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Defining a Set of Core Asset Classes

Defining a Set of Core Asset Classes
by: Geoff Considine posted on: August 13, 2008

 

At the heart of investing theory is the idea that investors can generate more return with less risk by combining assets in the portfolio that are not well correlated with one another. Weakly correlated assets tend to damp out total portfolio risk to some extent without decreasing return-and this is the value of diversification.

In my own analysis using Quantext Portfolio Planner [QPP] and in a review of a wide range of institutional research, I have previously suggested that really effective diversification is worth as much as 2.5% per year in annual return for an investor with a portfolio with the same risk level as a generic mix of 60% domestic stocks and 40% bonds.

As a rule-of-thumb, the well-diversified portfolio at this risk level is projected to have an annual standard deviation in return (a standard measure of risk) of about 10% and expected return of about 10%--a 1-to-1 ratio between risk and return. To build such a well-diversified portfolio, the investor or advisor needs to identify a set of core asset classes from which to determine the portfolio's asset allocation.

 

What is an Asset Class?

What are the "building blocks"-the core asset classes-- of a well-diversified investment portfolio? Most investors will list stocks, bonds and cash. Most investors will break stocks out into domestic and foreign stocks, and emerging markets and developed markets are typically treated as distinct. Some investors think about stock funds in terms of how large the companies are, and many consider large company and small company stocks as distinct asset classes.

The Intelligent Portfolio, by Christopher Jones, provides a succinct definition: an asset class is "a category of investments such as stocks, bonds, or cash that share similar risk and return characteristics." In the last ten years, the list of major asset classes that is discussed often includes commodities, REIT's, and (among institutional investors) private equity.

I add an additional component to the definition of an asset class. An asset class is a category of investments that are similar to one another but also that behave distinctively relative to other asset classes.

The "Starter Set" of Core Asset Classes

For our purposes, let's say that we want to start by defining a minimal set of asset classes that can yield a portfolio that is well diversified. We want to build a list of possible investments that does not include unnecessary redundancy. What does that list look like? Even a question that sounds as basic as this one will illicit a different answer from different experts. To get started, I propose the following "starter list" of asset classes, along with index funds (Exchange Traded Funds) that track them:

Defining a Set of Core Asset Classes  

 

Why choose this set of basic asset classes? Why don't we have "value" and "growth" breakdowns? Are utilities (IDU) and natural resources (IGE) distinct asset classes that are worthy of consideration? TIPS (TIP) are Treasury Inflation Protected Securities-government bonds that increase in value with CPI (a measure of inflation). TIPS are, in a nutshell, bonds with some embedded inflation protection. Are TIPS a distinct asset class from bonds? I treat utilities, energy, TIPS, commodities, and REIT's as distinct asset classes because they behave differently from one another and differently from broad equity classes. In plain terms, they do not track the major equity or bond indices. As such, these "asset classes" are valuable in diversifying a portfolio.

 

There are a wide variety of ways to break out the important asset classes. For the purposes of this discussion, what we care about is how many distinct "types" of investments we need to consider to build a portfolio which captures most of the available diversification benefits. There are certainly more nuanced breakdowns that we might look at, but I believe that the case can be made that those listed above are sufficient for generating a portfolio that will out-perform the vast majority of mutual funds. For examples of the weights that end up assigned to each of these asset classes using our portfolio theory approach, see the linked article.

 

Building a list of "core" asset classes for a portfolio starts with asset classes that do not track well with one another-i.e. that exhibit low correlation.

For an expanded set of "core" asset classes matched to ETFs, the reader may refer to either of these two articles.

