Asset Allocation & Rebalancing: (Still) Competitive Together

Passive asset allocation will never win any awards or front-page profiles, but it’s a competitive strategy that quietly and consistently delivers average to above-average performance relative to a broad spectrum of multi-asset class funds. That’s been the message through the years, as noted in the periodic updates on this front (see last October’s review of the numbers, for instance). Has anything changed three months later? Not really. Owning a wide selection of the major asset classes continues to give the majority of higher-priced active strategies a run for their money.

For instance, here’s how the horse race stacks up for the 10 years through the end of 2012 (see chart below). Once again, the Global Market Index (GMI), which is an unmanaged value-weighted mix of the major asset classes, has remained competitive against active funds that are fishing in the same strategic waters. To be precise, GMI’s trailing 10-year annualized total return continues to hang out in the 75th-percentile performance neighborhood vs. nearly 1,300 actively managed multi-asset class mutual funds with at least 10 years of history. Not bad for a know-nothing strategy that can be implemented for less than 50 basis points by anyone and everyone.

A regular regimen of year-end rebalancing back to market weights has a habit of juicing GMI’s returns a bit, pushing the 10-year results modestly higher, as shown by GMI-R. Equally weighting all the asset classes and rebalancing back to equality every December 31 does even better (see GMI-E).
Here’s how the chart above looks in terms of the underlying numbers:
The message once again is that you can grab quite a lot of the risk premia in the world with broad diversification across asset classes for minimal effort. Rebalancing the mix is a simple overlay for controlling risk, and it holds out a decent chance of boosting performance slightly through time. The combination of those two investing decisions is a powerful pairing. For most folks (and probably a good number of institutional investors as well) that’s about as far as they should travel on the money management road. Yes, some brilliant investors do better, but that thinly populated club is likely to be a lonely gathering at the annual reunion.
Should we be surprised by GMI’s routinely competitive results? Not really. As I discussed in some detail in Dynamic Asset Allocation: Modern Portfolio Theory Updated for the Smart Investor , several decades of research by financial economists have laid out the case for focusing on asset allocation and rebalancing as the primary weapons in the investing arsenal.
Theory wouldn’t mean much if the empirical record dispensed a radically different result. But as you can see from the chart above, along with a number of other real-world studies, you can do a lot with basic techniques, a bit of patience, and low-cost ETFs and mutual funds. That doesn’t mean that you shouldn’t try to do more. But the big mistake of many if not most investors is that they try to do too much.