This chapter is from the book
This chapter is from the book
This chapter is from the book
Summary
One can already find a number of morals of the asset-allocation story at this point. One deduction can be that those who rotate among the various asset classes are in for a rough ride. The data show that it is extremely difficult to randomly select the top performers each and every year. Although this can be somewhat discouraging, an upside does exist: It is also extremely difficult to choose the worst-performing asset class every single year. As well, it is fairly easy to randomly be above the median almost half the time, which means one-year buy-and-hold strategies are likely to generate average returns.
One question immediately comes to mind: Why not buy and hold a single asset all the time? The data provides the answer. Table 1.2 reports the average returns realized for each year by selecting the top-ranked asset class, the second-ranked class, and so on, for each year. Holding one asset class for 30 consecutive years (see Table 1.4) contrasts these returns with the returns produced. Looking at the 30-year example, it is apparent that the best-performing asset class—small caps—would only rank in the second or third tier of a strategy that chose the top-performing asset class each year. Large-cap, value, and growth stocks rank in the third (median) tier, while fixed income and international stocks rank in the fourth (median) tier. These results suggest rotating among the asset classes has the potential of expanding the upside, as no single asset held for all 30 years would take one to the top of the heap. On the other hand, one pays a price for increasing the upside: The downside is also increased. Each asset class, if held for the last 30 years, would have produced a performance well above those asset classes in the bottom two tiers, as reported in Table 1.2.
Table 1.4 Growth of $1 invested in each of the seven asset classes: January 1975–December 2004.
|
|
Growth of $1 |
Returns |
|
Small-Cap |
$184.38 |
18.99% |
|
Value |
$61.23 |
14.70% |
|
Large-Cap |
$47.70 |
13.75% |
|
Growth |
$33.39 |
12.41% |
|
International |
$16.96 |
9.90% |
|
T-Bonds |
$15.49 |
9.61% |
|
T-Bills |
$5.98 |
6.14% |
So, what have we discovered? A traditional strategic asset allocation can easily deliver a performance that is about average over a long horizon. A strategic allocation, however, that does not rotate among the various asset classes precludes it from capturing the upside the returns of the asset classes the top tier generates. Hence, if the upside of asset returns is to be realized, an active strategy that enhances strategic asset allocation must be developed.