There was an interesting article on Seeking Alpha this weekend in which author Daniel Moser dissected the 60/40 stock/bonds allocation. His starting point was that the "normal' 60/40 portfolio grossly tilts risk toward the equity portion, such that a 60/40 exposure results in a 95/5 allocation of risk taken. (I read the article twice and did not see where he defined how he measured risk so, to keep my post simple, I will just work with his assumptions.) He then tweaked a very basic starting point of SPY/AGG into a combo of SPY and some different bond funds so that the stock bonds mix was 40/60, yielding a more balanced mix of risk between stocks and bonds.
What Moser appears to be doing is something that Cliff Asness from AQR has talked about, which is allocating risk though not necessarily allocating asset classes. In noting a 60/40 portfolio consisting of SPY and AGG, in which almost all of the risk is saddled on the SPY side of the ledger, Moser writes that "most will agree" that "this is hardly a diversified portfolio."
While Moser is asking some good questions, I could not find where he tells us why it makes for poor portfolio construction to have 95% of the risk (again he did not define what he meant) isolated in the equity exposure. What he seems to be saying is that risk (what he means by the word) should be more balanced between the two asset classes; as such, I think he was saying to allocate more to bonds, but to take more risk with your bonds so that you can have less exposure to equities.
This doesn't make a lot of sense to me, if that is what he is saying, for a couple of reasons. First, depending on how more risk is taken in the fixed income market you might as well be in equities; at times the correlation between equities and high yield debt can be very high. The other thing is that many people think they own any fixed income at all to offset normal stock market volatility (volatility and risk are not the same thing).
If that is the reason that many investors own fixed income (I believe it is) then it is not clear what the benefit would be to have less equities while increasing the risk of the fixed income allocation. Also missing from the discussion was the fact that risk can change over time. Generically speaking the US 10-year has more risk at 1.7% than it did at 2.7% than it did at 5.7%. Bond risk going forward could be much different than it was looking back.
I would say that I do not believe that the risk needs to be allocated in the manner that I think Moser is talking about. If the conversation gravitates to several different asset classes, as Asness discusses, then that could very well be a different story.
Again, I think the article asks a very good question. Having a suitable asset allocation is a crucial element to a financial plan succeeding but it is also difficult to construct. Go too aggressive and the risk becomes panic selling at a generational low but going too conservative could result, of course, in coming up short.
Because this is so important it is worth exploring different theories (for those inclined to spend the time). If Mr. Moser comes back to tell us why we should consider his theory, I would be very interested. For now I will continue to view equities as the core asset class and use the other asset classes to try to smooth out the ride and reduce correlation. At our firm this obviously includes fixed income and gold for almost every client but has also included foreign currency and absolute return.