Posts filed under “Asset Allocation”
Source: Capital Spectator
The most perplexing thing I read this week was an odd column by Paul Merriman at MarketWatch, “Why Rebalancing Could Be a Huge Mistake.” He makes the counterintuitive claim that portfolio rebalancing doesn’t really work: “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.”
I dismissed Merriman’s claim offhand because what he described was not true asset class rebalancing. He was looking within the same asset class — U.S. equities — and subdividing them into four market cap weighted, style-based subgroups: large-cap, small-cap, large-cap value and small-cap value stocks.
His conclusion that rebalancing among these four didn’t work was a bit disingenuous. If you went on an all-Chicago-deep-dish-pizza diet and didn’t lose any weight, you wouldn’t exactly be justified in declaring that diets don’t work. But that is functionally the equivalent of Merriman’s critique of intra-U.S.equity rebalance.
But rather than rely on my own insights into rebalancing, I tracked down two experts who have studied rebalancing for years. Their criticism was much stronger than my own.
Robert Arnott runs Research Affiliates, where he helped craft the idea of fundamental (as opposed to market cap weighted) indices. RAFI, as the firm is known, generates returns through a combination of smart beta and asset allocation strategies.
Arnott critiques Merriman’s rebalancing claim as a “flimsy and meaningless straw man.” He shows through a series of examples what occurs if you chose not to rebalance a portfolio: The investor loses the benefits of diversification, as the portfolio over time morphs into a riskier, 99 percent stocks, mostly small-cap value fund.
The obvious risk (at least to me) with such a portfolio drift is the behavior of its holders. Any un-rebalanced portfolio eventually would become a gnarly mass of volatility and drawdowns. Imagine what that does to the psyche of the investor saving for retirement. It invites bad behavior and poor decision-making. Meanwhile, a diversified portfolio will have different sectors doing better or worse each year, producing more stable returns.
James Picerno takes a different critical approach to reach a somewhat similar conclusion. He starts with the caveat that the “optimal rebalancing strategy” is unknown in advance. Instead, it is designed specifically because we never know what the future holds. Rebalancing what is essentially an all equity portfolio of using only U.S. equities is not the same as rebalancing a broad asset allocation model. We should not expect “an equities-only portfolio” to have the same results via rebalancing than what we can achieve via a regularly rebalanced multi-asset-class strategy
We may not know in advance the precise improvements rebalancing produces over time, but we do know they are substantial. The alternative is a massive drift from one’s original asset weighting.
Any asset allocator who is comfortable with what will eventually become all equity portfolio should skip rebalancing. The rest of us continue to take advantage of what may be the only free lunch on Wall Street.
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. ~~~ …Read More
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
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
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.
Category: Asset Allocation
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
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
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