The year just passed was kind to investors holding risky assets. The Global Market Index (GMI), a passive benchmark that holds a broad mix of the world’s major asset classes, posted a strong 11.0% total return in 2012. That’s a sharp rebound from 2011’s disappointing 1.1% decline.
GMI’s handsome gain for the year was fueled by powerful gains in emerging market stocks (+18.2% in 2012), REITS (+17.8%), and foreign equities in developed markets (+17.3%). The only loser of any significance in broad terms: commodities overall, which fell slightly (-1.1%), largely due to lesser energy costs.
An 11% gain for GMI represents a fairly high bar for active managers in historical terms. In order to beat the benchmark within the context of a diversified strategy, managers had to take on a good deal more risk. For those that did, and failed, the comparisons with GMI (and similar indices) for 2012 are apt to be harsh.
Assuming, of course, you’re looking at the numbers. Benchmark analysis for asset allocation isn’t widespread, and so managers with relatively weak hands for 2012 will probably go unnoticed. It’s also easier to charge a higher fee for broad diversification across asset classes compared with single-asset class strategies.
How much is asset allocation advice worth? In search of an answer, you might start by asking how the real world results of a manager compare with GMI. Even better, take a look at how the investable version of GMI fared. This is simply replicating GMI with representative ETFs, a strategy that costs less than 50 basis points and returned 12% last year, as noted in the table above. Portfolio advice that charges more than 50 basis points may still be worth the price tag, but you should have a clear idea of why you’re paying more.
If your answer is primarily based on expectations of earning superior returns through time, that’s usually a sign of trouble. Why? I’ll outsource the answer to Bill Sharpe’s classic explanation: The Arithmetic of Active Management, a.k.a., the zero-sum reality for the supply of investment returns. Risk-adjusted performance is another story, but that’s a topic for another day.