Adapting asset allocation to the risk of stagflation
With the risks of stagflation – higher inflation coupled with lower growth – on the rise, investors need to reassess how their money is allocated.
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With the risks of stagflation – higher inflation coupled with lower growth – on the rise, investors need to reassess how their money is allocated. Traditional portfolios are likely to be less resilient, although elements remain valid. Subtle changes can improve the odds of a good outcome, while tactical additions have the potential to enhance portfolio efficiency and returns further.
Reports of the 60/40’s death have been greatly exaggerated
Rarely a year goes by without loud claims that the classic 60/40 portfolio (60% equities, 40% government bonds) is no longer fit for purpose. With stagflation a threat to both equities and bonds, this is once again high on the agenda.
The argument has merit. For equities, low growth is bad for sales, as businesses and consumers tighten their belts. High inflation adds to the headache. In a buoyant economy, companies can pass on higher input costs to consumers. When demand is already weak, this isn’t so easy. Corporate profit margins often take a hit instead, putting additional downward pressure on earnings. High inflation has also historically been associated with lower valuation multiples (in part because of the way that higher inflation feeds into higher bond yields which feed into the models used to value equities).
Figure 1: High inflation tends to hurt equity valuation multiples
Past performance is not a guide to the future and may not be repeated
Source: Robert Shiller, Schroders. As the focus is on high inflation, periods where inflation was below 0% i.e. deflation, are not shown. Y-axis has been capped at 60 to remove the distorting effect on the scale of a small number of outliers. Monthly data 1960–2025.
For bonds, the transmission mechanism is even simpler. Higher inflation erodes the value of the fixed interest payments they offer. Investors demand higher yields to compensate, and bond prices fall.
This double-whammy means bonds are less reliable at playing the risk-reduction role alongside equities which investors have grown accustomed to. In general, the correlation between equities and bonds is more likely to be positive than negative when inflation is in the driving seat for markets, meaning they fall and rise together. For asset allocators this presents a major challenge.
However, it is worth acknowledging that a positive equity bond correlation was the norm for several decades before the late 1990s (figure 2), when the 60/40, in fact, grew in popularity. Then, the motivation for buying bonds was income/yield, not a negative correlation. History doesn’t repeat but it does rhyme.
Figure 2: A negative equity-bond correlation is a relatively recent phenomenon
60-month rolling equity-bond correlation
Past performance is not a guide to the future and may not be repeated
Source: Morningstar Direct, accessed via CFA Institute, LSEG Datastream, S&P, and Schroders. Equities represented by Ibbotson® SBBI® US Large-Cap Stocks to 2024, S&P 500 thereafter, bonds by Ibbotson® SBBI® US Long-term Government Bonds to 2024, ICE BofA 10+ Year US Treasury Index thereafter. Data to December 2025.
So equities face extra risks, bonds face extra risks, and their ability to zig while the other zags also faces risks. Despite that, the 60/40 should not be consigned to the dustbin.
Based on data since 1926, the median yearly real return for equities in a stagflation-year has been about 0%. This is less than investors would typically want from equities over the long-run, but getting close to inflation in a high inflation environment is not a bad outcome. They have also more often than not outperformed cash.
Long-dated government bonds tend to struggle, as expected, and the 60/40 finds stagflation more challenging than other environments. But the 60/40 has had a higher median return across stagflation years than either equities or bonds have in isolation. Diversification benefits may be less reliable, but they don’t go away altogether.
Figure 3: In stagflation, the 60/40 has a better median outcome than either equities or bonds in isolation
Real returns when inflation and growth are above/below their 10-year average, 1926-2025 calendar year data
Past performance is not a guide to the future and may not be repeated.
Source: Morningstar Direct, accessed via CFA Institute, LSEG Datastream, S&P, and Schroders. Half of all outcomes fell inside the blue shaded area, with a quarter above it and a quarter below. HighInfl = inflation above the previous 10yr average, HighGrowth = real GDP above the 10yr average, and vice-versa for LowInfl and LowGrowth. Based on analysis of data on US equities 1926-2025. Because the first 10yrs are used to calculate the first 10yr averages, this leads to 90 years where an assessment of the economic status is made. Based on these criteria, there have been 17 HighInfl_ LowGrowth years, 22 HighInfl_HighGrowth, 23 LowInfl_LowGrowth, 28 LowInfl_HighGrowth. Equities represented by Ibbotson® SBBI® US Large-Cap Stocks to 2024, S&P 500 thereafter, cash by Ibbotson® SBBI® US (30-Day) Treasury Bills to 2024, US Treasury constant maturity 1-month rate thereafter. Data to December 2025.
