During
the financial crisis, it could be argued that the majority of diversified asset
allocation strategies failed to achieve their intended goals as asset class
correlations all seemingly dove toward 1.0 as the situation worsened. This left investors holding a bag full of
investments that had collapsed in value.
Equities, parts of the bond markets, commodities, real estate
(obviously), and alternative investments (for the most part) were all crushed. Add to that the illiquidity of certain areas
of these markets and people learned that they had really been thrown for a loop
by their investment portfolios and the advisors that had pitched them.
In a
new study, Richard Bernstein Advisors has set out to prevent such situations
from unfolding in the future with their Asset Allocation 2.0 program. We wanted to share because, at first glance,
the concept does seem to have merit. So
many advisors tell their clients that they need to own this or that simply
because it’s a “common” asset class.
Well what if many of their other holdings closely resemble it in terms
of risk and return profile? Is that
doing more harm than good? In their words:
“Traditional asset allocation
models seem obsolete. The much heralded “Endowment Model” failed in 2008, yet
asset allocators continue to cling to it as much as the Peanuts character Linus
hung on to his blanket. However, the global financial markets have changed
dramatically, and the macroeconomic backdrop that fueled the success of the
endowment approach no longer exists.
RBA’s approach, Asset
Allocation 2.0™, is based on a different asset allocation construct. We no
longer pigeonhole investments into traditional categories, such as Large Growth
or Value, Small Growth or Value, High Yield or Distressed debt, Absolute Return,
or the like. Rather, we group investments based on their returns and risk
characteristics.”
RBA’s
work argues that, “2008’s asset allocation debacle could have been mitigated or
maybe even prevented” had such strategies existed back then. We’ve linked to their introduction to the
study here.
This
current correction in the markets so far feels more like your run-of-the-mill
pullback (or maybe even a cyclical bear) and not something more sinister like
2008. However, you never know when a
confluence of events can quickly suck asset classes into behaving in similar
ways when investors just want to press the sell button. You should read the paper but if you’re
strapped for time we’ve listed their conclusions below:
Conclusions
➜ The so-called Endowment Model failed in 2008, yet investors continue to cling to the framework and ignore that the macroeconomic backdrop that fueled much of the Endowment Model’s success has significantly changed.
➜ The so-called Endowment Model failed in 2008, yet investors continue to cling to the framework and ignore that the macroeconomic backdrop that fueled much of the Endowment Model’s success has significantly changed.
➜ Asset Allocation 2.0™ is a different method for allocating
assets. Rather than relying on traditional asset categories, it seeks to
exploit sensitivities or characteristics within the global financial markets.
➜ Traditional correlation analyses can be manipulated and
should be used judiciously. Secular correlations seem much more useful.
➜ There is a spectrum of sensitivities. Investors need to
judge the cost/benefit of gaining exposures to those sensitivities.
➜ Asset Allocation 2.0™ is a dynamic process that removes the
traditional asset allocation boundaries to search for the most effective way to
gain factor exposure.
