Profiling Mr. Market’s Asset Allocation

Whenever I update returns for the Global Market Index (GMI) and its components (as I did last week) or crunch the data on projecting risk premia, I invariably receive emails asking for the associated asset allocation percentages. I get the impression that some readers see the asset weights for GMI as the keys to the kingdom. In fact, the weights aren’t all that useful–except as benchmarks for customizing a portfolio and related risk management/analysis. Knowing that you’re holding more, less, or the equivalent of Mr. Market’s asset allocation is valuable information.

The passive weights for GMI are, in theory, optimal for the average investor with an infinite time horizon. As a result, GMI isn’t really practical for anyone, although one can argue that pension funds and the like with very long investment horizons should hold something comparable. In any case, GMI’s weights are useful as the default mix for research purposes. Deciding if you’re more or less risk tolerant than “the market” begins by reviewing GMI’s asset mix.

As the first graph shows, the bulk of GMI is weighted in stocks and bonds in developed markets. US equities are the biggest component at nearly 36%, as of July 2014.

gmi.1.05aug2014

For another perspective, the second chart ranks the 12-month percentage changes for GMI’s weights. For instance, US equities register the biggest positive change among the major asset classes: +4.4%, which means that the current weight (35.8%) has climbed 4.4% through the end of last month vs. a year ago.

gmi.2.05aug2014

As for the details on calculating GMI, a few issues to consider. First, the data is based on calculations using market values at the close of 1997 and letting fluctuations in market prices dictate changes thereafter. The start date is an arbitrary choice, although the reasoning is rooted in the search for a wide spectrum of asset classes as far back as possible. Obviously, certain asset classes have much longer histories. The challenge is designing an index with a global focus that captures multiple markets. Compromises, it’s fair to say, are necessary.

Another issue is how to define market values for REITs/real estate and commodities. The task is relatively easy for stocks and bonds, but the analysis is a bit tricky otherwise. The main issue with REITs/real estate is deciding if the market values should be based on listed securities—real estate investment trusts. Securitized real estate represents a small fraction of actual property values in the world. The problem is that using the market values for brick-and-mortar real estate will reflect a massively inflated market value vs. what’s available for purchase via REITs. Once again, a compromise is required, and for GMI the choice is to stick with market-cap figures via REITs.

Commodities present a similar dilemma. Aggregating the market value of actual barrels of oil, gold bars, bushels of wheat, and so on is one way to value raw materials. Another is to use the market value of outstanding futures contracts, which is a considerably lower dollar amount vs. the planet’s true market value of commodities. Once again, the design preference for GMI is to use the exchange-listed data.

Ultimately, compiling a passive benchmark to track the world’s investable assets is a guesstimate, along with a mix of subjective choices in terms of picking representative indexes, selecting markets, etc. GMI is hardly the last word on multi-asset-class benchmarks. But after more than a decade of tracking and calculating GMI in real time, it claims some real-world value for measuring performance and risk in Mr. Market’s asset allocation. It’s also worth pointing out that Mr. Market’s portfolio strategy, while hardly perfect, has proven to be competitive.

Can you do better? Sure. Indeed, much of what passes for investment strategy in the world can be reduced down to an assumption that one can enhance the risk-adjusted results that are available at virtually no cost or effort through GMI. There are sound reasons for going down this route. No one, for instance, has an infinite time horizon and so customization makes sense. At the same time, don’t fall into the trap of assuming that beating Mr. Market at his own game is easy. Investing doesn’t have to be a horse race that’s obsessed with benchmarks, but that doesn’t mean you can’t get trampled by the herd.

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