Posts filed under “Asset Allocation”

Arnott: Rebalancing Still Works

Robert Arnott is Chairman & Chief Executive Officer of Research Affiliates, a global leader in smart beta and asset allocation strategies, and one of the originators of fundamental (as opposed to market cap weighted). His models now drive over $100 billion in assets in various funds, and an additional $75 billion at PIMCO.



“Conventional wisdom holds that regular rebalancing is a sound practice to control investing risk. But I’ve concluded that some of that conventional wisdom is wrong.”

-Paul Merriman, Why rebalancing could be a huge mistake


DFA has done some wonderful, and intellectually robust work, over the years. Merriman’s brief dismissal of rebalancing within the stock market is not part of that list. His same flimsy argument works just as well for rebalancing between stocks and bonds, a form of rebalancing that he finds acceptable. If Merriman believes that his analysis discredits rebalancing within segments of the stock market, then the same logic sure as heck discredits rebalancing between stocks and bonds.

Let’s go back 100 years for stocks and 10-year Treasury bonds. Stocks gave us 9.79% per annum, while 10-year Treasuries gave us 4.99%. We might think that a 50/50 blend should have given us the average of 7.39%. Nope … it gives us 7.94%. So, glass half full, rebalancing seems to have added 55 bps per annum. Over the last 50 years, when the difference between stock and bond returns has narrowed to a scant 2.77%, rebalancing still adds an impressive 44 bps per year above the average of stock and bond returns. That’s a lot!

Now, let’s try Merriman’s glass half empty analysis. What if we just let the mix drift? We’d have earned 9.0% per annum with a drifting mix! That’s 110 bps per year better without rebalancing, than with consistent annual rebalancing to a 50/50 mix! Wow. Of course, we’d also have finished the century with 99% in stocks. That’s not exactly the risk profile we intended up front, is it?

In fact, the mix drifts so far away from our intended 50/50 starting point that even the great depression doesn’t suffice to bring it back to 50/50. It first reaches 60/40 after 12 years, 70/30 after 15 years, 80/20 after 37 years, 90/10 after 42 years, 95/5 after 46 years, 98/2 after 68 years, and 99/1 after 85 years. Wow.

Merriman dismisses rebalancing among the four equity segments by saying, “Assuming each asset class started with $10,000, the portfolio would have grown to $6.6 million without rebalancing, versus only $4.2 million with rebalancing. Rebalancing, in other words, cost the portfolio $2.4 million, taking away 36% of its gains.” How bad is the corresponding situation for the balanced investor, who rebalances to a 50/50 stock/bond mix, a strategy that Merriman still seems to endorse? Assuming each asset class (stocks and bonds) started with $10,000, the portfolio would have grown to $115 million without rebalancing, versus only $42 million with rebalancing. Rebalancing, in other words, cost the portfolio $73 million, taking away 63% of its gains. Ouch.

Let’s now consider what happens to the asset allocation, with his four-asset-class portfolio within equities. Remember that the fallacy of Merriman’s argument is that the drifting mix takes us far away from our intended risk-controlled starting mix, all the way from 50/50 to 99/1 with a stock/bond portfolio after 100 years? For our investor who begins with 25% in each of the four equity portfolios, how does the mix change in 50 years, without rebalancing? The ending portfolio has 76% in small-cap value stocks and a scant 3% remaining in the S&P 500; the mid-range performers, small-cap stocks and large-cap value, have both dwindled to 9% and 12%, respectively. Is this the risk profile that Merriman’s diversified 25%-in-each-portfolio investor intended fifty years ago?

Merriman has merely put forth, and knocked down, a flimsy and meaningless straw man: His argument requires that an investor, who values a particular asset mix at the outset, has no cares about how far that mix may drift away from that starting mix over time. If rebalancing is useful for asset allocation, it’s useful within segments of the stock market; his argument against the latter is just as powerful – and just as weak – as an identical argument against the former.

Category: Analysts, Asset Allocation, Investing, Really, really bad calls

Nervous About Nest Eggs

Click to enlarge Source: WSJ

Category: Asset Allocation, Investing, Think Tank

Headwinds for Emerging-Markets

From Barron’s click for larger graphic Source: Barron’s   I am long Emerging markets so I look for items like this. None of these issues are unknowns, and should therefore already be reflected in price.

Category: Asset Allocation, Investing

AAII Asset Allocation Survey (Equities) – Deviation from mean

Click to enlarge Source: AAII, FusionIQ   Last week, we noted the US Equity markets have been outperforming the rest of the world by a huge margins (Spot the Outlier). This may be contributing to circumstances where US investor allocations are overweight US equities, and underweight other asset classes. In these circumstances, you might consider…Read More

Category: Asset Allocation, Investing, Psychology

Spot the Outlier

Source: Capital Spectator   A few weeks ago, I spoke at an Financial Advisor conference in Denver. There was some concern about asset allocation returns — it seemed that the more diversified you were, the worse your performance numbers were. Josh quoted a financial advisor who lamented: “Why bother diversifying at all? It’s just a drag…Read More

Category: Asset Allocation, Investing, Psychology

Annual Returns by Asset Class

Click for ginormous table
Source: J.P. Morgan


I really like the above table — its a terribly instructive reminder as to how little we know about the future. Look how often the sector you least expected to be the winner ended up on top.

Its also instructive to see what ends up near the top of the list on a regular basis.

The breakdown of Fixed Income annual winners is after the jump.

Read More

Category: Asset Allocation

Reducing Energy Weighting

Reducing Energy Weight David R. Kotok Cumberland Advisors, July 29, 2013     Last week we reduced our energy exposure to underweight. It had been overweight for a while, and we successfully participated in the rebound in natural gas prices and the narrowing of the spread between Brent and WTI (West Texas Intermediate) oil. It…Read More

Category: Asset Allocation, Energy, Think Tank

The Purgatory of Low Returns

Click to enlarge GMO 7-Year Asset Class Real Return Forecasts: 2007     Have a look at the charts above and below. They are from James Montier’s GMO Quarterly Letter, July 2013, titled The Purgatory of Low Returns; you can download the full PDF here (registration may be req’d). (Note to Josh: This quarter, Ben…Read More

Category: Asset Allocation, Cycles, Investing

Asset Classes

We have all seen the standard depiction of asset allocations — I thought this version — via UBS — was a more interesting depiction of the usual chart.   Click for ginormous graphic     Source: UBS House View, July 2013 Mike Ryan Monthly Investment Guide CIO Wealth Management Research

Category: Asset Allocation

Missing the big stocks rally: Readers push back Barry Ritholtz, Washington Post June 28 2013     Last time, I talked about what investors should do if they sat out the big market rally in recent years. In brief, I advised making changes of both a behavioral and investing nature. The behavioral issues included admitting…Read More

Category: Apprenticed Investor, Asset Allocation, Investing