Lazy Portfolios, Or, The Revenge of 60/40

There has been some discussion around the blogosphere regarding returns from strategic asset allocation strategies. Here is a post on the Yale endowment & Swensen’s allocation mix,

With the news that PIMCO is launching a real assets ETF, it now becomes possible to have a truly diversified portfolio with only 3 ETFs. 1 world equity, 1 bond, and 1 real assets. Doesn’t get much simpler than that.

Anyways, I thought I would update an old post on the performance of some lazy portfolios. You can do your own tests over on Asset Play with more granular asset classes, but I am presenting these below mainly to just be instructive. (Who runs this site by the way?)

Completely unrelated but nice interview with Paul Samuleson. Part 1 and Part 2.

ALLOCATIONS:

US Stocks (S&P500)

Bonds (10 Year US Govt)

Foreign Stocks (MSCI EAFE)

REITs (NAREIT)

Commodities (GSCI)

60/40

60% US Stocks

40% Bonds

Andrew Tobias Three Fund Lazy Portfolio (Also similar to Bill Shultheis & Scott Burns’s 3 Fund portfolios)
33% US Stocks
33% Foreign Stocks
33% US Bonds

Swensen model, from his book Unconventional Success
30% US Stocks
20% REITs
20% Foreign Stocks (He recommends emerging, but for simplicity we just used foreign developed)
30% Bonds (He recommends short term US and TIPS, but since TIPS only existed post 1997 we lumped them in with bonds)

El-Erian model, from his book When Markets Collide

(This is simplified from his longer allocation.)

15% Commodities

20% US Stocks
15% REITs
30% Foreign Stocks
20% Bonds

Ivy Portfolio (from our book – note this is the B&H allocation not the tactical)

20% US Stocks
20% Foreign Stocks
20% Bonds
20% Commodities
20% REITs

Some nice rules of thumb:

Most asset classes have a Sharpe of around .20 (over time).

A diversified portfolio gets you to around .3 to .4.

Active risk management can improve that to around .7 to .8.

Data from Global Financial Data:

click to enlarge

and a few more asset classes:

Comments

[Jasper M:]

Almost all of these seem unilaterally vulnerable to severe deflation. Lazy, indeed.

Jun 18 05:10 PM

[Gardener:]

Why would anyone advocate laziness in protecting wealth?

Jun 18 05:36 PM

[Henry Buttal:]

OK, you reference "Ivy Timing" in the comparison table.

Now I have to buy your book to determine what that means.

Jun 18 06:36 PM

[rdd:]

I use the Vanguard LifeStrategy funds which are relatively simple total US stock, foreign stock, total US bond market, and cash allocations. They are surprisingly difficult to beat over the long-run becasue of the diversification and low costs. I would recommend them as simple benchmarks for individuals to compare their active portfolios against.

Since the series has varying equity allocations ranging from about 80% to 20%, you need to compare your portfolio against the right fund. It is is useful to compare against multiple funds though to gauge the impact of different asset allocations over the long-term and during periods of rapid, dramatic change.

Jun 18 09:30 PM

[nym:]

Vanguard's Asset Allocation is over 20 years old and has not been a sterling performer, e.g., if you bought in 1999, you'd be down about 20% now. By "lazy" I think Faber is referring to allocations fixed to narrow ranges. With Vanguard's LifeStrategy you'd need to rebalance in a timely manner among the funds.

Jun 18 10:21 PM

[Sven T.:]

The problem with passive strategies is that they are exceptionally vulnerable to extreme situations. This vulnerability lies at the heart of the current criticism of Modern Portfolio Theory (MPT) and the Capital Asset Pricing Model (CAPM). Who's doing the criticizing? Folks like Prof. Taleb and Warren Buffett among others. So what's the deal?

First, when statisticians develop a model, it is common practice to completely ignore extreme events which occur only very rarely in the data. These extreme events are called outliers. Statisticians delete outliers from the data set before they run their analysis. They justify this because it "normalizes" their results under normal conditions. Unfortunately, when abnormal conditions occur, these models become completely useless. This is the heart of Prof. Taleb argument against CAPM and passive strategies in general. They may perform well in smooth waters and light storms, but they almost always fail to do their job when the hurricanes hit.

Second, the efficient market hypothesis states that since all available information is already priced into the stock, the best strategy is to mirror the market and keep costs low. But Mr. Swensen admits that some players (read hedge funds) are able to consistently take advatage of inefficiencies in the market and achieve positive alpha. This is at the heart of his book, "Pioneering Portfolio Management." His point in "Unconventional Success" is that individual investors cannot do this and should stay passive, instead. What nobody is asking is, "what are these inefficiencies the Yale sub-managers are taking advantage of?" We know who the winners are. But who are the losers? Could it be investors in passive funds and ETFs?

In at least one case, the answer is, "yes." ETFs trade openly on the market, yet the price is *usually* kept in line with NAV. How? If the market price is too high, big enough players can buy the underlying basket, short the ETF and trade in their individual shares for shares in the ETF to close the trade. Risk-free profit courtesy of you, the passive investor. If the price of the ETF is too low, these big players can go the other direction and bring the ETF back up. Unfortunately, recent history in bond ETFs shows that the arbitrage players are much more careful about taking the trade the other way, especially if the market in thin for the underlying securities.

I'm not suggesting that passive investing is wrong or foolish. What I am saying is that they are plenty more hidden costs involved that investors need to be aware of.

Jun 19 11:05 PM

[E.D. Hart:]

Going forward it might make more sense to be long:

Commodities 25%
US Stocks 20%
International Large cap 20%
Emerging market 15%
International bonds 15%
Short: US 10-30 Tres. (TBT) 5%

Whole asset classes will under perform for decades. (US Real Estate anyone?)
Just a thought, thank for the thought provoking article.

Jun 22 05:49 PM

[Sovestor:]

Good information. The lazy portfolio is...well...designed for lazy investors...nothing bad about that as long as those investors have long-term perspective and patience to withstand ups and downs.

Jun 22 08:28 PM

[dirty_dirty:]

what's wrong with a nice s&p 500 index fund? like the toyota commercial. everyone compares their car to a camry. why not own a camry? same thing here. all equity funds compare themselves to their benchmark. and rarely do they beat them.

Jun 23 10:28 AM