That is the title of an article from Tom Lauricella at the WSJ and picked up on by Abnormal Returns. In the last year or so there has been much lament over asset allocation appearing not to have worked. Whether it worked or not is more likely in the eye of the beholder because while I am not sure that failed is correct it certainly worked differently.
This is going to come off as very harsh, and while I may not be 100% correct I believe I could be on to something.
In my opinion total reliance on some sort of long standing formula is simply lazy (talking about people who get paid to manage assets). Every asset class has fundamental dynamics that change in some ways over time and over reliance on some sort of static allocation model ignores what should be intuitive; nothing stay exactly the same forever.
Most of the time asset allocation has worked and it will work most of the time in the future but not always. This ties in with the passive argument debate that pops up here occasionally. One question I always ask is whether the passive indexers do any sort of forward looking analysis. Invariably this line of thought draws out a comment or two about speculation and how difficult it is to look forward.
A big part of looking forward is to see when risks of more trouble than normal are prevalent. In a way this is the most important forward looking analysis one can do. It is certainly more important than picking between two alternative energy stocks during a bull market and betting on the one that ends up rising by 120% as opposed to the one that only goes up 80%.
I have very little sympathy for a lazy advisor who bet on the status quo and was let down. There can be no guarantee that any action taken in advance can be successful in avoiding pain but I do not know how you tell a client "I never saw this coming and it never occurred to me to try to do anything to protect your assets."
Obviously no one would word it that way to a client but that is the net result by many advisors for their clients. One theme on this blog has been the evolution of all things related to markets and investing. Obviously I didn't invent the idea, many other people have said essentially the same thing.
I obviously believe in the work of managing money and being proactive and make efforts in that direction as obvious from the blog posts but no one cares more about your money than you do and no one should have more respect for whatever it took to accumulate your money than you (IMO too many don't people respect their money which contributes to big bets, over-spending and other forms of recklessness) If you pay someone then you should like his answers to questions about this. Keep in mind no one can be correct every time but I think someone willing to make the effort to protect your assets and who can explain it easily to you is probably a keeper.
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16 comments:
Richard Shaw at qvmgroup.com had an excellent post last Sunday, in which he argued that asset allocation didn't fail as much as the asset allocators themselves failed. And they did so by confusing asset classes with all the asset categories that have cropped up in the recent past. It's a very good read.
Roger, I think (to your credit) that you're in the minority of advisors who take proactive analysis to heart. In my experience, most advisors are simply content to gather assets and let their clients invest as they see fit. They're not necessarily passive indexers but rather passive advisors.
Excellent point anon 5:48. I really don't think a mix of stocks and treasuries behaved unexpectedly.
A lazy advisor may have considered corporate bonds, especially higher yielding ones, to be adequate for the bond allocation, when in fact the features that make them riskier than treasuries show up at the same time as equity risk. Chasing yield has consequences.
I still can wrap my head around the concept of "forward looking" except to ask, "what if I'm wrong?"
"passive advisors," well put.
what if you are wrong? this is mitigated some by not making big bets. China might be the most important country in the world to invest in, i have 2% in china and might go as high as 5% at some point. if i am wrong about china i won't hurt clients.
So now that asset allocation has been declared dead, does that mean that since no one uses it anymore that it will work again? [chortle].
Seriously, I think that declaration is as idiotic as the justifications for daily, hourly, minutely market gyrations. (I won't name names, just initials ... CNBC). This declaration by several is arrogant and reckless. They don't know if AA is dead just like they don't know what the Dow is going to close at today.
I'm still digging up the research, but I seem to recall reading that in big down years, all asset classes were down big. People flock to cash and sell everything. I don't think that mentality will ever change. That is a 'risk' of AA and Roger spends a lot of time hedging that risk. Some may choose to accept that risk.
So if asset allocation is dead, does that mean bonds, gold, stocks, real estate, money markets should all perform the same? Asset classes have no underlying fundamentals?
Sorry if I'm sounding critical and skeptical, but I mean to be. It's misinformation and damaging. I'm relieved to see that the comments from this morning are already showing that people are reading past this. RR readers are apparently smarter than the average bear.
I've heard "asset allocation is dead" a lot in the past 6 months and it confuses me.
Aren't bonds assets? Aren't they part of asset allocation? Didn't people who allocated 40% of their investment assets to bonds do twice as well (or better) as the overall market?
20% is still a big loss. Maybe that's the issue here. Proper asset allocation is supposed to guarantee you that you get nothing worse than a 5% loss.
I dunno.
