July 30, 2012
Asset Allocation Could Use A Few Good Benchmarks
A pair of analysts at Lyxor Asset Management have a request for index vendors: create a new generation of multi-asset class benchmarks. "The need of such indexes is crucial for all investors that manage multi-asset classes," write Rodolphe Louis and Thierry Roncalli. "Today, it is unthinkable to manage an equity or a fixed-income portfolio without a reference to a benchmark. And this benchmark is generally an index representing the market portfolio." It's time for a renewed focus on stock/bond indexes, they assert. While we're at it, let's develop a suite of multi-asset class indexes beyond a basic equity/fixed-income mix.
Finding good indexes that track passive multi-asset class combinations shouldn't be a chore. Quick, name an asset allocation benchmark from a major index provider... coming up with a blank? You're not alone. Finding a robust, transparent index for asset allocation isn't impossible, but it isn't easy either, which is one reason why I created the Global Market Index (GMI) and update its performance in context with the major asset classes every month. Not surprisingly, GMI's performance is competitive, to say the least, with a broad sample of actively managed multi-asset class funds. Nonetheless, the world needs more GMI-type benchmarks from the usual suspects--and they need to be conspicuous.
That's probably hoping for too much. For the same reason that the design and management of asset allocation too often takes a back seat to sexier investment subjects, building and promoting multi-asset class indexes tends to be an after-thought, if that. Perhaps the marketing opportunities are unattractive. Or could it be that investor demand is minimal? Whatever the reason, investors suffer. Without a clear and transparent yardstick of the broad playing field, it's hard to know if professional fund managers and financial planners are adding value without a fair amount of due diligence. It's also hard to properly frame your investment decisions without first considering the opportunity set in broad, objective terms.
As Andrew Ang of Columbia Business School advises: "The foundation for a long-term investment strategy is rebalancing to fixed asset class positions, which are determined in a one-period portfolio choice problem where the asset weights reflect the investor’s attitude toward risk. Rebalancing is a counter-cyclical strategy that has worked well even during the Great Depression in the 1930s and during the Lost Decade of the 2000s."
This is old news, of course, or at least it should be. It's also news that implies that passive, multi-asset class benchmarks, such as GMI, should be standard fare at this point. The reality, alas, is that it's still hard for the average investor to find robust indexes of even stock/bond mixes. That's a sign that something's amiss in the world of investment analysis and index design.
The problem starts with the overemphasis—an obsession, really—in tracking and analyzing individual asset classes in isolation of their counterparts. Ground zero for this obsession is, of course, all the light and heat about the stock market and where it might be going, or not, next month.
The fact that the world is teeming with indexes that slice and dice equities into broad and narrow pieces is Exhibit A for thinking that the analytical focus that prevails is unhealthy for investors' long-term financial objectives. Yes, there's a genuine need for stock market indexes—and for other individual asset classes as well. But the dearth of obvious benchmarks for asset allocation is a black eye for the cause of developing strategic investment perspective.
Even worse, the opportunity to buy the ETF equivalent of a GMI or equivalent--along with some basic variations such as an equally weighted GMI fund--is an oversight that deserves a solution. Such funds would be ideal as core portfolios, which can form the foundation for a customized investment strategy. We are at a point where virtually all the major asset classes are now available in ETF (or ETN) form. In some cases, the supply greatly exceeds a reasonable menu of choices. It's time to move to the next level in the analysis of combining asset classes and offering simple, clear-headed benchmarks, related analysis and low-cost ETF solutions. Yes, there's been some progress on this front, particularly in the separate account world. But in the wider realm of money management, these topics are rarely treated as a priority.
The fact that the underlying research that inspires managing a mix of asset classes has been around for decades is yet another reminder that there's a big hole in serving the public's best interests in matters of money management. No wonder that several studies (including this 2010 research paper) tell us that relatively few investors exploit market volatility through timely rebalancing strategies. Shocking? Not really. It's hard to optimize something you're not monitoring all that closely.
Posted by jp at July 30, 2012 9:45 AM
There appears to be new interest in a global portfolio.
IGOV has mysteriously gone up in market cap to over $300 million.
I've rarely seen ETF/ETN's gain market cap while their performance has lagged. Any insights?
Posted by: preserve at July 30, 2012 11:56 AM