Running The Numbers On A Strong Asset Allocation Fund

Human nature being what it is, investors are forever looking for a magic mix of investments that will soar in good times and offer a safe harbor amid turmoil. Nirvana doesn’t exist, of course. If it did, the world would figure out the secret and pile in, arbitraging away any future value in the process. Different asset allocations do generate different results over time, of course, and so we should spend time thinking how to design and manage our portfolios. But there are limits to even the best-laid plans of mice and men. The question, then, is figuring out a prudent framework for considering out options and evaluating the potential rewards. What follows is an example of how we might proceed by looking at one asset allocation fund that’s actively managed and boasts a handsome record.

The inspiration for kicking the tires comes via The Wall Street Journal, which reviews several mutual funds with encouraging track records for weathering rough seas. BlackRock Global Allocation (MDLOX), for instance, is listed as one of several mutual funds that “beat the market during the last big downturn.” Fair enough. But it’s also important to recognize what’s possible in the art of self defense in money management with minimal effort, skill or expense.
As always on these pages, I start with the Global Market Index (GMI), a passive mix of all the major asset classes weighted by market values. It’s useful to consider how GMI fared against the BlackRock fund during the worst stretch of the last downturn, as per the period noted by The Journal. I’ve adjusted the dates slightly, since The Journal picks specific intra-month days whereas I calculate GMI monthly. That said, the BlackRock fund retreated by a cumulative 26.6% from the end of September 2007 through February 2009’s close. The S&P 500 suffered a deeper loss over that span, shedding roughly 50% on a total return basis, based on data from Morningstar Principia. But that comparision’s not really fair since the S&P represents large U.S. stocks and the BlackRock fund has a broad mandate to invest across asset classes on a global basis.
For a somewhat fairer comparison, GMI was lighter by 34.3% over that span. Of course, that’s not quite realistic, since that’s reference to a paper index. That real world performance using ETFs to replicate GMI (as per the investable version of GMI, a.k.a. GMI-F) shows a modestly deeper loss of 35.8% over those 17 months through February 2009’s close.
The BlackRock fund, in short, delivered superior performance. But it’s not obvious that we’ve found strategic nirvana. Let’s play devil’s advocate for a minute and consider some facts. For starters, there’s no guarantee that what’s unfolded in the past will repeat in the future. That’s true for GMI too. But the warning is doubly relevant for actively managed portfolios with moving parts, such as MDLOX. The management team for the fund surely is a talented bunch, but there’s always an element of simple risk exposure that explains results, for good or ill. Beta, in other words, is always a factor.
Exactly how much a factor beta plays is debatable. Depending on the strategy and the manager, it’s a factor that can vary considerably. For most conventional investment strategies, however, beta’s usually a fairly large presence. The fact that GMI’s results are within shouting distance of the BlackRock fund’s performance suggests that beta—even for a broadly diversified, active asset allocation fund such as MDLOX—is more than a trivial variable.
Nonetheless, the BlackRock fund has delivered an impressive run when we look back over the good times and bad. For the five years through the end of June 2011, MDLOX posts an annualized 7% total return, according to That’s a handsome premium over GMI’s 5.1% performance, or GMI-F’s 4.8%.
On the other hand, the performance gap closes further if we consider a mindless, end-of-year rebalancing strategy for GMI that returns the mix back to its previous year’s profile: GMI-R earned an annualized 6.3% return for the five years through last month. Alternatively, an equally weighted version of GMI fared even better with a 7.4% return over that span. In fact, that’s slightly better than MDLOX’s 7% gain.
What are we to make of these numbers? There’s beta in them ‘thar performance hills, and some of the alpha can be replicated with simple rebalancing and/or minimizing hefty allocations to any one asset class.
Let’s go a step further and run a factor analysis test to evaluate beta’s influence. This is simply performing a multiple regression on the numbers by comparing the monthly risk premium for MDLOX vs. the equivalent for the proxy indices of the major asset classes (see the list here) and GMI. I chose to review the 10 years of monthly data through May 2011. The results show that roughly 97% of MDLOX’s monthly risk premium (total return less the performance of a 3-month T-bill) is driven by GMI.
Yet that small difference on average was used intelligently and efficiently by the fund’s managers. MDLOX’s alpha (statistically labeled as intercept of coefficient) is roughly 2.5% a year. In other words, the BlackRock fund over the last decade has beat GMI by around 2.5% in risk premium terms.
How did MDLOX manage that feat? In part by veering away from GMI’s passive allocation, according to factor analysis. Relative to a passive mix, MDLOX appears to have made relatively heavy bets on U.S. stocks, foreign equities in developed markets, and foreign government bonds issued by mature countries over time.
Overall, MDLOX has done a handsome job in adding value. Perhaps the record is strong enough to consider owning the fund for the future. But the managers have a high bar to overcome. MDLOX’s net expense ratio is 1.17% plus a steep one-time front end load of 5.25%, according to Morningstar Principia. That compares with GMI-F’s load-free 0.5% expense ratio.
Keep in mind too that GMI tends to fare competitively against asset allocation funds generally, as I discussed earlier this year. On average, GMI does quite well, especially after adjusting for its simplicity and low expense.
The basic message is that if we compare GMI to a broad measure of funds intent on adding value, there tends to be a handful of winners, a handful of losers and a large supply of mediocre results. MDLOX is one of the winners over the last 10 years. An impressive achievement, and one that doesn’t come easily or often to funds. Nonetheless, the issue to consider before buying this fund, or any actively managed fund, is whether you have a high degree of confidence that the past will continue to endure for positive alpha. The analysis above offers some reason for hope, although the costly fees raise some questions. In any case, additional research is required.
The broader point is that it’s important to know what risk premium is available at low cost for everyone regardless of skill. GMI is no silver bullet, but it’s a competitive benchmark and it can be transformed into an investable strategy at minimal expense. Given the transparency and simple strategy, it’s also an investment portfolio with a relatively encouraging level of reliability for delivering a modest risk premium. GMI or something similar is where the analysis should always begin.
You can do better, of course, but you should have a clear understanding of why you expect you won’t do worse. Or perhaps the better question: Why do you expect that you won’t suffer the fate of roughly half the investment community and underperform GMI?

One thought on “Running The Numbers On A Strong Asset Allocation Fund

  1. Josh

    I’m about to ‘fire’ my morgan stanely guy and move everything over to my E*Trade acct. .. i’ve been doing well with a bucket of 10 – 20 individual stocks over the past couple of years, handily outpacing the funds he has me in at MS. As I do this migration, i’m deciding whether to keep any of the funds – definitely keeping sgenx, fairx, and tibax.. on the fence with regards to wasax and mdlox… found your page researching the blogosphere for info about mdlox.
    Thanks for the article… it sounds like, if i’m already IN mdlox, you’d counsel staying in.. am I reading that right?

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