 

The Perils of Diversifying by Names

It is common for investors to believe that they are diversified because they buy assets that sound as though they should act differently. Many mutual funds (and even broad asset classes) that "sound like" different investments actually track one another very closely-which means that having all of these different funds in a portfolio does not actually add value. This point is easy to demonstrate. The chart below compares investments in three Vanguard funds-large cap, mid cap, and small cap stocks funds-for two years. These three funds, despite representing different sizes of companies, have tracked one another remarkable closely for the last two years:


Defining a Set of Core Asset Classes
Vanguard Large Cap Stock Fund [VLACX] vs. Mid Cap Stock Fund [VIMSX] vs. Small Cap Stock Fund [NAESX] for two years through July 2008

Over the past two years, investors who thought they were diversified because they spread assets across these three funds have not generated much diversification benefit-these three funds have tracked one another very closely. Diversification is especially important as a way to manage risk-to protect the downside-and it should be obvious that these three funds of companies sorted by size have all gone down together. Given these high correlations to one another, why do we include small cap stocks and large cap stocks as distinct entities in our "Starter Set" of asset classes? First, small cap stocks provide higher expected returns than large cap stocks (on average). Second, small cap stocks and large cap stocks provide different diversification benefits with respect to other asset classes.

How about foreign stocks? The chart below compares an investment in the Vanguard Large Cap fund [VCACX] with an investment in the Vanguard Developed Markets fund [VDMIX]. Even these two have tracked remarkably closely over the past two years.

 

Defining a Set of Core Asset Classes
Vanguard Large Cap Stock Fund [VCACX] vs. Developed Markets Index [VDMIX] for two years through July 2008

Spreading money between this international fund and this domestic stocks fund provides very little protection during the recent market declines. By no means am I saying that any of these funds are bad-these are all fine funds. The issue that I am raising is that many investors would think that they had reasonably well-diversified equity portfolios if they invested in four Vanguard funds representing domestic large cap, mid cap, and small cap funds, along with an international stock fund.-but such a portfolio was not well diversified at all.

A reasonable definition of effective diversification is that a diversified portfolio is somewhat insulated from moves in any single asset class. This is surely not the case in if you simply mix an EAFE index with an S&P500 index. Still, the EAFE index does provide some diversification benefit-and this is why we have included it in our core set.

By contrast to these fairly well-correlated "asset classes," consider some of my alternative suggestions from the Starter Set over the same period:

 


Defining a Set of Core Asset Classes

Vanguard Large Cap Stock Fund [VCACX] vs. TIPS (TIP), energy (IGE), utilities (IDU), and REIT's (ICF) for two years through July 2008

The central idea in diversifying a portfolio is to combine assets in a portfolio that do not all go the same direction at the same time. The chart above provides a nice example of why we will be looking at utilities (IDU), real estate (ICF), and energy stocks (IGE) as distinct asset classes. The portfolio value of combining various asset classes can only be determined via quantitative analysis.

Too many investors have been trained that combining broad index funds for large-, mid-, and small-cap funds is a good practice but that adding sector-specific funds (such as the utility index) is not terribly desirable. Rather than going by name, it makes far more sense to apply tools that analyze the behavior of different portfolio components-and that is the core theme of portfolio theory.

 

These charts are merely presented as examples-correlation between asset classes over some period of time must be calculated between asset returns-and these charts are showing prices. This belief has a solid foundation in financial theory, but I cannot expand upon it here.

It is all well and good to write about the portfolio benefits of energy and utilities or the limited value of international developed stocks after the fact of this market decline. The reader may be somewhat more engaged if he/she takes the time to go back and see that I have been writing about the portfolio benefits of utilities and energy and that the portfolio benefits of emerging and developed foreign markets had been over-stated for quite some time-considerably before this bear market.

In this discussion, I am not holding out this particular set of ETFs as the ideal "core asset classes" but rather as a decent place to start. Based on the statistical properties of these ETFs, they each add some incremental value to the portfolio. In other words, each of these asset classes works well with the other parts of the portfolio to assist in generating more return for a given level of risk. The choice of the set of core asset classes should be determined by the properties of these asset classes-they should not all track together-and the bear market of 2008 has provided a compelling real-life example.

 

Looking Forward

Defining the set of core asset classes is not a trivial under-taking. You need a statistical model (like QPP) that generates forward-looking projections of portfolio risk and return, using projections for the individual asset classes. When you are considering whether an asset class adds value, you add it to a model portfolio and project forward. If this asset increases return at a given risk level, it is worth considering. If this process is done using historical data only (i.e. looking backwards), you will end up with a portfolio that would have done well historically but that often tends to under-perform as you go forward.

