Asset Allocation Worked in 2008

I’m annoyed.

Last year was a terrible year for investors. Now, the peanut gallery is making the claim that asset allocation failed and diversification didn’t work. That’s bull.

Although there have been several articles from a variety of places, it is this front-page article from the Wall Street Journal that has my blood boiling.

The incendiary title started me off on the wrong foot: Fail-Safe Strategy Sends Investors Scrambling.

Any responsible investor with any appreciation for markets knows that no strategy is fail-safe. The only thing that worked all the time was Bernie Madoff (that is, until it didn’t).

The thrust of the article is that everything went down. It is true that pretty much all stock indexes went down, and diversifying amongst equity asset classes didn’t offer any benefit. However, it is outright false to say that asset allocation didn’t work.

For me, the Ibbotson SBBI Classic Yearbook is like the Rosetta Stone because SBBI was instrumental in developing my thinking about asset allocation and diversification. So, I start there with the six asset classes that Ibbotson lays out in the Basic Series:

Large Cap Stocks - 37.00%
Small Cap Stocks (really Microcap) - 36.72%
Long-Term Corporate Bonds + 8.78%
Long-Term Government Bonds +25.87%
Intermediate Term Government Bonds +13.11%
U.S. Treasury Bills (Cash) +1.60%

At the most basic level, asset allocation worked perfectly well. Stocks went down, but bonds and cash went up.

It is true that pretty much all stocks went down. It didn’t matter if you were large or small, international or domestic, growth or value. All of the subsets and derivations lost big.

As for bonds, I am not sure exactly where Ibbotson gets their Long-Term Corporate Bond data; it isn’t quite what I saw last year. For example, the Barclays US Long Credit A/Better Index lost 0.24 percent. Ibbotson says that their index is based on 20 year maturities, but the current maturity for the Long Credit Index is 24.80 years (11.7 year duration).

Other credit bond indexes were as follows:


iBoxx $ Liquid Investment Grade Index: +0.96%
Barclays U.S 1-3 Year Credit Index +0.30%
Barclays U.S. Intermediate Term Credit Index: -2.76%
Barclays U.S. Credit Index -3.08%

These aren’t exactly eye-popping returns, but they were lowly correlated with U.S. stocks. And, this was the year that credit markets were broken. Take a look at Treasury bond performance:

Barclays U.S. 20+ Year Treasury +33.72%
Barclays U.S. 10-20 Year Treasury +19.69%
Barclays U.S. 7-10 Year Treasury +17.97%
Barclays U.S. 3-7 Year Treasury +13.26%

And, you didn’t have to be solely in Treasuries either. The Barclays U.S. MBS Index gained 8.34 percent, and the Barclays U.S. Agency Index gained 9.26 percent.

Even muni indexes posted positive returns, despite the increasing trouble in many states and municipalities. The Barclays National 0-5 Year Municipal Bond index gained 5.05 percent.

This isn’t to say that all bonds went up – some went down. Preferred stocks, non-Agency mortgage backed securities, high yield (junk) bonds all lost substantially. These are derivations of the credit markets, which had a lot of trouble. They also shouldn’t be in the vast majority of portfolios. Professional investors know, for example, that junk bonds trade like stocks, not bonds.

If you didn’t want to bother with all of the various bond market sectors, just take a look at the Barclays U.S. Aggregate Index. It gained 5.25 percent last year, which is pretty consistent with what you would expect from a long-term bond allocation. In fact, the long-term rate of return for Intermediate Term Government Bonds according to Ibbotson from 1926 through 2008 is 5.24 percent.

Despite one money market mutual fund breaking the buck, all the others held up. It’s true that the government had to come in and lend a helping hand, but cash is pretty much cash. Those who had made sure that their cash didn’t contain undue credit exposure for a little extra yield didn’t have any problems.

If it wasn’t obvious, this article was meant to say that the basic building blocks of asset allocation worked exactly as one would expect. My next article on the subject will look at whether one year is the right time frame to make the statement that asset allocation doesn’t work. I’ll bet you can guess where I come down on that when I say that investing is for the long term…
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David Ott