De-Stressing Balanced Fund Investing

December 17, 2011

It's time to de-stress the balanced fund mandate.


De-Stressing Balanced Fund Investing

David Allen’s bestselling book Getting Things Done has become a productivity miracle for the stressed, stretched, conflicted and, in short, the unbalanced. Allen describes the antithesis of feeling unbalanced and stressed, what martial artists call “mind like water” and world-class athletes call “the zone.” In this state, the mind is clear and we react to our external world instinctively and with ease, a natural flow producing desired results. Allen says this higher state is no longer a luxury but a necessity “for high performance professionals who wish to maintain balance and a consistent positive output from their work.”

Balanced fund management is sadly nowhere near such a zone of clarity and positive outcomes. Like dedicated stock and bond mandates, active asset allocation has largely become a benchmark-hugging exercise where strong convictions are muted by concerns over career risk and overly aggressive performance measurement. In this issue, we highlight some improvements for those interested in active asset allocation programs.

Fair and Balanced?

Balanced portfolios add value in two primary ways: better security selection (picking stocks that outperform the equity benchmark such as the S&P 500 Index, bonds that outperform the bond index, etc.) and through managing the asset mix (shifting money between stocks, bonds, and other categories.) Given that (on a naïve basis) half of the value proposition comes through asset allocation management, we would expect to find a sizeable amount of variation in asset mixes in these portfolios. However, as Figure 1 shows, the median equity allocation hovers between 55% and 65% over the seven-plus years analyzed.1 Further, as the 75th and 25th percentile observations show, the managers do a remarkably good job sticking near one another: Half of the managers were within 5% of the median.

(For a larger view, please click on the image above.)


To illustrate the thoughtlessness of this allocation “bunching,” we compared the median balanced manager to two alternative approaches—a “religious rebalancer” and a “diehard drifter.” Our “religious rebalancer” maintains a near-continuous 60% equity allocation by rebalancing the portfolio back to 60/40 every month. In contrast, our “diehard drifter” never rebalances, allowing his portfolio mix to drift with the whims of the market.

The black line in Figure 1 plots the mid-point between these two allocators. Virtually all of the allocation movement of the peer group is captured by a combination of price drift and continuous rebalancing!

The other interesting tidbit is the performance of stocks versus bonds over this stretch. From June 2004 through September 2011, the S&P 500 underperformed the BarCap US Aggregate Bond Index by a significant margin (2.0% versus 5.8% compound annual return). This underperformance shouldn’t come as a shock as during virtually the entire time horizon—save for a couple of months at the depths of the Global Financial Crisis—stocks were expensive, trading at Shiller P/E ratios well above the historical average. Asset allocation managers evidently don’t put a whole lot of independent thought into these asset mixes.



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