60-40 Portfolio Or Alternative Assets

Reader Question

Hi - I wondered what you thought about the 60/40 stock/bond ratio debate recently published in a NY Times article http://www.nytimes.com/aponline/2013/01/17/business/ap-us-of-mutual-interest-6040-portfolio.html . Did either of the two perspectives give readers useful advice? Thanks!

My Reply

Thanks for writing and bringing this article to my attention. I don't think it carries much (any?) new information for investors but it is extremely educational in another way -- to which I will get shortly. I started writing my usual long-winded reply about how active management (represented by Ben Inker in that NYT piece) will always try to justify its existence by making empty promises to beat the market. In this case Mr. Inker is promising to beat the 60/40 portfolio on returns and/or safety. Then I noticed the mention of WARAX, the alternative asset allocation mutual fund co-managed by Mr. Inker.

What better way to cut to the chase and evaluate Mr. Inker's claims of superiority of alternative asset allocation than to compare the alternative asset allocation fund he manages to the very definition of a boring 60/40 portfolio -- Vanguard's VBINX? Here we go!

Guess what? In just about nine and a half months (which is all the history Morningstar.com has for this fund), Mr. Inker managed to lose about 1.8% to the 60/40 portfolio he so looks down upon. Look closely at this chart. Do you see the superior performance of alternative asset allocation when implemented by investing luminaries such as Mr. Inker? Do you see how alternative asset allocation provides greater safety when the market falls? No? Me neither.

This chart is a great summary of everything that active management represents. Active management, in all of its many forms and tens of thousands of practitioners, is nothing more than a giant leech sucking on investors' portfolios, extracting a large portion of market's returns for itself. It is a very charming and intelligent and eloquent leech. The kind of leech you want to invite into your house and have a deep philosophical discussion with. But it is still a leech.

You don't even have to take my word for it. In a moment of candor, Jeremy Grantham, co-founder of GMO -- the very firm that Mr. Inker heads asset allocation in -- said the following:

Let’s start with the Investment Industry component.  It is so obvious in this business that it’s a zero sum game. We collectively add nothing but costs.  We produce no widgets; we merely shuffle the existing value of all stocks and all bonds in a cosmic poker game.  At the end of each year, the investment community is behind the markets in total by about 1% costs and individuals by 2%.

(see Appendix of http://www.ritholtz.com/blog/wp-content/uploads/2010/01/GMO-Quarterly-Letter-What-a-Decade.pdf ). This is the second time in a week I bring up this quote. It just so perfectly captures what active management is. And it was said by a very prominent active investment manager. Who just happens to be Mr. Inker's boss.

[Update: I looked into WARAX in a little more detail and learned that it is actually nothing more than a wrapper around GMO's own Benchmark-Free (ha!) Allocation Fund GBMFX which has had very good returns in its first 6 or so years and subpar returns in the last 3-4. I hope to explore that fund and GMO's other funds soon in continuation of what I started in my AQR review, as requested by one of my readers.]