Monday, June 16, 2014

a perfect portfolio?

Like most people who write about finance, I have a problem.

My job makes it effectively impossible for me to manage my own investment portfolio. When I first became a full-time investment writer back in 2007, I had to sell all my stock . . . in Diageo (DEO), Amazon (AMZN) and Berkshire Hathaway (BRK.A). (I don’t even want to think about how much that cost me.)

So where does this leave me?

Oddly enough, it leaves me in a very good place . . . for a financial writer. Because it means that by accident I have landed in the same spot as a great many readers: It leaves me looking for a new way.

I want a simple investment portfolio that I don't have to fool around with, and which I know maximizes my chances of earning a good long-term return, and minimizes my chance of ending up in the poor house.

I want an investment portfolio that is exposed to all likely environments, and committed to none. One which is based on intelligence and reasonable suppositions about the future, and not merely data mining from the past.

Have I found it? I think I may have.

To reach this solution, I've spent more than six months plucking at the sleeve of every wise investment expert I know. I've tapped the opinions of the bullish and the bearish, the optimistic and the fearful. I looked up the investment strategy of a tycoon in medieval Germany.

Here are the principles I've relied upon:

The portfolio, in the words of Albert Einstein, should be as simple as possible, but no simpler.

It is based on humility. I don't know what's going to happen next, nor does anyone else. It is prepared for all potential economic environments, but committed to none.

The portfolio is weighted toward equities, because even most bears concede that those have produced the highest long-term returns.

The portfolio is exposed to natural-resource stocks and to real estate, as distinct asset classes which have often done very well during periods of inflation, when other assets have done badly. It prefers natural-resource stocks to pure commodities, despite their equity risk, because they generate income and because "commodity funds" are often hosed by fees and trading costs.

The portfolio owns long-dated "zero coupon" Treasury bonds as insurance. They are the one thing that has gone up in a crash, such as in 1929, 1987 and 2008.

The portfolio owns long-dated Treasury Inflation Protected Securities, which offer some hedge against inflation and deflation.

The portfolio is truly global in its exposure to stocks, bonds, natural resources and real estate, because the U.S. is just a small, and shrinking, percentage of the world economy.

The portfolio uses periodic rebalancing to take advantage of "reversion to the mean." Rebalancing allows you to benefit from volatility and contrarianism without actually having to sweat.

The portfolio includes cash, or a near-equivalent, because as the financial consultant Andrew Smithers, the GMO strategist James Montier and the late investment legend Sir John Templeton have all argued, cash is a distinct asset class, and it is correlated with nothing else.

The portfolio takes advantage of research showing that "riskier" stocks have tended to produce worse returns over time than higher quality or less volatile stocks, and for sound reasons.

The portfolio also keeps its costs as low as possible, because fees are a straight loss.

nd so, what is in this all-weather portfolio?

It's 10 percent each in the following 10 asset classes:

    U.S. "minimum volatility" stocks

    International developed "minimum volatility" stocks

    Emerging markets "minimum volatility" stocks

    Global natural-resource stocks

    U.S. real estate investment trusts

    International real estate investment trusts

    30-year zero-coupon Treasury bonds

    30-year TIPS

    Global bonds

    Two-year Treasury bonds (cash equivalent)

For simplicity's sake, the portfolio I've modeled is rebalanced once a year, on Dec. 30.

I suspect performance in the last 15 years has been flattered unduly by the boom in emerging markets, which were in crisis in the late 1990s. I would be staggered if this portfolio produced a similar performance over the next 15 years to what it has produced over the last 15. However, what are the alternatives? It entails much broader diversification, and lower risk, than the three alternatives I've included (the "balanced" portfolio in the chart, by the way, is 60 percent MSCI All-World Stock and 40 percent U.S. Intermediate Bond Index).

I still think those of you who manage a portfolio of individual securities can earn the best returns, so long as you approach the task with great wisdom. But for the rest of us, this all-weather portfolio may be a good alternative.

By Brett Arends, MarketWatch

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