All the time, Every time

Most investors, especially those at or near retirement, would give a limb or two for consistent returns. They wouldn’t even have to be staggering, Bernie Madoff 12% consistent returns. 4-5% real returns year in and year out is a pension trustee’s dream.

Of course, it’s not surprisng then that so many investment products and strategies promise this, or something that smells enough like it to pass muster. Some of these have become quite popular in recent years as investors are still trying to avoid another 2008-2009 bear market but keep stock-like returns (or at least something better than a 2.2% Treasury yield). Some risk parity or “all-weather” strategies have gained notariety, including a spin on Ray Dalio’s All-Weather retail strategy highlighted in Tony Robbin’s recent book (which I covered in some detail here).

So just how all-weather has said strategy been of late? I ran a historical simulation with publicly available products to fill in the allocations as follows:

  • 40% Long Term Treasury Bonds (TLT)
  • 30% US Stocks (VTI)
  • 15% Intermediate Bonds (BND)
  • 7.5% Commodities (GSG)
  • 7.5% Gold (GLD)

Now, as I’ve pointed out before, this portfolio allocation is bond heavy and duration heavy. When long term bonds hold up, this portfolio will too. When they don’t, it’s going to be tough going. Year to date through 11/30/2015, this allocation is down -2.30%, despite long term bonds (TLT) having an impressive gain of 9.07% over the same period. Commodities have been crushed (-42.35%) and gold is down (-8.79%), wiping out gains elsewhere.

It’s not like I’m sitting here saying -2.30% is terrible. The Vanguard Balanced Index Fund (VBINX) is only up 1.80% over the same period (YTD through 11/30/2015). But the “All Weather” portfolio doesn’t come with any guarantees. The worse 12-month period in my simulation (4/2007 – 11/2015) had a double-digit loss like most other strategies (-15.26 through 2/2009). And we honestly haven’t seen an environment with rising rates to really test this out. The returns from long term bonds (TLT) over this period drove more than 100% of the return of this “All Weather” strategy over the test period. That’s right, diversifying away from long term bonds hurt you. (How many people made that bet when the Fed took the Fed Funds rate to zero?) If you think that long-term returns from high duration bonds are going to be 7-8% from here, you might have a surprise coming. With an average duration of 14.30 in this portfolio, there’s no escaping the impact of higher long term rates on performance, if and when they come.

My real point here isn’t to pick on the All Weather portfolio per se. It’s to help us all understand that no strategy is ideal. Nothing is going to work all the time, every time. “All Weather” is a misnomer. It’s not totally unreasonable to think there is a period of time when rates can go up (long bonds go down) and stocks are flat or down. Or when rates are up enough to offset any potential gains from stocks. Or a year like 2015 when losses in commodities are sufficient to take out healthy gains from long term bonds. Despite our best attempts, investing involves risk. We can mitigate that through portfolio diversification, but there is no eliminating inconsistent short term returns. Some years are going to be better and some will be worse. I don’t know which will be the case for your portfolio next year, but if you aren’t prepared for that, you’re going to find yourself making some nasty mistakes.

 

 

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