This result is nicely demonstrated in an analysis by William Bernstein in The Intelligent Asset Allocator that shows that investors who build portfolios relying simply on trailing performance do very poorly. Forward-looking statistical models are the standard of practice for this type of analysis.

I believed that a lot of the reason that retail investors generate such poor results is that they do not have any solid idea of what a set of core asset classes is. For investors who have professional advisors, sitting down and engaging in a discussion of the choice of core asset classes in the portfolio will be time well spent.

There is certainly room for debate as to the optimal set of core asset classes. PIMCO's Mohamed El-Erian proposes the following.

The reader will note similarities between these asset class choices and the core asset classes proposed here. One interesting apparent difference is that Mr. El-Erian has "infrastructure" broken out into its own class as a real asset. This relates to my use of utilities as a core asset class. Utilities represent a centrally important "infrastructure" investment in both developed and emerging economies.

Further, if you look at the expanded set of core asset classes that I discuss, you will see specific allocations to other "infrastructure" equity classes, such as transportation and telecom. In the All-ETF portfolio that I proposed in June of 2007, for example, there are specific allocations to IYT (transport) and IYZ (telecom).

I believe that an expanded set of core asset classes adds value, but the basic set proposed here is a reasonable place to start-particularly for the investor who is not yet conversant with a portfolio-centered approach to asset allocation. It is crucial to understand why you are investing in specific assets/asset classes.

Summary

I will attempt to summarize in brief. A crucial step for investor and advisors is to define the universe of core asset classes that will be used in a portfolio. There should be good reasons for specifying each choice. The "invest a bit in everything" approach is a poor approach to portfolio construction.

I have proposed a minimal "starter set" of asset classes and some ETFs that capture these classes. There is certainly room for debate in this area. Portfolio analysis using QPP (a forward looking portfolio model) has long suggested that utilities, for example, deserve to be treated as a distinct asset class.

By contrast, QPP has suggested that breaking out "value" and "growth" adds less value. QPP suggests that TIPS provide unique value that is not captured by generic bond indices. QPP has also favored commodities (DJP) and natural resources (IGE) as distinct asset classes. The analysis from QPP is bolstered by a range of perspectives in the importance in assets that will tend to keep pace with inflation from PIMCO, David Swensen, and Ibbotson [pdf file] (among others).

What is most important is not that everyone agrees with this set of core asset classes, however. What is important is that investors and advisors have an objective plan and reasoning as to the universe of asset classes that will be considered. The choice of asset classes to be considered in the portfolio will, ultimately, have a substantial impact on the performance of the portfolio.
This article has 34 comments! Add yours below...




This article has 34 comments:
irondoor91
Aug 13 10:12 AMThis all sounds very good. Modern portfolio theory, diversification, splitting of the hairs, etc. There's just one problem as I see it. It's backward looking over the past 70 years and does not take into account what will happen to any portfolio or asset class in a deflationary environment. All of these asset classes mentioned depend on one thing--and ever increasing amount of bank lending and expanding credit.

You show no allocation to cash, which is the best performing asset class over the past 8 years. Why not? All of the asset classes mentioned may have increased slightly or not at all in dollar terms, but in terms of real money (gold) they are losers by a large margin. That's why a million bucks just doesn't buy you much any more.

These asset classes may protect an investor during inflation. But when the great unwinding finally hits, there is no place to hide no matter what your "mix". It then has just been another case of intellectual analysis.
LarryH
Aug 13 10:32 AMIrondoors91 is right on. What has worked in the past may offer no protection for the future. I think anyone with less than a 20-year time horizon for investments may be very poorly served by all porfolio theories. I may be wroing, but I see the present as a time when I don't want many of the assest classes. I believe in the idea of fewer baskets right now and watch them like a hawk. I think this is a horrible time for a shotgun approach--such as an index funds or mutual funds. There are just too many sectors that should be avoided now, in my opinion.
Geoff
Considine
Aug 13 11:19 AM
My WebsiteHi Irondoor and LarryH:

Your perspective is not uncommon--and it is all the more common during down markets. In fact, your perspective is why the vast majority of retail investors have done so badly over history. If you look at my most recent article before this one, for example, I show an All-ETF portfolio that is down only 0.5% in the last year or so. This portfolio also hold no cash and it is well positioned to out-perform when equities recover. The problem with cash is that it is a wasting asset--it loses purchasing power with time--especially with higher inflation of course.

