Lazy ETF Portfolios Inspired By The Gurus

One of the most often asked questions I get regarding my paper is "Why do you have such a large allocation to real assets?" (i.e. I divide the asset classes evenly with 20% weightings, thus assigning 20% each to Commodities and REITs).

The main reason was making the portfolio as simple as possible. Second, I wanted to emulate the endowment method of investing. As described in a previous post where I examined the Harvard and Yale endowments - once you stripped out the private equity and hedge funds (something the typical retail investor doesn't have access to and they are neither liquid nor exchange traded), and then averaged the two endowments, the results were a near even distribution between US Stocks, Foreign Stocks, Real Estate, Bonds, and Commodities.

Inspired by all the Laziness going on at the Kirk Report (they're reporting on Guru recommended asset allocation weightings), we set up to examine the historical performance of each Guru portfolio since 1972. We will provide both historical returns for that strategy, as well as the results had you used my timing method. All results are total return, gross of any fees or taxes, and rebalanced.

Portfolio will refer to buy and hold, while "Timing" will refer to the trendfollowing method outlined in my paper. Sharpe uses 4% rfr, and MaxDD = maximum drawdown since 1972.

Example ETFs that reflect asset classes discussed in this article are: US Stocks (SPY), REITs (VNQ), Foreign Stocks (EFA), Commodities (GSP), US Govt. Bonds (IEF).

1. Endowment Model (From my paper)

20% US Stocks (S&P 500)
20% Foreign Stocks [MSCI EAFE]
20% US 10Yr Gov Bonds
20% Commodities [GSCI]
20% Real Estate [NAREIT]

2. 60/40 Standard Allocation

60% US Stocks, 40% US Bonds

3. 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

4. Swensen model, from his book Unconventional Success

30% US Stocks
20% REITs
20% Foreign Stocks
30% Bonds (He recommends short term US and TIPS)

5. William Bernstein Basic No-Brainer Portfolio

25% US Stocks
25% Small Cap Stocks (We use Nasdaq as our small cap index doesn't start till 1978)
25% International Stocks
25% Bonds

Here is a summary of the results for the Buy and Hold allocations (Note that the Timing model increased the Sharpe ratio in every case). As you can see, the endowment method produces both the highest CAGR with the lowest volatility (lower than bonds), resulting in the highest risk adjusted returns. This is very likely due to the inclusion of commodities into the portfolio, an allocation that Guru's have been missing for a long time. What is interesting to note is that virtually all the Guru portfolios have about the same characteristics, notably not acting much differently than a simple 60/40 stock bond allocation. The endowment method produces returns that are equity like, with bond like risk and drawdown measures. As is often missed in the asset allocation debate, the golden key is finding truly uncorrelated asset classes. . .Comic books anyone?

What Buy and Hold Allocation had the best risk adjusted returns? In order from Best to Worst was (Sharpe, CAGR):

Endowment .75, 11.57%
Swensen .56, 10.80%
Tobias .53, 10.69%
60/40 .52, 10.43%
Bernstein .44, 10.66%
S&P500 .41, 11.24%
Bonds .39, 8.35%

Below are the equity curves that closely resemble rainbows. . .both log and non-log.

Comments

[R. Ford:]

Excellent article - thanks! One tiny note: Though a bit confusing, I think Swenson advocates *long*-term Treasuries, not short-term ones (balanced equally with TIPs at 15% + 15% of the portfolio total). (I'm playing with a 10%/10%/10% allocation to long-term Treasuries, TIPs and cash.)

2007 Feb 15 09:44 AM

[Rik Kwan:]

One BURNING question I have is: how often does one re-balance the portfolio assuming that they are following the Endowment Model? In David Swensen's book, he advocates rebalancing as often as possible, but that is not practical for the average investor. However, I have also read completely different viewpoints, such as rebalancing only when the investments are at extremes (for example, if the S&P500 was at 3 std deviations from its 200dma, then it would be a good time to rebalance and sell some stocks). Such a viewpoint was hinted at in Barton Biggs' book Hedgehogging (and he was talking about Swensen's approach--which is why I am confused!!!). Thank you for your time and I am eager to hear people's responses.

2007 Feb 15 12:11 PM

[MachineGhost:]

It seems reasonable enough to rebalance at the end of April before the seasonally negative 6-month period for equities.

2007 Mar 28 11:39 PM

[Geoff Consi...:]

Hi:

Where can I get a copy of your paper? The link above only gives me the abstract.

Geoff

2007 Feb 15 03:29 PM

[WorldBeta:]

Here:

papers.ssrn.com/sol3/p...

2007 Feb 22 12:20 PM

[MachineGhost:]

Indeed, Swensen recommended 30% domestic equity, 15% developed market, 5% emerging market, 15% U.S. long-term Treasury bonds, 15% TIPS/I-BONDS and 20% real estate, so the Swenson model as currently presented is totally incorrect.

2007 Feb 16 03:01 AM

[WorldBeta:]

Sorry, I am aware of the exact allocation, but to compare apples to apples (some of the time series dont go back to 1972), I had to lump some together. . .

2007 Feb 22 12:21 PM

[Javaharv:]

I may have missed it, but what is CAGR???

2007 Feb 17 10:57 AM

[Vinsanity:]

Compound Annual Growth Rate

2007 Feb 21 03:13 PM

[Javaharv:]

As for the bond allocation, wouldn't a floating rate holding make the most sense, given the unpredicability of rates. Why hold long bonds and endure principal volitility for so little relative yield?

2007 Feb 17 11:02 AM

[MachineGhost:]

The long-term Treasuries are there to act as protection against deflation and financial crisis, such as what occured briefly around Feb 27, 2007. Also, I-Bonds will not be allowed to go under the starting principal in a deflation as opposed to TIPS, so that gives them an added advantage at cost of liquidity.

With PowerShares' new Private Listed Equity ETF and Rydex's Managed Futures, Hedge Fund and Long/Short mutual funds, it's easier to emulate the Yale Endowment than ever before. The last major shortcoming is there is not yet a Real Asset ETF/fund focused on providing current income (inflation protection). I don't relish the work of managing numerous MLP's, Canadian royalty trusts, REIT's, etc..

2007 Mar 28 11:28 PM