Commodities could help pare losses for the traditional 60/40 investment strategy, which is seeing the worst performance in nearly 50 years

• The classic 60/40 investment portfolio of stocks and bonds dropped by 14% this year through August.
• Adding commodities to that mix could help soften the blow, said Bespoke Investment Group.

Steep losses in equities and bonds have dragged the classic 60/40 investment portfolio sharply lower this year, but adding commodities to the mix could be one way to soften the blow, according to Bespoke Investment Group.

The 60/40 portfolio of stocks and bonds dropped by a "brutal" 14% through the end of August, the worst first eight months of a year since at least 1976, the independent research firm said in a note published Thursday.

"Typically, declines in stocks are offset by gains from bonds and vice versa. That's why the 60-40 portfolio has historically been an easy allocation rule of thumb that has served investors very well. But it hasn't this year," wrote Bespoke analyst George Pearkes.

The S&P 500 lost 17% this year through August while the Bloomberg US Aggregate Bond Index slid about 11%. Investors have hammered down equity and bond prices largely as the Federal Reserve has undertaken an aggressive rate-hike campaign to cool high inflation. Bond yields have soared as prices have fallen and inflation threatens to eat into the value of bonds. The global bond market has sunk into its first bear market in more than 30 years.

Investors seeking diversification could turn to commodities, a move that also lowers volatility.

"Instead of a 60/40 portfolio, a three-part portfolio equally weighted between stocks, bonds, and commodities would be down only 1.1% so far this year, a vast outperformance versus the 60/40 approach," said Pearkes.

But a diversified equal weight portfolio of stocks, bonds, and commodities tends to underperform the classic portfolio mix of stocks and bonds, with total returns of 1.2% each year since 1976. Bespoke said there was a stronger 60/40 return advantage over the last decade as commodities endured a sustained bear market over most of that period.

It's difficult for investors to remain committed to a commodities-heavy portfolio considering the lag in almost every year for a decade.

"When they do, though, gains can be truly dramatic," said Pearkes. "[Long] performance droughts can get made up quickly on a relative basis. That looks likely to be true this year, too; the commodities-heavy equal weight approach is up 15% versus a 60/40 portfolio year-to-date."