Read more of my articles in which I made the case for asset allocations that have held up quite well--considerably ahead of this downturn.

Now, you could be right--and you both may be that elusive person who can effectively time the market. Think about who is on my side though:
David Swensen, Warren Buffett, John Bogle, El-Erian, William Bernstein, etc. Swensen and Buffett are two of the best investors for whom we have track records.

A bet on timing vs. asset allocation is great if you can do it--but the vast majority of timers fail. I sincerely wish you both good luck, but I feel that the evidence points overwhelmingly to diversification as the winner over the long haul.

Anyway, I will not convince you--nor you me--and thats okay. Let's all just hope that we can find our ways to dealing effectively with this down market, without missing the gains in the recovery.

Geoff
rr0710
Aug 13 11:20 AMEven in a secular sideways market (if you recall 1966-1982,) having a core base of non-correlated asset classes worked as a skeletal start to an allocation. We tend to let the present experiences rule future perceptions as opposed to following rules and disciplines. This is a good start to understanding when you're in bear cycle, most asset classes join up and move in the same direction. Natural resources, long-short components, correlate consistently low with U.S./Int'l common stocks. Bull cycles, even if they're cyclical, last 3x longer than bear cycles going back to 1885. And movement out of the bear cycle is fast so if you miss the beginning, you've missed everything and nobody can time the entrance. Dr. Considine is always right on the money
rr0710
Aug 13 11:21 AMDr. Considine, your comments about retail investor perspective is spot on
Geoff
Considine
Aug 13 12:15 PM
My WebsiteBTW, I suggest the following article here on SA by Larry Swedroe for those who are trying to time the bear market:

seekingalpha.com/artic...

mkreisel
Aug 13 05:49 PMRetails never learn. They are the most manic-depressive bunch in the market.

When things go well, they think they are invincible; when things go bad, they thing the sky is about to fall.

Also depending on their state of mind, they follow "gurus" slavishly who usually don't have a clue themselves.

And finally, retails often have strong "BELIEF" in themselves and their "gurus".
Geoff
Considine
Aug 13 06:09 PM
My WebsiteFYI--a useful article on this theme:

online.barrons.com/art...


BlueDog
Aug 13 08:02 PM
My WebsiteNice article, Geoff. The correlation between Vanguard Large Cap Stock Fund [VLACX] vs. Mid Cap Stock Fund [VIMSX] vs. Small Cap Stock Fund [NAESX] was particularly interesting. In defining a set of core asset classes, I think it's also important to keep expenses as low as possible in order to maximize performance. I've created a core portfolio which creates diversification at a very low expense ratio/cost: EEM, EFA, IWM, IVV, SHY, TLT, LQD, TIP, RWR. I'll have to look at DJP and IGE as potential adds. Thanks for the article.

