Boosting Efficiency with Levered 60/40

When most people think about leverage, they think about it through the lens of added risk. While that’s one view, leverage can also be an effective means of preserving a higher Sharpe ratio in a portfolio while seeking higher absolute returns. In our view, leverage can be a powerful tool for boosting the efficiency of portfolios, even during potentially volatile markets.

Take the standard 60% equity/40% bond portfolio (60/40)¹, for instance. Historically, the 60/40 portfolio has produced a higher Sharpe ratio than that of 100% equities (0.62 vs. 0.50).² If investors were to lever a 60/40 portfolio by 1.5, the resulting 90/60 portfolio³ could potentially achieve equity-like returns while maintaining the diversification benefit of the bond allocation. Figure 1 below shows this exact story. Looking at this analysis back to 1991, a 90/60 portfolio funded by 1–3 Month Treasury Bills produced a higher return and had lower volatility than the S&P 500 Index.

Figure 1: Levering a Higher Sharpe Portfolio

The WisdomTree 90/60 U.S. Balanced Fund (NTSX) seeks to apply 1.5x accounting leverage to a traditional 60/40 portfolio to create exposure equal to 90% equities, 60% bonds. This exposure is created by investing 90% of Fund assets in equities and 10% in short-term fixed income. The 60% bond exposure is achieved by overlaying Treasury futures contracts to achieve the net 90/60 target. Interestingly, in its limited history, NTSX was able to protect against an equity downdraft while keeping up with a market rally.

While many investors understand the strategy conceptually, looking at live returns provides some extremely instructive use cases. The most recent equities drawdown, which was followed by a post-Christmas rally, is a clear example of this. When equities, as proxied by the S&P 500 Index, fell by 19% in late 2018, NTSX fell by only 16% due in large part to the bond exposure in the Fund (figure 2). When equities rallied after Christmas, NTSX kept up in performance. NTSX returned 15%, keeping up with SPY (16.4%) from 12/24/18 to 2/6/19 (figure 3).

Figure 2: Peak to Trough in the Latest Correction in 2018

Figure 3: Post-Christmas Rally (12/24/18–2/6/19)

For standardized performance of NTSX, please click here.

In our view, NTSX provides investors with the potential to boost returns while achieving better overall portfolio diversification. Despite an increase in volatility, we believe this approach provides investors with a powerful tool to enhance their asset allocation and free up capital for other, less correlated investments.