Undifferentiated Asset Allocations

Jan 26, 2011

With the growth of the ETF market, you see increasing amounts of discussion of asset-allocations. While this is a good thing, a few realities need to be addressed more often.

An allocation that has no particular bias to it does not do much good.  Yes, it is possible to create a fully-diversified portfolio for very low cost these days. But while having a little exposure to everything might be ok to use as a benchmark, let's not forget that you do actually have to materially bias your portfolio to differentiate it from the benchmark. 

Let's look at an example --- I saw a recent article that attempted to use the "wisdom of the market" to tell you how to set your allocation.   The methodology took the asset allocations from a number of other sources, averaged them and came up with this:



It looks diversified.  It's definitely low-cost.  But that is about all you can say about it.   Using our (free) Backtest Portfolio Allocations App, I ran the above allocation and here is how it looks for the past two years relative to the S&P 500 index:



As you can see, an allocation that has no bias or particular bets just reverts you back to the same basic overall market exposure.  Outperformers and underperformers just offset each other for the most part in this particular portfolio.  It is not just that the overall return is the same --- but the chart makes it clear the path from start to end is the same as well.  If you didn't run the chart and see this for yourself, you probably would have thought that the allocation was actually doing something it is not.

Summary: The hot topic these days is about asset-allocation --- however, don't necessarily assume that just because it's an 'asset-allocation' that it actually is differentiated in any way, shape or form.  Many asset-allocations just ultimately mimic the same basic exposure.   It doesn't take much testing or research to determine this -- but it does take a little.

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Comments (12) -

Jan 27, 2011 01:39 #

Good post. I had a similar experience with my Mother's portfolio recently, except she thought she was 'diversified' because she held equities all over the world with no consideration of other asset classes really.

hotairmail United Kingdom

Jan 27, 2011 05:48 #

Either the chart is wrong, or you used a "2 year period" specifically because the chart would ovarlay just so. I am surprised that 20% bonds and 20% international stocks failed to make the portfolio deviate even a little from the S&P 500.

I don't know United States

Jan 27, 2011 06:53 #

The issue, in my mind, is correlation -- the assets picked have high correlation.

Damian United States

Jan 27, 2011 10:15 #

FYI,  Tadas Viskanta at Abnormal Returns tied together a number of articles nicely in todays video:


Chris United States

Jan 28, 2011 17:06 #

On the other hand, if a very similar portfolio is run as a momentum strategy the past three years (top ETF each month out of AGG, EEM, EFA, HYG, ICF, IWM, SPY, TIP we get a CAGR of 16.4%, with max drawdown of 12.4% - an outstanding result by any measure, but especially compared to the SPY.

Jim United States

Jan 28, 2011 17:27 #

. . . following on my prior post - one could have also equal-allocated the portfolio and used a 10-month moving average hedge to get a CAGR of 9% with a max drawdown of only 7.2%. Lots of good options besides trying to make it through the night with a buy and hope asset allocation.

Jim United States

Jan 30, 2011 20:59 #

I Ran the numbers with the same allocation (roughly 60% US Equity, 20% Fixed Income, 20% International Equity) going back just 4 years, and the portfolio outperformed SPY, 13.8 vs 10.1, with lower volatility 19.1 vs 24.9.

So, time frame really makes a big difference.

I don't know United States

Jan 30, 2011 21:40 #

The allocation above is a better portfolio than the raw S&P 500 -- which has been quite a poor relative performer.    

I would check your numbers as they are not correct--- the S&P 500 is not up anywhere close to +10.1% for the past 4 years.

Chris United States

Jan 31, 2011 07:27 #

You are correct.  S&P not up 10% (certtainly not annualized) in last 4 years.  I ran a 5 year number - 1/27/2006 to 1/27/2011, and the 10.1% total return checks out.

your point on it being better than the S&P500 is mine as well.  The article implies that diversification or asset allocation is waste, based on last 2 years of returns.

I don't know United States

Jan 31, 2011 08:02 #


The article states that there isn't much value-add to this portfolio.    There is some value-add -- but I don't think its enough to be considered differentiated.  I think the numbers back this up:

I ran the above portfolio back starting when HYG first came on to the market (April 2007).   The above allocation had a -45% drawdown during the bear market.     Then for example on Friday Jan 31 --- it dropped almost exact same amount as SPY.

The theme of ETFreplay.com is that allocation is just a starting point.   Asset allocation is a good step for sure -- assuming you allocate well.   But there are such wide differences in asset allocations, that the term is somewhat meaningless.    When it means something like the above portfolio, that is not much value added.    

Tactical Asset Allocation is what really adds value.  



Chris United States

Jan 31, 2011 08:25 #

Agree with you totally.  Asset Allocation means many things to many people.  And just because you think you are diversified, or have been sold an "asset allocation" it may not mean that much in terms of different returns to a benchmark.

Thanks for the commentary.

I don't know United States

Feb 06, 2011 00:39 #


Paul Belgium

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