BD
zptdo
Aug 13 09:45 PM"I show an All-ETF portfolio that is down only 0.5% in the last year or so. " By design ETFs as a basket will cancel each other. All-ETF will show very little change at any time but will make your broker very happy :)).
www.proshares.com/abtf...
Geoff
Considine
Aug 13 10:39 PM
My WebsiteZPTDO: Uhh, I think you missed the point. Your link is to inverse ETF's and yes, if you combine them with long ETF's, you end up with almost zero net return and zero risk. That is not at all what we are discussing here. These are all LONG ETF's.
granger
Aug 14 01:39 PMGreat info as usual. I always look forward to your articles. I have to read them a couple of times (my way of understanding things), but always worth the effort. Thank You
Aquater
Aug 14 01:52 PMThis is a very useful article. It is thoughtful and provokes thinking. A great piece. I have following points, however, to further the dialog.
1. On the one hand you say timing cannot be done and so one must stay invested in multiple widely uncorrelated asset classes. On the other hand, you want to look forward and marginalize history as backward look. Trying to have it both ways?
2. Also, no clue is provided as to how exactly you look forward. What tools are used to look forward and how are they better than other timing tools? Just saying QPP is not enough. You may be holding QPP as a proprietary device, but you would gain credibility if you share at least some philosophy behind it.
3. Thinking about reader comments, the name-calling match between retail and elite was entertaining heat but did not provide much light. The guru stuff was highly speculative. Both timers and non-timers have to resort to past record to justify themselves. It is indeed hard to really discount history. Snap discrediting of it as nothing but looking backward is a bit dogmatic. Its usefulness may be limited but it surely is debatable how to assess it.
4. It is not consistent to talk about cash as wasting asset because of inflation. To be consistent all assets and not just cash should be systematically weighed against inflation. Any way, cash is better than losing your capital. Including it as one of so many others is not a sin at all. It is also important to take advantage of emerging opportunities. It would be simpler and easier to do it if you have cash.
5. You hint at percentage allotment to the asset classes. Would like to know more about the concepts behind this.
All in all, your article is highly beneficial, thoughtful and noteworthy.


Geoff
Considine
Aug 14 02:18 PM
My WebsiteAquater: QPP is available to retail investors and advisors alike--see quantext.com. As far as how it works, I have more than 1000 pages of documentation and tests on my website (free) and much if it is also published here on SA. I suggest that you may want to start with this article:

seekingalpha.com/artic...

History has a place in analysis but this must be conditioned with models that capture the fact that just because an asset class out-performed in your specific historical sample, it may not out-perform in the next. Pure historical analysis gets tripped up by this.

Part of what I am trying to explain is that institutional investors manage portfolios very differently than retail investors. It is not just about a few gurus. Again--this is discussed in many of my articles.

Thanks for the comments.

Geoff
dumbo
Aug 14 03:56 PMGC, Cna you calrify:
- What time frame did you use for Correlation measurement? And the pros/cons of using this time frame vs some other.
- Did you use returns based on 'raw' prices or 'dividend-adjusted' prices?
- For returns, did you use RateOfChange (%) or log-normal returns?
Thanks in advance.
Flav
Aug 14 07:48 PMHi Geoff. I made a question to you in other article that wasn't answered, so i will reformulate it in this one.
You say that hisorical data is of no use, but in order to obtain forward looking assets class combinations with QPP, you have to enter past information about those assets classes. So, as i asked before, to determine the correct weight asigned to each holding (the way that produces the highest return with a given level of risk), should the oldest available information be introduced? or is it sufficient with just a few years back?
Geoff
Considine
Aug 14 08:07 PM
My WebsiteFlav:

I am not saying that historical information is of no use--rather than that data must be tempered with a model that reduces your reliance on the specific relative performance of those assets in the historical period selected. The challenge with how much data to use is the motivation for forward looking models like QPP. If you use too long an historical data record, you will end up with stats that do not reflect the evolution of the markets. How can you model tech stocks or internet stocks if you want to use 40 years of data, for example? The domestic auto industry is in an entirely different state than it was even 15 years ago...

I have tested and benchmarked QPP using three years of data to initialize the model and then QPP brings in long-term analytics on the way risk and return balance in capital markets--i.e. you don't need security specific data for this. RiskMetrics is even more extreme in terms of emphasis on recent data--they use an exponentially decaying weighted average going back in time for many parameters.

I do not know that 3 years, my default in testing, is optimal--but it has tested out well for long-term tests spanning decades (I have articles on this with out-of-sample tests).

Does this clarify?

