Key takeaways:
- To capture the earnings growth that is essential for long-term capital appreciation, the equity allocation of a balanced portfolio should focus on high-quality companies with multi-year secular growth prospects, such as those presented by artificial intelligence (AI) innovation.
- The fixed income allocation of a balanced portfolio should work to maximize income and limit drawdowns. In today’s environment, we believe shorter-duration securities may provide a hedge if the economy wavers, while higher-quality securitized assets can add both income and diversification against downside equity volatility.
- The third key element of a balanced strategy is the ability to dynamically adjust the equity-to-bonds mix. A flexible allocation offers easier navigation of risks and opportunities in a changing investment landscape.
With U.S. stocks turning in their third straight year of double-digit gains in 2025 and all major U.S. fixed income sectors recording strong returns, balanced strategies – defined as a combination of stocks for capital appreciation and bonds for income – achieved strong positive results. A simple 60%/40% split between the S&P 500 Index and the Bloomberg US Aggregate Bond Index would have yielded a 13.7% return in 2025.
With a resilient U.S. economy, AI-driven investment, and accommodative Federal Reserve (Fed) policy likely continuing in 2026, balanced portfolios could be set to have another positive year. Investors might consider whether their balanced strategies have the following three elements that we believe are essential to achieving strong risk-adjusted returns.
1. Equities with strong secular growth prospects
The primary role of the equity allocation in a balanced portfolio is to provide capital appreciation. To do so, it is important that this part of the portfolio be positioned to grow. A focus on high-quality companies poised to benefit from multi-year secular growth themes, such as digital and AI innovation, should present a robust opportunity set to capture earnings growth.
What to watch in 2026
The U.S. economy is expected to grow in 2026, benefiting from a historic capital expenditure boom, with artificial intelligence (AI) as a primary driver. A shift toward greater efficiency has become increasingly evident as companies deploy AI to achieve meaningful productivity gains, boosting margins and supporting earnings growth despite tariff pressures and rising costs.
Our conviction in the AI secular growth theme continues to increase. Capital spending on AI remains robust with no signs of plateauing, and as businesses accelerate AI deployment across sectors, productivity improvements are likely to persist. However, should the AI investment cycle plateau and earnings trajectories change, investors may need to consider adjusting allocations. That’s why a flexible, active strategy focused on individual companies that can continue to grow earnings is vital, in our view.
2. A bond allocation that does its job
The bond allocation within a balanced portfolio should perform two main duties: Generate meaningful income while limiting drawdowns during periods of stock market stress. A 100% allocation to high-yield bonds might satisfy the former while a 100% allocation to U.S. Treasuries could satisfy the latter, but positioning a fixed income portfolio to do both is more complex and, in our view, key to a balanced portfolio’s success. Unfortunately, fixed income benchmarks do not always achieve this balance, making an actively managed fixed income allocation a critical component of a balanced strategy.
What to watch in 2026
Given the positive outlook for U.S. economic growth, both policy rates and rates farther out on the yield curve could stay higher than expected. That said, if the economy were to falter, the front end of the yield curve may offer a better hedge compared to longer maturities given the Fed has ample room to cut rates. There is also the possibility that new Fed leadership may try to push rates lower despite a strong economy. If this were to happen, we would expect term premiums – the extra yield to compensate investors for holding longer-term bonds – to rise, resulting in further curve steepening.
In terms of income generation, we believe in the importance of maximizing carry per unit of risk. Currently, attractive valuations relative to many corporate bonds and the strong credit quality available within securitized sectors support our positive outlook for securitized credit. Additionally, securitized sectors often exhibit lower correlation to equities than corporate bonds, meaning they can provide better diversification against equity drawdowns than typical corporate-heavy portfolios, further helping to manage volatility.
3. A flexible asset allocation mandate
The economy and financial markets are constantly in flux, and the relative value between equities and bonds is no exception. While equities are expected to outperform bonds meaningfully in the long run, they are subject to bouts of short-term underperformance and heightened volatility.
A balanced portfolio with a flexible mandate that allows for adjustment of the equity-to-bonds mix to suit current conditions is essential, in our view. This type of dynamic allocation may allow a skilled manager to reduce the equity weighting ahead of anticipated spikes in volatility and falling equity markets, which may result in lower drawdowns and better risk-adjusted returns in the long run. Similarly, having the flexibility to raise equity allocations during periods when the manager expects stocks to outperform could contribute to better long-term risk-adjusted returns.
Conclusion
Given the combination of a resilient economy, corporate AI investment, the positive impact of recent rate cuts, and continued geopolitical uncertainty, investors should be prepared for the opportunities – and risks – that come with a changing investment landscape.
Being well positioned in both equity and fixed income allocations, as well as in the overall equity-to-fixed-income mix, will be crucial for balanced portfolios navigating markets in 2026.
IMPORTANT INFORMATION
Actively managed portfolios may fail to produce the intended results. No investment strategy can ensure a profit or eliminate the risk of loss.
Diversification neither assures a profit nor eliminates the risk of experiencing investment losses.
Equity securities are subject to risks including market risk. Returns will fluctuate in response to issuer, political and economic developments.
Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.
Securitized products, such as mortgage- and asset-backed securities, are more sensitive to interest rate changes, have extension and prepayment risk, and are subject to more credit, valuation and liquidity risk than other fixed-income securities.
Bloomberg U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
Correlation measures the degree to which two variables move in relation to each other. A value of 1.0 implies movement in parallel, -1.0 implies movement in opposite directions, and 0.0 implies no relationship.
Duration measures a bond price’s sensitivity to changes in interest rates. The longer a bond’s duration, the higher its sensitivity to changes in interest rates and vice versa.
Monetary Policy refers to the policies of a central bank, aimed at influencing the level of inflation and growth in an economy. It includes controlling interest rates and the supply of money.
S&P 500® Index reflects U.S. large-cap equity performance and represents broad U.S. equity market performance.
U.S. Treasury securities are direct debt obligations issued by the U.S. Government. With government bonds, the investor is a creditor of the government. Treasury Bills and U.S. Government Bonds are guaranteed by the full faith and credit of the United States government, are generally considered to be free of credit risk and typically carry lower yields than other securities.
Volatility measures risk using the dispersion of returns for a given investment.
A yield curve plots the yields (interest rate) of bonds with equal credit quality but differing maturity dates. Typically bonds with longer maturities have higher yields.
These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.
Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
There is no guarantee that past trends will continue, or forecasts will be realised.
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