The Alternative 60/40 Portfolio: A Defense-First Approach to Asset Allocation

The traditional 60/40 portfolio, 60% stocks and 40% bonds, has been the cornerstone of investment advice for decades. But what if we flipped conventional wisdom on its head?

Thomas Carlson’s “Defense First” strategy, as analyzed by Allocate Smartly, presents a compelling alternative that challenges traditional approaches to tactical asset allocation.

Key Takeaways

• Defense First uses defensive assets to guide portfolio allocation, only holding stocks when defensive assets show weak momentum
• The strategy allocates across four defensive assets: long-term Treasuries (TLT), gold (GLD), commodities (PDBC), and the US dollar (UUP)
• Historical performance shows benchmark-like returns with better downside protection
• Low correlation to other tactical strategies makes it valuable for diversification
• The approach reverses traditional momentum-based allocation methods

Understanding the Defense First Philosophy

Traditional tactical asset allocation strategies use stock momentum to determine portfolio risk posture. When stocks show positive momentum, portfolios tilt toward risk assets. Defense First takes the opposite approach – it uses the momentum of defensive assets to guide allocation decisions.

This counterintuitive method only allocates to stocks when defensive assets are underperforming, essentially treating equities as the “asset of last resort” rather than the primary growth engine.

The Strategy Mechanics

The Defense First approach follows a systematic monthly rebalancing process:

Asset Selection and Momentum Measurement

The strategy tracks four defensive assets plus a risk-free benchmark:

• Long-term US Treasuries (TLT)
• Gold (GLD)
• Commodities (PDBC)
• US Dollar Index (UUP)
• 13-week T-bills (BIL) as the risk-free rate
• Momentum is calculated as the average of each asset’s 1, 3, 6, and 12-month dividend-adjusted returns.

Allocation Framework

Assets are ranked by momentum and allocated as follows:

40% to the highest momentum defensive asset
30% to the second-ranked asset
20% to the third-ranked asset
10% to the lowest-ranked asset
The critical twist: if any defensive asset’s momentum falls below the T-bill rate, that allocation shifts to US stocks (SPY).

Historical Performance Analysis

The website Allocate Smartly has backtested the alternative 60/40 portfolio:

Based on backtesting from 1971, Defense First would have delivered several notable characteristics:

Statistic	Strategy	Benchmark
Annualized Return	11.7%	9.5%
Annualized Volatility	10.2%	9.9%
Sharpe Ratio	0.70	0.50
Sortino Ratio	1.28	0.84
Max Drawdown (EOM)	-17.2% (03/1980)	-29.5% (02/2009)
Longest Drawdown	39 months	40 months
Ulcer Performance Index	1.53	0.82
% Profitable Months	63.5%	64.5%
Best Month Return	14.6%	10.7%
Worst Month Return	-16.2%	-10.7%
Average Trades per Year	20.0	0.0
Annual Turnover	232.2%	11.9%

Return Profile

• Benchmark-like returns after approximately 1980
• Better downside protection during market stress periods
• Focus on capital preservation over maximum growth

Risk Management Benefits

The strategy’s defensive orientation means it generally weathered market downturns more effectively than traditional equity-heavy approaches. This aligns with the principle that over long time horizons, bear markets don’t matter much, but over short periods, they are significant, particularly relevant for retirees facing sequence risk.

Diversification Value

Perhaps most importantly, Defense First exhibited relatively low correlation to other tactical strategies, making it valuable as a portfolio diversifier when combined with other approaches.

The Predictive Power of Defensive Asset Weakness

A key question emerges: Does negative momentum in defensive assets predict positive stock returns? The analysis reveals nuanced findings:

Individual Asset Performance

When examined individually, defensive assets showed mixed predictive power:

• Commodities demonstrated some predictive ability
• Gold and the US dollar showed little correlation
• Treasuries were actually negatively predictive

Collective Signal Strength

However, when multiple defensive assets simultaneously show weak momentum, the predictive power improves significantly:

• 2 assets agreeing: Middling stock returns (acceptable given 30% equity exposure)
• 3+ assets agreeing: Strong predictive power for outsized returns (with 60%+ stock exposure)

This suggests the strategy’s strength lies not in individual asset signals but in the collective weakness of defensive alternatives.

Potential Improvements and Considerations

One notable limitation is that Defense First doesn’t require positive stock momentum before allocating to equities. This creates a potential “dumping to stocks” scenario, similar to how some strategies blindly dump to bonds during defensive periods.

A potential enhancement could include a rule that prevents stock exposure above a certain threshold when stock momentum is negative, with unallocated funds remaining in cash.

Currency Exposure Challenges

The strategy’s use of the US Dollar Index (UUP) presents practical challenges. Currency movements tend to be small relative to trading costs, making UUP positions potentially unprofitable after accounting for transaction fees and slippage. Many practitioners might consider substituting cash for UUP allocations.

Comparing to Traditional Approaches

To understand Defense First’s appeal, consider the long-term performance of major asset classes since 1928:

• Stocks: 9.9% annual returns
• Gold: 5.0% annual returns
• Bonds: 4.6% annual returns
• Real Estate: 4.3% annual returns
• Cash: 3.3% annual returns

While stocks have clearly outperformed over the long term, the longer you hold an asset, the more likely you are to get the historical average returns. However, the path matters enormously for investors, particularly those in or near retirement.

The Diversification Imperative

Defense First recognizes that higher returns often come with higher risk. Just as day traders can benefit from focusing on daily bars rather than intraday noise to reduce behavioral mistakes, long-term investors can benefit from strategies that filter out market noise while maintaining systematic discipline.

Implementation Considerations

Like successful day trading strategies that rely on systematic rules rather than discretionary decisions, Defense First provides a framework that helps investors avoid behavioral mistakes. The monthly rebalancing schedule and clear allocation rules remove emotion from the process.

Time Efficiency

The strategy’s monthly rebalancing requirement makes it accessible to investors who cannot monitor markets constantly, similar to how day trading with daily bars can be more time-efficient than using intraday timeframes.

The Role in Modern Portfolios

Defense First shouldn’t necessarily replace traditional allocation approaches entirely. Instead, it offers several potential applications:

Core-Satellite Implementation

Defense First could serve as a satellite holding within a broader portfolio, providing diversification benefits due to its low correlation with other tactical strategies.

Risk Management Tool

For investors concerned about sequence risk or those approaching retirement, Defense First offers a systematic approach to downside protection while maintaining growth potential.

Complement to Growth Strategies

Just as international diversification has historically provided benefits despite US market dominance, Defense First’s defensive orientation could complement more aggressive growth strategies.

Conclusion: Rethinking Asset Allocation

Thomas Carlson’s Defense First strategy challenges fundamental assumptions about portfolio construction. By utilizing defensive asset momentum to inform allocation decisions, this approach offers a unique perspective on tactical asset allocation, prioritizing capital preservation while maintaining growth potential.

The strategy’s historical performance suggests it could serve as a valuable component in diversified portfolios, particularly for investors seeking better downside protection than traditional approaches provide. However, like any strategy, it requires careful consideration of individual circumstances and risk tolerance.

As with the principle that the longer the time horizon, the less erratic and random the investment curve becomes, Defense First offers a systematic approach that may help investors navigate market volatility while maintaining long-term growth objectives.

The key insight remains: sometimes the best offense is a good defense, and Defense First provides a framework for implementing that philosophy systematically.