Geoff
Flav
Aug 14 09:28 PMHello Geoff:

Thank you very much for your quick response. It does clarify.
I'm an economics and finance student, and i often have discussions with classmates and friends about several subjects regarding portfolio management. I must say that i have used some of your articles to support some of my arguments. I believe that for long term planning, there's nothing better than the analysis being made in your articles. But suppose that some investor or trader has a shorter time horizon; that person is willing to take on larger risks, in order to achieve larger returns. Would you still recommend this individual to diversify? Or given the shorter time frame and less risk aversion, should this investor have a more concentrated portfolio?

Again, thank you very much

Looking forward to read more of your articles
dumbo
Aug 15 10:14 AM[Repeat post; no reply to yesterday's post]
Geoff,
Can you clarify:
- What time frame did you use for Correlation measurement? And the pros/cons of using this time frame vs some other (e.g. why 36 months instead of 12)
- Did you use returns based on 'raw' prices or 'dividend-adjusted' prices?
- For returns, did you use RateOfChange (%) or log-normal returns?
Thanks in advance.
Aquater
Aug 15 12:18 PMThanks for your response. I understand the rationale for three-year look-back, tentative though it is it is back-tested by you. But on what basis is the QPP projection for one year based? I have hard time finding this. All I find is the details of its being tested. I need to see some articulation about the basis and method as to how the projection is made. Thank you, again for sharing what you have.
Geoff
Considine
Aug 15 01:13 PM
My WebsiteDumbo:

* three years for correlations -- there is a literature on the stability of correlations and other second order moments. 36 points is a nice compromise with stable stats.

* returns are total returns-dividends reinvested
* returns are what you are calling Rate of Change -- i.e. basic percentage change in monthly closing prices.

Geoff
Considine
Aug 15 01:13 PM
My WebsiteAquater: not sure I understand the question.

Geoff
Geoff
Considine
Aug 15 01:15 PM
My WebsiteFlav: shorter time horizons have more momentum effects dominating--and this means different models will be preferred. I have done and continue to do work on momentum effects for shorter time horizons but I cannot share it here I'd afraid. There is a substantial literature on momentum effects, however.
Geoff
Considine
Aug 15 01:37 PM
My WebsiteUseful article:

finance.yahoo.com/reti...

With explosive growth in emerging markets and more companies with worldwide operations, a corporation's official "headquarters&quo... will become less relevant, says Jeremy Siegel, a professor of finance at the University of Pennsylvania's Wharton School. "People think they're diversifying by investing in a country, and it leads to inadequate diversification," he says, "because the country of origin or incorporation is not the primary influence on the stock price."

Ranger Ric
Aug 16 10:24 AMGeoff:

Your finding that there are minimal diversification benefits between large, mid and small cap stocks is interesting. During the first half of this decade my portfolio outperformed the S&P 500 because I was overweighted in small cap stocks which prospered while large cap stocks were flat (This is not any brilliance on my part but simply reflected my opposition to using a market weight portfolio. I equal weighted rather than market weighted different portions of my portfolio giving me a higher smaller cap weighting than if I had had a market weighted cap approach.)

Perhaps the disparity can be explained by findings made by William Coaker in the September 2007 Journal of Financial Planning, "Emphasizing Low-Correlated Assets;The Volatility of Correlation" Coaker compared the long-term correlation of 18 different categories. Nine of the categories were the nine Morningstar categories. He found very high levels of correlations between some categories, large growth-large blend; mid growth-mid blend; small cap-small blend; large value-mid value. He found less correlation, however, between other categories. For example, he found a .96 correlation between large growth and large blend stocks but a .78-.79 correlation between mid blend and each of the small cap categories. This correlation is still higher than he found for other categories like international stocks, bonds and real estate but much lower than other domestic correlations. So perhaps there are some correlation benefits within domestic stocks but investors may need to be more sophisticated than just choosing large, mid and small cap stocks.

I continue to enjoy your insights.
dumbo
Aug 16 02:37 PMGC, you wrote >>returns are what you are calling Rate of Change -- i.e. basic percentage change in monthly closing prices. <<
Correct me if I am wrong, but aren't log-normal returns the "base currency" in quantitative analysis?
Geoff
Considine
Aug 16 05:57 PM
My WebsiteDumbo:

The baseline standard for analysis is normally distributed returns, which then leads to a lognormal distribution of prices--and this is what I am using.