The 60/40 also has a higher “hit rate” when it comes to outperforming cash, doing so in 65% of stagflation years compared with 59% for stocks in isolation. And it has done so without sacrificing returns, with the median outperformance of cash roughly the same for the 60/40 as for equities (figure 4).
The sample size is small, at only 17 stagflation years out of the past 100, so we should be wary of putting too much confidence in these results. Nonetheless they do suggest that it would be premature to read the 60/40 its death rights for the umpteenth time.
Figure 4: Across stagflation years, the 60/40 has outperformed cash more often than equities or bonds, without notably sacrificing returns
Analysis of the calendar years when inflation was above, and growth below, their 10-year averages, 1926-2025
Past performance is not a guide to future performance and may not be repeated.
Source: Morningstar Direct, accessed via CFA Institute, ICE Data Indices, LSEG Datastream, S&P, and Schroders. Analysis based on 17 HighInfl_LowGrowth years. Equities represented by Ibbotson® SBBI® US Large-Cap Stocks to 2024, S&P 500 thereafter, long govs = long-term government bonds by Ibbotson® SBBI® US Long-term Government Bonds to 2024, ICE BofA 10+ Year US Treasury Index thereafter, cash by Ibbotson® SBBI® US (30-Day) Treasury Bills to 2024, US Treasury constant maturity 1-month rate thereafter. Data to December 2025.
But can you improve on the traditional 60/40 model?
Yes, by implementing one simple change: shortening the duration of your bond portfolio. Shorter duration bond prices are less sensitive to changes in yields, reducing downside risks. For illustrative purposes, using 5-year Treasuries instead of long-dated (>20-year) Treasuries has historically improved the risk/reward dynamics.
Figure 5: Shortening bond duration can enhance the performance of the 60/40 during stagflation
Analysis of the calendar years when inflation was above, and growth below, their 10-year averages, 1926-2025
Past performance is not a guide to future performance and may not be repeated.
Source: Morningstar Direct, accessed via CFA Institute, ICE Data Indices, LSEG Datastream, S&P, and Schroders. Analysis based on 17 HighInfl_LowGrowth years. Equities represented by Ibbotson® SBBI® US Large-Cap Stocks to 2024, S&P 500 thereafter, long govs = long-term government bonds by Ibbotson® SBBI® US Long-term Government Bonds to 2024, ICE BofA 10+ Year US Treasury Index thereafter, intermediate govs by Ibbotson® SBBI® US Intermediate-term Government Bonds until 2024, Bloomberg U.S. Treasury Bellwethers: 5 Year thereafter, cash by Ibbotson® SBBI® US (30-Day) Treasury Bills to 2024, US Treasury constant maturity 1-month rate thereafter. Data to December 2025.
This same tactic can be applied to other areas, such as corporate bonds. Shorter dated bonds offer a higher margin of safety than longer dated bonds. When the yield curve is upward sloping, as it is at present, the tradeoff with this approach is accepting a lower yield. But, historically, the reduced sensitivity to rising yields has been in its favour.
Figure 6: Shorter-dated bonds can absorb a much larger rise in yields before investors would lose money
Past performance is not a guide to the future and may not be repeated.
Source: Schroders, LSEG Datastream, ICE Data Indices, J.P. Morgan. Data as at 31 May 2026. Yield = yield to worst. Margin of safety is a measure of how far yields would need to rise over the next 12 months to cause investors to earn a negative return.
Another tactic for fixed income investors is to consider floating rate securities, such as leveraged loans or securitized credit/asset-based finance. These pay a coupon which is linked to short term interest rates. If central banks hike rates to combat inflation, it boosts their income and returns. This contrasts with corporate and government bonds whose value falls when yields rise (technically these are not quite the same thing, as returns on floating rate securities are sensitive to short-term rates whereas bond returns are sensitive to longer term yields, but they are related). These assets expose investors to different kinds of risk than traditional assets. A detailed discussion of these is outwith the scope of this paper, and would moreover be hampered by their shorter return history.
A risk to bear in mind with corporate bonds
Credit spreads usually rise during stagflation years, with the median rise 0.3%. This is a challenge for corporate bond investors today, as spreads are near their tightest levels for 20 years. It would take a mere 0.1-0.2% rise in spreads to leave investment grade corporate bonds underperforming government bonds. There is a significant risk of this happening if we enter stagflation.
Figure 7: Credit spreads are back at exceptionally tight levels vs history
Diamonds show current position vs. 20yr history: 0% = lowest spread in 20yrs, 100% = highest spread
Source: Schroders, LSEG Datastream, ICE Data Indices, J.P. Morgan. As of 30 April 2026. Lookback period 20yrs.
