Asset Allocation

Above, I've shown a chart depicting asset class returns for both 2014 and longer term.  This slide is from the presentation put together each quarter by the folks over at JP Morgan Asset Management.  You can see the whole thing here.  I've blown this up on the blog as large as I can so you can see each of the style boxes more clearly.   I want you to focus on the white box with the line through it marked asset allocation.

The asset allocation story gets lost in years like 2012 and 2013 when a major and well known index like the S&P 500 posts above average returns.  What investors should focus on however are  the longer term returns.  In JP Morgan's work the long term returns {2005-2014} of an asset allocation strategy show investment returns roughly a percentage point lower than the Russell 2000 and the S&P 500 but in 4th place overall.  This despite never having a year when an asset allocation strategy would have been the top performing asset.  

This should make sense as a strategy that spreads your money around will benefit from the winners but also be dragged down by the losers.  Of course if one could see perfectly into the future then we could avoid the losing asset classes and overweight the winners.  Nobody is that good all of the time. To point that out  let's take a look at the asset class for REITS or Real Estate Investment Trusts shown above.

REITS are the second best performing asset class longer term in JP Morgan's work, while also being  the best performing asset class in nearly half of the years listed in the study.  REITS significantly underperformed the major markets in 2013 when investors worried about rising interest rates and a slowing economy.  Given what we knew at the beginning of last year and given the performance of REITS in 2013, how many people would have picked them to be the best performing asset class in 2014?  Well not many did.  

The real benefits of asset allocation are apparent in 2008.  Asset allocation strategies lost nearly 25% in value in that terrible year.  But that is a lot better than the equity related portions of the investment curve.  These all lost in excess of 30-50% of their value back then.  Which leads to the other major benefit of asset allocation.

You win more by losing less!  The way the math works it takes a 11.1% return to recover from a 10% decline and a 25% return to get back to even from a 20% decline.  An asset class like emerging markets back in 2008 had to make in excess of 110% in order to just make back that 53.2% loss.   Asset allocation strategies typically have less of a road to travel back after market declines.  Along with spreading risk and having the potential to lower volatility, the real advantage of asset allocation is that it keeps you in the game by usually giving investors the potential for lower declines in portfolio values during corrections.

We have our own take on asset allocation via our various investment strategies but the importance of the asset allocation is worth remembering after a pretty good run for equities when these sort of disciplines may come into question by both investors and the chattering investment classes.

*We are long various asset classes depicted above via ETFs  in client and or personal accounts.  Positions can vary in accounts depending on account strategy and the unique risk/reward characteristics of our clients.