quigleydoor
07-18-07, 03:04 PM
Some people were interested in reading more about the asset allocation policy I have been using, since it has earned steady returns with low risk. (I previously boasted that my retirement funds have earned 12% annualized returns since mid-1999, with only 2% maximum drawdown. For the record the actual maximum drawdown, between 12/2000 and 9/2001, was 22%. However this was fully recovered by 6/2002.) The point is, diversification has worked well.
My allocation policy has become more sophisticated or nuanced over the years, as I have combined the results of different authors' research. The first really compelling research that I acquired was a paper by Christopher Moth, an international bond portfolio manager at Delaware International Advisers. That paper is no longer online, but you can read my synopsis of it in <a href="http://socialize.morningstar.com/NewSocialize/asp/FullConv.asp?forumId=F100000079&convId=152389&t1=1184788827">this Morningstar thread</a>. (I tried to upload a PDF of the paper, but the iTulip server is too busy.)
Quoting from my 8/16/2005 post on Morningstar:
I'd like to clarify what I think the original poster is doing. He/She recognizes the fragility of the financial system, and is interested in <b>preserving value</b> in the face of many possible disaster scenarios. Instead of relying on supposedly risk-free government paper to preserve value, he/she is using a diversified approach. If USD securities become worthless, then maybe foreign ones will be okay. If the whole system caves in, there will still be commodities which retain some value.
I hold the same view, and have used the Christopher Moth paper (cited in my previous post) as a touchstone. I use his best return/risk asset allocation as my core portfolio:
<table>
<tr><td>American stocks (S&P 500)<td>31%
<tr><td>US Treasury bonds (SSB GBI)<td>24%
<tr><td>Foreign government bonds (SSB WGBI ex-US)<td>22%
<tr><td>A basket of commodities (GSCI)<td>23%
</table>
Moth states that this portfolio has an expected annual return of 11.5% (not adjusted for inflation, not reflecting management fees) and a risk of 7.5% (measured as standard deviation of quarterly returns). This is based on a regression analysis of data in the period 1973–2000—a period which experienced a bad streak of stagflation as well as the best, longest bull markets for stocks and bonds in the 20th century (1982–2000).
My over-arching belief is that I cannot guess what is going to happen, or how long it is going to take to happen. While I am pessimistic about the financial system's health, I am also impressed by how long the central planners (erm, I mean central bankers) have kept the game going. They might have a few more tricks up their sleeves. So instead of positioning for stagflation or for more bull markets, I maintain a core portfolio which I can expect to do well in many possible futures.
In addition to the core, I keep a growth portfolio, about 10% as big as the core portfolio, where I speculate.
Since reading Moth, I have come across other studies which do not emphasize foreign bonds as much. In another post I will discuss some of the reasons behind that difference (not all of which I agree with, or understand).
My allocation policy has become more sophisticated or nuanced over the years, as I have combined the results of different authors' research. The first really compelling research that I acquired was a paper by Christopher Moth, an international bond portfolio manager at Delaware International Advisers. That paper is no longer online, but you can read my synopsis of it in <a href="http://socialize.morningstar.com/NewSocialize/asp/FullConv.asp?forumId=F100000079&convId=152389&t1=1184788827">this Morningstar thread</a>. (I tried to upload a PDF of the paper, but the iTulip server is too busy.)
Quoting from my 8/16/2005 post on Morningstar:
I'd like to clarify what I think the original poster is doing. He/She recognizes the fragility of the financial system, and is interested in <b>preserving value</b> in the face of many possible disaster scenarios. Instead of relying on supposedly risk-free government paper to preserve value, he/she is using a diversified approach. If USD securities become worthless, then maybe foreign ones will be okay. If the whole system caves in, there will still be commodities which retain some value.
I hold the same view, and have used the Christopher Moth paper (cited in my previous post) as a touchstone. I use his best return/risk asset allocation as my core portfolio:
<table>
<tr><td>American stocks (S&P 500)<td>31%
<tr><td>US Treasury bonds (SSB GBI)<td>24%
<tr><td>Foreign government bonds (SSB WGBI ex-US)<td>22%
<tr><td>A basket of commodities (GSCI)<td>23%
</table>
Moth states that this portfolio has an expected annual return of 11.5% (not adjusted for inflation, not reflecting management fees) and a risk of 7.5% (measured as standard deviation of quarterly returns). This is based on a regression analysis of data in the period 1973–2000—a period which experienced a bad streak of stagflation as well as the best, longest bull markets for stocks and bonds in the 20th century (1982–2000).
My over-arching belief is that I cannot guess what is going to happen, or how long it is going to take to happen. While I am pessimistic about the financial system's health, I am also impressed by how long the central planners (erm, I mean central bankers) have kept the game going. They might have a few more tricks up their sleeves. So instead of positioning for stagflation or for more bull markets, I maintain a core portfolio which I can expect to do well in many possible futures.
In addition to the core, I keep a growth portfolio, about 10% as big as the core portfolio, where I speculate.
Since reading Moth, I have come across other studies which do not emphasize foreign bonds as much. In another post I will discuss some of the reasons behind that difference (not all of which I agree with, or understand).