This is particularly relevant where investors are taking more tactical views on corporate bonds. Those who intend to hold to maturity are less affected: in this case, what matters more is the risk of non-repayment and, historically, the average default rate on investment grade bonds since 1920 has been 0.1%. In other words, 99.9% have not defaulted in any given year. There is no need for buy-and-hold investors in investment grade bonds to rush for the exit. However, as described earlier, shortening the duration of the portfolio will reduce the sensitivity of overall returns to rising yields.
Fine-tuning allocations within equities
When it comes to the performance of equity styles or sectors, the interaction between inflation and growth can be complicated and important to recognise. We have summarized the various relationships in a novel way in the table below, based on data since 1963. The table needs some explanation but provides a useful multi-dimensional presentation of the data.
Sector and style performance uses the Fama-French dataset to enable the longest-term analysis possible. These are defined slightly differently to those more typically seen from index providers such as MSCI, but most have obvious parallels. Whereas analysis in the previous section was of calendar year data, given the reduced number of calendar years since 1963, this section uses quarterly data. This increases the number of data points available to analyse.
- Dimension 1: a style/sector’s position left-to-right is based on how often it has outperformed when growth has been weakening. For sectors, outperformance is relative to the broad market. For example, healthcare stocks have outperformed the broad market between 52-53% of the time when growth has been weakening. For styles it is relative to the opposite end of its style scale. For example, value’s outperformance is the performance of cheap companies vs expensive ones, for quality it is the performance of companies with high operating profitability (defined here as profits relative to assets) vs low profitability ones.
- Dimension 2: a style/sector’s position top-to-bottom is based on how often it has outperformed when inflation has been above 3% and rising. For example, healthcare stocks have outperformed the broad market 58-59% of the time when inflation has behaved like this.
- Dimension 3: the number which appears alongside each sector is the average quarterly outperformance, on an annualized basis, when GDP growth is weakening and inflation is high and rising. For example, healthcare stocks have outperformed by an average of 7.2% annualized when these two economic outcomes have coincided
- Dimension 4: the shading corresponds to how high/low the outperformance has been, for easier reading
The styles and sectors which have the best track record if we head in a stagflationary direction are those furthest to the right and bottom, in the deepest shades of green. Those to the top and left are least reliable. Those with redder shading have suffered more severe underperformance.
Figure 8: What equity styles and sectors perform well when growth is weakening and/or inflation is high and rising?
Figures in table show average quarterly outperformance, on an annualized basis, when GDP growth is weakening and inflation is high and rising, 1963–2025.
Past performance is not a guide to the future and may not be repeated
Source: Kenneth French’s data library, Schroders. Quarterly data 1963-2025.
The stand-out is the Quality style. Companies with higher operating profitability (profits relative to assets) have outperformed less profitable ones more than 60% of the time when either growth has been weak or inflation high and rising. The average outperformance has been 4% on an annualised basis. Quality has had a tough few years of performance, but there is a strong argument to allocate to this style given current macroeconomic forces.
Value has also outperformed growth. Growth stocks tend to command higher P/E multiples because of anticipated future earnings, but the higher interest rates that typically accompany stagflation raise the discount rate applied to those earnings. This disproportionately erodes their present value, leaving growth more exposed. Value companies have a bigger margin of safety given their relatively low starting valuations.
Importantly for today’s capex cycle, companies with more conservative investment strategies have usually outperformed those with more aggressive strategies when inflation has been high and rising (although with a less clear-cut relationship when growth has been weakening). A rationale for this is that the higher interest rates which occur in this scenario negatively impact the cost of debt which backs more aggressive investment strategies. With the global market dominated by companies embarking on one of the biggest capex cycles in history, index investors are highly exposed.
A closer look by sector
Energy equities have a strong track record of outperforming when inflation has been high and rising. This makes sense as high energy prices have often been the cause of that inflation. As energy demand is correlated to economic activity, this counts against it in a weaker growth environment, but the inflation-shock element has historically dominated when we head into stagflation. With the energy sector having fallen from a peak of 14% of the global stock market to only around 4% today, a specialist sector allocation is required to gain meaningful exposure. Either that or an allocation to the regional/country stock markets with larger energy weightings, such as the UK or some Latin American markets.
Elsewhere, classic defensive sectors – healthcare, nondurables (broadly similar to consumer staples), and utilities – have relatively reliable performance and high levels of outperformance in a high inflation/weak growth environment.
Gold equities are a bit of an anomaly. Their performance has not been especially reliable but average outperformance has been the strongest of any sector. In other words, when they do outperform, they outperform by a lot. Gold today also benefits from structural demand from central banks seeking to diversify their reserves, especially among emerging economies. Gold equities are an even more extreme case than energy sector, making up only less than 1% of global market cap. The only way to have meaningful exposure is through specialist vehicles.
