Does Asset Allocation Work?
July 13, 2010
Despite "everyone knowing" interest rates going to rise, here we sit today with the 10-year yielding 2.97%, and its appreciation buffered about half of the market's decline. Not a bad diversifier for its 15 basis point expense ratio. The non-profit investment committee got more comfortable with owning Treasury bonds of this maturity when I showed them the worst twelve month return for them going back to 1926 was a decline of less than 10%. Contrast that track record with other diversifiers’.
You would think people would learn
What about the really devastating markets of 2008? The differences there were even more extreme.
|
Price Return (excludes dividends/interest) |
IShares Barclays 7-10 Year Treasuries (IEF) |
15.99% |
Vanguard Total Domestic Equity (VTI) |
-36.99% |
Vanguard World Equity Ex-US (VEU) |
-43.43% |
IShares Treasury Inflation Protected ETF (TIP) |
-2.05% |
IShares iBoxx $ Investment Grade Corp. Bond Index Fund (LQD) |
0.11% |
IShares iBoxx High Yield Corp. Bond Index Fund (HYG) |
-17.56% |
IShares S&P/Citigroup Int’l Treasury Bond Index Fund (IGOV) |
N/A |
VALIC Company I Intl Govt Bond (VCIFX) |
-0.55% |
IShares JP Morgan USD Emerging Mkt. Bond Index Fund (EMB) |
-4.30% |
IShares MSCI EAFE Index Fund (EFA) |
-42.13% |
IShares MSCI Emerging Markets Index Fund (EEM) |
-49.47% |
IShares Dow Jones U.S. Real Estate Index Fund (IYR) |
-40.54% |
IShares FTSE EPRA/REIT Developed Real Estate ex U.S. (IFGL) |
-52.10% |
IShares S&P GSCI Commodity-Indexed Trust (GSG) |
-45.75% |
IShares COMEX Gold Trust (IAU) |
5.22% |
(IGOV wasn't available in 2008 which is why I included the Valic International Government Fund.)
Unlike the recent decline, during which some of the expensive "diversifiers" actually did help a tiny bit, most of them made the performance even worse in 2008 ... the exact opposite of what they were supposed to do. Those inexpensive Treasury bonds, on the other hand, protected capital as they should, even tripling the return of gold.
Here's the scam: The basic asset allocation theory that caught on was based on some long-term data that showed the value of blending stocks, bonds and cash. In fact, the Brinson, Hood and Beebower study held in high esteem by advisors demonstrated that more than 90% of the variance in returns among large pension plans was explained merely by their allocation to stocks, bonds and cash. In other words, less than 10% of variation was explained by all these expensive so-called diversifiers. But advisors can charge more if their pie charts look more complicated, touting the supposed value of "non-correlating assets" that tend to correlate a lot when you need them not to the most.
Advisors have a conflict of interest in this game — they have an incentive to make things far more complicated than is necessary to justify higher fees. Moreover, their friends who manage the expensive products get to charge a lot more in management fees. Even low-fee Vanguard charges more than three times the management fee for their World Equity Ex-US ETF (VEU, 25 basis points) versus their Total Domestic Equity ETF (VTI, 7 basis points). And check out the huge weighting semi-passive fund company DFA suggests for their expensive real estate and foreign funds where they earn double or more the fees of other funds they manage. The product vendors and research departments fool advisors to get more product fees, and advisors in turn often unwittingly end up fooling their clients. But, as we’ve seen with Treasury bonds: To achieve diversification, you don't need to spend a lot of money.
I'm in no way implying that I know where markets are going. They are always uncertain, and if anyone tells you otherwise, he is either lying to you or lying to himself, if not (in reality) both. I'm also not even remotely inferring that past performance is indicative of future results. If the economy gets stronger, it is likely that interest rates will rise and bonds will suffer, but odds are stocks would take that as pretty good news, providing the uncorrelated performance investors desire.
We all need diversification to protect our portfolios from market shocks, recessions and depressions. Treasury bonds have done well during declines similar to this spring’s, the decline of 2008, the 1987 Crash and even the Great Depression. I cannot guarantee they will do it again, but when the markets get scared, Treasury bonds have been the consistent beneficiary of the ensuing flights to safety.
A popular industry speaker and writer, David B. Loeper is the CEO and founder of Financeware, Inc. in Richmond, VA. He is author of the top-selling book Stop the 401(k) Rip-off!, three other books released in 2009 by John Wiley & Sons (Stop the Retirement Rip-off, Stop the Investing Rip-off and The Four Pillars of Retirement Plans) and numerous white papers. You may subscribe to our educational emails.
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