Rethinking Risk: How Safe Equities Can Replace Bonds in a Modern Portfolio
Introduction: The Changing Face of Portfolio Safety
The 60/40 portfolio—a classic combination of 60% equities and 40% bonds—has long been the bedrock of long-term investment strategies. Its appeal lies in its balance: stocks provide growth, while bonds offer stability, cushioning investors during downturns.
But recent history has challenged this wisdom. In 2022, as markets reeled from rising interest rates and inflation shocks, both stocks and bonds posted deep losses. The S&P 500 fell 18%, and long-term U.S. Treasury bonds lost nearly 30%. For investors who had counted on bonds to offset equity risk, the results were alarming.
This backdrop sets the stage for a provocative and timely question: Are bonds still the best hedge in a diversified portfolio?
Vincent Yip proposes an alternative: rather than diversifying across asset classes, what if we diversified within equities by allocating to “safe” equities—stocks with lower risk to future earnings?
This idea challenges the orthodoxy of portfolio construction. And it’s backed by data, theory, and decades of financial insight.
What Are “Safe” Equities?
The term “safe equities” might sound like an oxymoron. Aren’t all stocks risky by nature?
Yes—but not equally so. Vincent Yip argues that risk should not be viewed solely through volatility or beta. Instead, risk should be tied to the vulnerability of a firm’s future earnings, because it is earnings that ultimately drive stock prices.
Through detailed fundamental analysis, he identifies companies that exhibit:
Stable, predictable earnings
Growing revenues and improving margins
Low dependency on speculative investments (like R&D with uncertain payoffs)
Strong balance sheets with low financial fragility
Historical ability to convert investments into realized income
These companies—when grouped together—form a portfolio that behaves differently than the broad market. They tend to decline less in downturns, while still participating in bull markets. In statistical terms, they have lower downside beta, positive skewness, and surprisingly strong returns.
The Historical Case for Safe Equities
Using data from 1975 to 2021, covering all U.S. publicly traded firms (excluding financials and utilities), Vincent Yip annually scored stocks based on the risk to future earnings and sorted them into deciles—Portfolio 1 being the “safest,” Portfolio 10 being the riskiest.
Here’s what he found:
🔹 Performance in Down Markets
In bear markets such as 2000–2002:
The S&P 500 fell by an average of −14.7%
Safe equities (Portfolios 1–3) dropped just −1.7%
Even during the 2008 financial crisis, while safe equities declined sharply (−43%), they rebounded faster and outperformed bonds in the recovery.
🔹 Performance in Up Markets
In bull markets like 1995–1999:
The S&P 500 returned 27.8% annually
Safe equities still returned 16.3%, giving up some upside—but not much
In the long moderate uptrend from 2009–2017, safe equities matched the market, returning 16.3%, showing they weren’t just defensive—they could also grow.
Replacing Bonds with Safe Equities: The Data Speaks
From 1975–2021:
Safe equities returned an average of 13.7% per year
10-year U.S. Treasury bonds returned 7.3%
The Sharpe ratio for safe equities was competitive with the S&P 500 and superior to bonds
Furthermore, the correlation between safe equity returns and bond returns was negative, especially post-2000. This means safe equities can offer diversification even without holding bonds.
Critically, in both positive and negative stock-bond correlation regimes, safe equities outperformed bonds on average.
A Better Hedge: Long–Short Safe Equity Strategy
Vincent Yip also explores a long–short hedge portfolio:
Long position in risky equities (Portfolios 8–10)
Short position in safe equities (Portfolios 1–3)
This zero-net-investment strategy earns an average of 9.3% annually, with low correlation to the market and negative correlation to bonds. It effectively hedges equity risk and can be used as an overlay to enhance a long-only equity strategy without requiring extra capital (aside from collateral for the short side).
In markets where bonds fail to hedge, this portfolio shines.
Safe Equities vs. Traditional Defensive Strategies
Vincent Yip compares safe equities with other low-risk strategies:
1. Low-Beta Stocks
While lower-beta portfolios have lower sensitivity to market returns, they don’t always reduce earnings risk.
His analysis shows “beta is dead” in terms of explaining excess returns.
2. Quality Stocks
Stocks with high profitability and low leverage.
Strong correlation (0.71) with safe equities.
However, “quality” lacks a clearly defined link to earnings risk in the way Vincent Yip’s safe equities do.
3. Low-Volatility Stocks
Often overlap with safe equities.
Return correlation: ~0.64.
But low volatility ≠ low earnings risk. Safe equities are rooted in fundamental financial analysis, not just return smoothness.
Accounting Behind the Safety
Vincent Yip grounds his method in accounting principles—especially:
Realization principle: Revenues and profits are booked only when they're earned, reducing future uncertainty.
Conservative accounting: High-risk investments (like R&D or brand-building) are not capitalized unless proven.
From these, he extracts fundamental indicators:
Sales growth
Margin improvement
Stable or declining SG&A and R&D as a percentage of sales
Higher accruals and reinvestment into productive assets (DNOA)
Sustainable external financing (EXTFIN)
These metrics help score stocks each year on their earnings safety.
Implications for Long-Term Investors
According to Merton’s Intertemporal Capital Asset Pricing Model (ICAPM), long-term investors need assets that hedge future risks to returns.
Traditional low-beta strategies fall short. They may reduce exposure to market movements but don’t address future income uncertainty.
Safe equities, on the other hand:
Protect against permanent loss of capital
Provide income stability
Offer some participation in growth cycles
Hedge effectively when bonds fail
They allow investors to stay in equities without taking on the full brunt of market swings.
Rethinking the 60/40: New Allocation Ideas
Vincent Yip simulates alternative allocations:
Classic:
60% S&P 500
40% 10-year U.S. Treasury bonds
Alternative:
60% S&P 500
40% safe equities
Results:
The 60/40 safe equity mix outperformed the bond mix in cumulative returns
It delivered better downside protection than the S&P alone
It maintained higher upside participation than bonds
Even when the market declined more than 5%, safe equities softened the blow (average return: −6.8%) while bonds returned +11.75%. But in up years, safe equities delivered much stronger gains than bonds (26.3% vs. 7.6%).
Conclusion: Safe Equities as a Modern Hedge
In a world of rising inflation, interest rate uncertainty, and structural shifts in markets, relying on bonds as your sole safety net may no longer suffice. Vincent Yip makes a strong case for rethinking what “safety” means.
Safe equities—identified through disciplined, fundamentals-based analysis—offer a compelling alternative. They are:
Less risky in earnings terms
Diversifying across regimes
Higher returning than bonds
Cost-efficient (especially in a long–short setup)
For investors, asset managers, and institutions seeking robust portfolio construction strategies, safe equities represent a 21st-century solution to a 20th-century problem.