IT companies have typically found the going tough, another warning signal for index investors given that around 50% of the US stock market (and around 40% of the global market) is exposed to IT, once you add in Amazon and Tesla which sit in consumer discretionary, and Alphabet and Meta Platforms which sit in communication services. Performance challenges have historically come from a combination of demand weakness, rising supply costs, and valuation impacts. Assuming the AI-supercycle continues, the first may be less of an immediate concern but the final one is, for the same reason that growth companies are vulnerable.
Real estate also has a chequered history. This is to do with the push and pull between it being a real asset which often has inflation-linked cashflows, and the high degree of leverage involved in real estate financing. When we conduct alternative analysis of annual performance in years when inflation has been above its 10-year average and growth below its 10-year average, real estate comes out with a higher average and median real return than any other sector. But it also has the widest range of outcomes of any sector. When it comes to individual investments, performance depends on the sector of the real estate market, the length of and any inflation linkage in the rental agreement, debt maturity profile, and other factors.
Figure 9: Key equity style/sector tilts
Source: Schroders
Additional asset classes: commodities and hedge funds
Investors seeking diversification could consider adding commodities and hedge funds to their portfolios. Periods of market turbulence thrown on by high and rising inflation is precisely when they have historically earned their keep in portfolios as highlighted in Figure 10.
Figure 10: Commodities and hedge funds have outperformed equities when inflation has been high and rising
% of quarters that sector/style outperformed MSCI USA when inflation >3% and rising, 1990-2025
Past performance is not a guide to the future and may not be repeated
Source: HFRI, MSCI, LSEG Datastream, Schroders. Data Q1 1990-Q4 2025. Commodities is S&P GSCI Commodity index, hedge fund strategies are HFRI indices. Equity long/short is proxied by Equity hedge (total) index and Macro (fundamental) by Macro (total) index as these have historically been the largest component of each. Outperformance is relative to MSCI USA index but overall conclusions are the same if MSCI World index is used. All returns are total returns in USD terms.
There have only been 23 quarters out of 144 during this period where growth has been falling and inflation has been high and rising. Over this limited sample, hedge funds have an even higher hit rate of outperforming equities than in high and rising inflation environments in isolation. It is interesting that this is true across all of the major styles of hedge fund. Commodities have a slightly less reliable track record, given their sensitivity to economic growth, but also have the highest average outperformance.
Figure 11: Commodities and hedge funds have a reliable track record of outperformance during stagflation
% of quarters that sector/style outperformed MSCI USA, and average quarterly outperformance, on an annualized basis, when growth has been weak and inflation >3% and rising, 1990-2025
Past performance is not a guide to the future and may not be repeated
Source: HFRI, MSCI, LSEG Datastream, Schroders. Data Q1 1990-Q4 2025. Analysis is limited to the 23 quarters when GDP growth has been weakening and inflation has been above 3% and rising. Commodities is S&P GSCI Commodity index, hedge fund strategies are HFRI indices. Equity long/short is proxied by Equity hedge (total) index and Macro (fundamental) by Macro (total) index as these have historically been the largest component of each. Outperformance is relative to MSCI USA index but overall conclusions and broad orders of magnitude are the same if MSCI World index is used (average annualized excess returns are 4-5% higher vs MSCI World). All returns are total returns in USD terms
Given that stagflation presents challenges to bonds as a traditional diversifier, the case for adding commodities and hedge funds is strong. They do not reliably outperform across other economic environments (this should not be a huge surprise as they usually aim to deliver better risk-adjusted returns, not better absolute returns) but have historically had an edge in this kind of environment. It goes without saying that you don’t want to pay high hedge fund fees for average performance. Manager selection is key.
Private markets
This paper focusses on public markets but they only represent part of the opportunity set. Private markets, in all their flavours, offer additional levers that asset allocators can pull to adapt their portfolios, including to the risk of stagflation. This is both in terms of return enhancement and differentiated drivers of those returns. More limited data is available on a consistent basis across private markets and that data comes with its own challenges, such as infrequent valuations. The nature of many private markets (such as capital being drawn down over a period of several years for traditional private equity vehicles) also means they are less suited to tactical positioning. For these reasons, we have not covered them in this paper but believe they should be considered as part of a strategic asset allocation process.
Conclusion
The popular 60/40 portfolio is not dead but investors can enhance their chances of successful outcomes if the global economy goes in a stagflationary direction of weaker growth and higher inflation.
- Within bond portfolios: shorten duration
- Within equities:
- increase exposure to quality and value styles, to balance growth-heavy exposure in the global market
- increase exposure to the energy sector, using specialist allocations or regional tilts
- increase exposure to defensive sectors and companies
- consider gold equities
- Add allocations to commodities and hedge funds
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