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India Equity Research Reports, IPO and Stock News
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Part I – The conventional approach to Asset Allocation – which began with the staple 60/40 policy portfolio of stocks and bonds, before morphing into highly leverage-sensitive alternatives - is approaching a generational inflexion point in our view. As it continues to serve as the industry default setting, we begin with a
critical appraisal of the conventional 60/40 policy portfolio across long periods of time and 26 countries. The policy portfolio is built on a foundation of highly dubious assumptions, and our analysis reveals dramatic variability in 60/40 portfolio returns which could render the 4% real long-term average return in the US a frail reed to lean upon. For instance average returns to the 60/40 portfolio across seven of the past eleven decades have barely kept pace with inflation in
the US. The remaining four decades have done all of the heavy lifting, though importantly, these periods were associated with rare events: post-World War recovery (1920s and ‘50s), or a one-off secular decline in inflation and bond yields
(1980s and ‘90s). Over the course of the 1970s (a period we think bears some semblance to today), a 60/40 portfolio lost 3% p.a. in real terms across the G8 (both stocks and bonds declined). More worryingly, a 60/40 portfolio has produced
negative real returns over a rolling 10-year holding period for almost a quarter of our 111-year US sample. Severe and lengthy 60/40 portfolio drawdowns are
commonplace across countries. Our reservations with the 60/40 portfolio are magnified after reviewing its underlying risk factor exposure. On statistical
grounds, we find serious instability in the diversification properties of stocks and
bonds, as well as highly unbalanced contributions to portfolio risk, rendering
bonds inefficient hedges. On valuation grounds, we argue negative real bond yields now impair the ability of bonds to act as a shock absorber, and show real bond returns were negative for 45 years from similar valuation levels as today. We also caution the secular 1980s/90s equity bull market was driven by a fall in real
bond yields, a decline in inflation uncertainty, and a rise in the corporate profit
share of GDP - none of which can be repeated from today’s starting point. We forecast a paltry 1% p.a. in real terms from a 60/40 portfolio in the US over the next decade, well shy of long-term averages and pension fund requirements. On
economic grounds, we suggest a 60/40 portfolio is in effect 100% short both
inflation and sovereign risk, and argue a long-only stock and bond portfolio is ill-
equipped to navigate a stagflationary environment similar to the 1970s. In short,
we find the 60/40 policy portfolio unreliable, inefficient and ill-equipped.
Part II – The ‘second generation’ industry response to the challenges of the 60/40 policy portfolio was to expand into more assets, notably leverage-sensitive alternatives (HFs, real estate, private equity, infrastructure). We question this as a
viable solution, as most of these assets are short a common risk factor (along with
equities) - the soft underbelly was revealed in 2008. Against this backdrop, the asset allocation process will evolve in a number of directions in our view. First,
diversification by common risk factors and risk premias will replace conventional asset class silos as the key building blocks in portfolio construction. Second, the biological concepts of regime shifts, regime persistence and adaptation will
increasingly feature in investment management processes. Finally, the line of
demarcation distinguishing strategic and tactical asset allocation will become blurred, as best practice from the Endowment Model (with a focus on seeking
long-term risk premia) and Macro Hedge Fund community (centered upon risk management) is fused together.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Part I – The conventional approach to Asset Allocation – which began with the staple 60/40 policy portfolio of stocks and bonds, before morphing into highly leverage-sensitive alternatives - is approaching a generational inflexion point in our view. As it continues to serve as the industry default setting, we begin with a
critical appraisal of the conventional 60/40 policy portfolio across long periods of time and 26 countries. The policy portfolio is built on a foundation of highly dubious assumptions, and our analysis reveals dramatic variability in 60/40 portfolio returns which could render the 4% real long-term average return in the US a frail reed to lean upon. For instance average returns to the 60/40 portfolio across seven of the past eleven decades have barely kept pace with inflation in
the US. The remaining four decades have done all of the heavy lifting, though importantly, these periods were associated with rare events: post-World War recovery (1920s and ‘50s), or a one-off secular decline in inflation and bond yields
(1980s and ‘90s). Over the course of the 1970s (a period we think bears some semblance to today), a 60/40 portfolio lost 3% p.a. in real terms across the G8 (both stocks and bonds declined). More worryingly, a 60/40 portfolio has produced
negative real returns over a rolling 10-year holding period for almost a quarter of our 111-year US sample. Severe and lengthy 60/40 portfolio drawdowns are
commonplace across countries. Our reservations with the 60/40 portfolio are magnified after reviewing its underlying risk factor exposure. On statistical
grounds, we find serious instability in the diversification properties of stocks and
bonds, as well as highly unbalanced contributions to portfolio risk, rendering
bonds inefficient hedges. On valuation grounds, we argue negative real bond yields now impair the ability of bonds to act as a shock absorber, and show real bond returns were negative for 45 years from similar valuation levels as today. We also caution the secular 1980s/90s equity bull market was driven by a fall in real
bond yields, a decline in inflation uncertainty, and a rise in the corporate profit
share of GDP - none of which can be repeated from today’s starting point. We forecast a paltry 1% p.a. in real terms from a 60/40 portfolio in the US over the next decade, well shy of long-term averages and pension fund requirements. On
economic grounds, we suggest a 60/40 portfolio is in effect 100% short both
inflation and sovereign risk, and argue a long-only stock and bond portfolio is ill-
equipped to navigate a stagflationary environment similar to the 1970s. In short,
we find the 60/40 policy portfolio unreliable, inefficient and ill-equipped.
Part II – The ‘second generation’ industry response to the challenges of the 60/40 policy portfolio was to expand into more assets, notably leverage-sensitive alternatives (HFs, real estate, private equity, infrastructure). We question this as a
viable solution, as most of these assets are short a common risk factor (along with
equities) - the soft underbelly was revealed in 2008. Against this backdrop, the asset allocation process will evolve in a number of directions in our view. First,
diversification by common risk factors and risk premias will replace conventional asset class silos as the key building blocks in portfolio construction. Second, the biological concepts of regime shifts, regime persistence and adaptation will
increasingly feature in investment management processes. Finally, the line of
demarcation distinguishing strategic and tactical asset allocation will become blurred, as best practice from the Endowment Model (with a focus on seeking
long-term risk premia) and Macro Hedge Fund community (centered upon risk management) is fused together.
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