(June 12, 2013) – The few investors who stuck by their classic 60/40 portfolios post-financial crisis have likely been laughing all the way to the bank.
A new paper published by asset manager/outsourced CIO firm HighVista Strategies found most investors did learn from the draw downs and diversify. Unfortunately, many have paid for their “free lunch” with returns.
From 2007 through March 2013, portfolios with assets such as foreign equities and real estate showed greatly increased volatility and lowered rate of returns, whilst safe haven US treasury bonds have decreased volatility and increased returns.
“Investors should factor changing asset class volatilities and correlations into their investment policies and strategies, which also necessitates the use of a shorter time horizon for asset allocation,” HighVista authors Jesse Barnes (managing partner) and André Perold (CIO) suggested.
Diversification via emerging markets, real assets, hedge funds, private equity, and other less traditional assets had previously granted outsized returns to large investors, such as university endowments and pension funds.
However, things have changed.
The study compared a 60/40 portfolio (stocks to bonds) with a model fully diversified portfolio containing US equities (20%), developed equities (20%), emerging equities (10%), US REITs (10%), commodities (10%), and US bonds (30%). From 1972 to 2007, the diversified portfolio had significantly lower volatility than the 60/40 portfolio, while also receiving a higher average returns.
However, since 2007 the diversified portfolio has delivered less than half of its average return from prior years with 60% more volatility. The 60/40 portfolio, in contrast, had similar volatility and real return in both periods. The old adage the only “free lunch” is diversification is no longer applicable in the post financial crisis, according to the outsourced CIO firm.
The study concluded that risk characteristics of asset classes will change over time, and investors should evaluate asset classes through the lens of required returns.
“The recent outperformance of the 60/40 portfolio is a significant outlier in the context of a longer history,” Barnes and Perold pointed out.