Geoff
Geoff
Considine
Aug 16 06:07 PM
My WebsiteRanger Ric:

Thanks for your comments. The fact that small cap and large cap are highly correlted does not alter the fact that small caps, with higher risk, also yield higher average returns--this is in no way contradictory. A small cap tilt will result in higher returns--no mystery. Equal weighting a portfolio creates such a small cap tilt.

Your point about the stability of correlations is correct, but I have found in long backtests that the stability of the correlations is sufficient via QPP to yield good portfolio outlooks--I have tests going back thirty years in three-year out-of-sample increments. Also, to be clear, QPP does not strictly preserve linear correlations.
jmorace
Aug 18 07:32 AMHi Geoff,

I great, helpful article. Thank you for it.

I have a question about core asset classes. I see that you have used the DJ Utilities index as a surrogate for what El-Erian terms as the infrastructure asset class allocation. What other etfs do you see as adequate surrogates? Would railroads or natural gas pipelines count? Should this infrastructure investment be international or domestic etc.

A second question: I notice that pimco has a bond fund that invests in emerging market debt denominated in local currencies. Would participation in this constitute a different asset class or would it be a subset of the bond portion of the portfolio?

Thank you,

null
oldman
Aug 18 08:20 AMI thought I was doing ok with a managed futures RYMFX fund but not now.

finance.yahoo.com/q/ta...

It seems that commodities have disrupted any benefit, in the short term, at least. How can this be prevented?
oldman
Aug 18 09:20 AMHi Geoff,

I have mostly managed mutual funds with managers I find are some of the best, Evillard, Leuthold, Romick, McGregor, Rudolph-Riad Younes, Royce, Cuggino. I don't own any bonds or bond funds except those in the funds I own. Can those bonds serve as my allocation to bonds? If I have 40-50% bonds from those mutual funds, can they be considered my bond allocation? I am 75 and only recently retired.
whidbey
Aug 18 05:35 PMDear 75 and retired. Being in bonds in a mutual fund is not the same as owning the bond itself where the risk is the return of capital and realization of the yield. At your age I would prefer to see you in bonds not funds which removes the interest rate/yield risk and assures your money is returned.


On Aug 18 09:20 AM chick wrote:

> Hi Geoff,
>
> I have mostly managed mutual funds with managers I find are some
> of the best, Evillard, Leuthold, Romick, McGregor, Rudolph-Riad Younes,
> Royce, Cuggino. I don't own any bonds or bond funds except those
> in the funds I own. Can those bonds serve as my allocation to bonds?
> If I have 40-50% bonds from those mutual funds, can they be considered
> my bond allocation? I am 75 and only recently retired.
oldman
Aug 19 10:40 AMThanks for the comment Xu tiu. In my IRA accounts, I can see it makes sense but not sure about the taxable accounts. Perhaps,still better for the equites and mutual funds.
Geoff
Considine
Aug 19 12:07 PM
My WebsiteI will try to cover a range of questions here. With regard to bonds vs. bond funds, this depends very much on your personal situation. In a hypothetical world, bond funds and bonds accomplish the same thing in a portfolio.

With regards to infractructure, if you look at my All ETF model portfolio, you will see that I have utilities, transport, and materials as specific allocations--these are all infrastructure. These come up simply because they have such nice portfolio effects via QPP. I am awaiting a copy of Mr. El-Erian's book to see how he motivates these asset classes in depth.

With regard to the recent losses in commodities: the whole point of asset allocation is offsetting risks. Commodities have had a great run but they cannot out-perform forever. Also, risk and return go hand in hand--you cannot have the returns of commodities unless you take on the volatility. This brings us to the broader issue of whether timing makes sense, etc. I have written about this elsewhere: of course relative value is important--but history suggests that it is secondary to some other factors.

Geoff

 


 

Ref : http://seekingalpha.com/article/90746-defining-a-set-of-core-asset-classes

 

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