How Changing Global Demographics Could Destroy One of the Most Popular Ideas in Portfolio Management

Portfolio managers who adhere to a method of asset allocation that has served them well for more than three decades may be in need of a wake-up call.

The warning comes as a number of prominent economists are arguing that a demographic sea change threatens to foster rising interest rates, reduced inequality, and stronger wage growth around the globe. This could have huge practical implications for people who manage money, potentially upending the long-standing schematic for asset allocation that sees many portfolio managers split their investments between bonds and stocks.

"Most pension funds and endowments around the world have a similar sort of way of sussing out their projected returns from bonds and from equities and then use historical correlations from bond and equities to build efficient frontiers," Toby Nangle, head of multi-asset allocation at Columbia Threadneedle Investments, said in an interview with BloombergTV. "But if that data that that historical correlation matrix is based on is based on this 35-year period of declining real yields and low levels of correlation, with bonds meaningfully outperforming cash, then this is sort of challenged if that starts to go into reverse."

Such a change would upend typical portfolio management, which has seen asset managers look to the past performance of both bonds and stocks as their guide to the future. Managers usually examine historical volatility and returns to construct portfolios that smooth and maximize returns, depending on an investor's risk tolerance.