Fake Diversification Exposed: Does Asset Allocation Work?

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David Loeper

When the market closed on June 29, 2010, domestic equities were down 14.5% from their April 23rd high — a formidable decline. Many advisors tout sophisticated (and very expensive) asset diversification strategies, supposedly to protect their clients against precisely these circumstances. 

So, with this recent decline, did all of these supposed diversifiers, like foreign and emerging market stocks, real estate, corporate and high-yield bonds (junk), foreign bonds, inflation-protected bonds, commodities, etc., protect portfolios?

Not exactly. The table below shows the price-only return (excluding dividends and interest) from the April 23, 2010 market high through the June 29 market close for a variety of ETFs and other funds that claim to be such diversifiers.

 

Price Return (excludes dividends/interest)
4/23/10 - 6/29/10

IShares Barclays 7-10 Year Treasuries (IEF)

7.26%

Vanguard Total Domestic Equity (VTI)

-14.52%

Vanguard World Equity Ex-US (VEU)

-14.28%

IShares Treasury Inflation Protected ETF (TIP)

2.97%

IShares iBoxx $ Investment Grade Corp. Bond Index Fund (LQD)

2.49%

IShares iBoxx High Yield Corp. Bond Index Fund (HYG)

-3.65%

IShares S&P/Citigroup Int’l Treasury Bond Index Fund (IGOV)

-3.30%

VALIC Company I Intl Govt Bond (VCIFX)

0.00%

IShares JP Morgan USD Emerging Mkt. Bond Index Fund (EMB)

-0.02%

IShares MSCI EAFE Index Fund  (EFA)

-17.06%

IShares MSCI Emerging Markets Index Fund (EEM)

-12.75%

IShares Dow Jones U.S. Real Estate Index Fund (IYR)

-10.41%

IShares FTSE EPRA/REIT Developed Real Estate ex U.S. (IFGL)

-12.90%

IShares S&P GSCI Commodity-Indexed Trust (GSG)

-13.34%

IShares COMEX Gold Trust (IAU)

7.24%


Hmmm… funny — the only things you could add to your portfolio to materially dampen the recent market's decline were 7-10-year Treasury bonds and gold.  But gold doesn't pay any interest, costs money just to hold, and has a 200-year real return of 0%, according to Jeremy Siegel in his book Stocks for the Long Run.

Last fall, when I took over the management of a $25 million portfolio for a non-profit, they were very concerned about our 50% allocation to IEF, the 7-to-10 year Treasury ETF. After all, "everyone knew" that interest rates were going to rise (the 10-year Treasury was yielding around 3.5% at the time). Indeed, when the market rallied earlier this year, the 10-year yield rose to almost 4%. That hurt Treasury bonds, but stocks were rallying.

Read more articles by David B. Loeper, CIMA, CIMC