottom) shows the strategy still has life.

● “Starting yields matter” — today’s 4%+ yields provide a much better cushion than 2021’s 1%.

Many sophisticated investors are moving “beyond 60/40” to address its weaknesses:

1.    Adding real assets — gold, commodities, infrastructure, real estate — which tend to perform better in inflationary environments and have low correlation to both stocks and bonds.

2.    Shorter-duration bonds — reducing interest rate sensitivity while still capturing the new higher yields.

3.    Alternative investments — private equity, private credit, hedge funds — seeking different return drivers.

4.    Dynamic/tactical allocation — moving away from static 60/40 towards frameworks that adjust based on inflation regime, valuation and cycle position.

The 60/40 portfolio failed spectacularly in 2022 because:

1.    Inflation returned, breaking the negative stock-bond correlation that was the strategy’s foundation.

2.    Bonds started from near-zero yields, giving them no room to act as a hedge and massive downside exposure.

3.    The 40-year bond bull market — which had provided extraordinary tailwinds — came to an abrupt end.

While the strategy has recovered since 2023, the world has changed. A simple, static 60/40 allocation is unlikely to deliver the same “7% to 8% annualised returns with low volatility” that investors enjoyed from 1980 to 2021. The formula may not be “dead” but it “needs to be adapted” for a world of higher inflation, higher rates and shifting asset correlations.

Tan Sri Andrew Sheng writes on global issues from an Asian perspective

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