Bill, nice pun,
SD treasuries yes, most everything else, not so much.
it is unfortunate so many advisors do not comprehend the concept of risk adjusted returns. There are two critical questions that one has to address when constructing portfolios. First, where are we in this secular bear market? Second, are we dealing with inflation or deflation? If an advisor cannot properly address these issues than RUN AWAY! IMO, the secular bear is near halftime and yes there will be pulses of inflationary events creating cyclical bulls and relief rallies (like the current one) however the key to investing success over the coming years is portfolios built for deflation and dealing with a sideways to down market. A closet buy hold with small hedges will not work. There are no equity safe havens as China and other emerging economies will be hit the hardest. Be careful of both corporate and muni bond default.
So what is one to do?
1. Cd ladder
2. Harry Browne's permanent portfolio is a wise choice.
3. Invest with truly skilled hedge managers such as HSGFX, hstrx, tglmx, pgaix, merfx, ccvix, coagx, gteyx, rymfx, and a little gld and vfiix
Good article-- the "lazy advisor" point is especially well-taken.
Felix Salmon has a great take on this, too, at http://seekingalpha.com/article/148614-the-end-of-asset-allocation
As soon as I read that, I thought, "Roger will be interested in this," and sure enough...!
Regarding "risk-adjusted" returns (Anon. 8:06): no, advisors do risk adjustments, but on the wrong measure of "risk." It became fashionable to measure risk as volatility. Real risk, as Roger has discussed before, is that the asset loses value permanently. That is not in the model, AFAIK.
What I like most about asset allocation targets - regardless of what your specif target is for an asset class - is that it forces you to sell high and buy low (at least realitively, if not always absolutely) to maintain your preset allocation percentage.
I must admit I think trends last longer than a year and therefore I am not in a hurry to reallocate on an annual basis (maybe after 2 to 4 years - depending on how fast the rise is - the faster the rise the quicker you may want to rebalance)
correlations have always increased during bear markets. Problem is people are short sighted and only remember the tech bubble, where valuations still did matter so they assume thats how it always must be going forward.
Risk measured as volatility is equivalent to permanent loss in the sense that there is a significant probability that prices will be low when an investor has to sell (including those times when price drops below cost basis or to zero) so permanent loss AKA realized loss is present in the most widely accepted models even if the implications of that are not often widely broadcast.
But even those models depend upon a more or less normal distribution of asset prices and, as we have discussed here before, there are theories that argue for a different kind of distribution and, hence, model; e.g., correlations of different asset classes may not so much "go to one" as expose the reality that price variance is simply undefined (effectively infinite as in a stable power distribution for e.g.) or that correlations only reflect investor behavior(s) and not fundamental properties or relationships of the asset(s) in question.
Still the meaning of discipline even for 'amateurs' has always implied something more than the ability to follow a recipe and, one would think, professional discipline should imply something greater still. It's hard to be forgiving when a professional investment adviser misses but, in most cases, the pecuniary rewards of investment advising are linked to AUM so an ability to gather clients and assets may obscure an inability to adequately advise until evidence of incompetence becomes overwhelming (by which time the client's business may hardly be worth retaining); it's a cold world out there.
"the pecuniary rewards of investment advising are linked to AUM so an ability to gather clients and assets may obscure an inability to adequately advise until evidence of incompetence becomes overwhelming (by which time the client's business may hardly be worth retaining); it's a cold world out there."
Well said RW. I must admit I had to look up "pecuniary", but your observation summarizes nicely why I have tried to educate myself in investing matters. If feel that if I can at least match market returns (equities and fixed income) then I should be fine. For that reason passive investing works for me. An "advisor" may or may not make the mark, but he has to overcome his fee. Although the standard fee of 1% of AUM may not sound like much, 1% of the often mentioned 4% SWR is 25%, that's a high hurdle in my book!
If nothing else, this blog is great for vocabulary building ;)
All models fail in systemic risk events. There is no 'safe'haven in systemic risk except for government bonds. Money markets proved to be filled with toxic waste. AND, so-called t-bond funds were sometimes a blend of this or that.
There was surprising little discussion about how asset allocation would not save one in such an environment as the one that we were facing. (Unless the allocation model shifted to 100% government bonds).
I dare say that most of Roger's readers give more attention to some of these details than most so-called money managers. For many of the wealth management firms, the folks are interested in one thing: getting more money from you and into the portfolio. It's one reason why it is important to portray the market waters as always safe.
A simple acceptance that one doesn't always have to be invested in equities, particularly when the risk profile is elevated, would avoid alot of pain. Individuals can do this. Mutual funds cannot.
"Individuals can do this. Mutual funds cannot."
actively managed multiple asset class mutual funds can.
Not all asset allocation approaches are equal. The asset allocation outlined the book "Fail Safe Investing" by Brown did an outstanding job for investors.
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