The Power Of Two Simple Investing Ideas

In theory, the recent increase in market volatility opens the door for superior results from active management. In practice, it’s still hard to beat relevant benchmarks. You wouldn’t know it from the promises from the usual suspects, but the numbers suggest another reality.

Every few months I like to review how my proprietary benchmark that passively weights all the major asset classes—the Global Market Index (GMI)—fares vs. a broad swath of actively managed multi-asset class funds. Once again, the results are typical: GMI delivered a competitive above-average return relative to the competition.
For example, consider GMI’s track record over the last 10 years through the end of this past July. This unmanaged, market-valued weighted index posted an annualized total return of 6.5% over that decade-long stretch. That translates into well-above average performance relative to more than 1,000 actively managed mutual funds and ETFs toiling away with a multi-asset class mandate of one form or another.

Using Morningstar Principia software, I screened for funds with at least 10 years of history in the following Morningstar categories: conservative, moderate, aggressive and world allocations, along with balanced funds. I looked only at distinctive portfolios to throw out various share classes of the same funds. The result was a hodge-podge of funds in excess of 1,000 products. A handful delivered stellar results. In fact, the leading fund has been nothing less than amazing (see black line in chart above). Maybe it’ll deliver equally strong results in the decade ahead. Then again, maybe not. GMI, on the other hand, is likey to remain an average, perhaps an above-average performer.
Presumably, high expectations also accompanied investors in the worst performing fund over the last decade (red line in chart above). This unfortunate product somehow managed to suffer an annualized loss of 1.3% over the past 10 years.
The bulk of the funds did much better, of course, although the results are fairly mediocre. The fund in the 75th percentile—i.e., the fund that outperformed three-fourths of its competition—earned 5.2% a year. Not bad, although GMI did moderately better.
In fact, if you mindlessly rebalanced GMI, you could have enjoyed an even higher return for virtually no extra risk. Returning GMI’s asset allocation back to its year-earlier mix every December 31 (GMI-R) boosted results to roughly 7.3% a year (see red line in the second chart below). Meantime, a “model-free” allocation plan of equally weighting the major asset classes (and returning the mix to equal weighting at the end of each year) fared even better (GMI-E), delivering a 9.6% annualized total return (gray line in chart below) vs. 6.5% for the unmanaged, unrebalanced GMI.

Ah-ha! you say. GMI and its counterparts are theoretical indices. What about real world results? Well, you can replicate GMI with ETFs for less than 50 basis points. That compares with expense ratios that are typically higher in the 1,000-plus-fund universe noted above. In fact, it’s not uncommon to see funds in this niche charge 100 or even 200 basis points or more. That’s a performance drag that weighs heavily on results as the years go by, and so you need to be one extraordinary manager to overcome this headwind. As the first chart above reminds, most managers fall short of the challenge.
Granted, none of this is terribly surprising. It’s hard to beat a broadly diversified asset mix over time. Meantime, the idea that you can earn a premium with little or no risk by rebalancing a broad array of asset classes isn’t radical either, at least not in some circles. Judged by where investors end up putting their money, however, all of this seems to fall on deaf ears.
Don’t misunderstand: the analysis above isn’t an argument for investing in GMI, although you could do a lot worse. Rather, the point here is simply a reminder that diversifying across asset classes and keeping the mix from going to extremes is competitive and easy to do, and therefore you shouldn’t pay too much for the service. But simple ideas that have a history of working don’t always attract a crowd in finance.