Richard Bernstein of RBA Advisors came out this week with his firm’s version of Asset Allocation 2.0:
Traditional asset allocation models seem obsolete. The much heralded “Endowment Model” failed in 2008, yet asset allocators continue to cling to it as much as the Peanuts character Linus hung on to his blanket. However, the global financial markets have changed dramatically, and the macroeconomic backdrop that fueled the success of the endowment approach no longer exists.
RBA’s approach, Asset Allocation 2.0™, is based on a different asset allocation construct. We no longer pigeonhole investments into traditional categories, such as Large Growth or Value, Small Growth or Value, High Yield or Distressed debt, Absolute Return, or the like. Rather, we group investments based on their returns and risk characteristics.
To our clients, Asset Allocation 2.0™ looks no different from traditional asset allocation. Our external reports show exposures to traditional asset categories. Internally at RBA, however, we view asset classes very differently. An investment doesn’t necessarily belong in a fixed-income category if it acts more like an equity investment than a fixed-income investment. An equity investment shouldn’t be characterized as equity if it acts more like a fixed-income investment than an equity investment. Similarly, an alternative investment shouldn’t be classified as alternative if it acts like traditional equity or fixed-income.
Asset Allocation 2.0™ also incorporates the productivity of an investment. Productivity does not mean efficiency in an efficient frontier analysis. Rather, it means incorporating a cost/benefit analysis. Fees and lock-ups make little sense when similar exposures can be gained in investments without onerous terms.
I’ve seen Bernstein speak in the past and am a huge fan of his work. He makes some great points in this piece, especially when it comes to the changing nature of correlations between investments. He rightfully has some concerns about the Endowment Model of investing in that it failed as a provider of liquidity when it was most needed during the financial crisis. And I completely agree that the best way to think about asset allocation is in terms of risk and return characteristics.
But at the end of the day, a new name for asset allocation is mostly just window dressing. In my dealings with various foundations, endowments and pensions over the years I’ve seen this game of musical chairs play out over and over again as asset allocation definitions and models are constantly changing. Institutional investors assume it’s a bad look to stand pat with their strategy so every couple of years they rearrange the furniture, so to speak. Granted it’s the same couch, table, love seat, chair and ottoman. It’s just now they’re in in a different place with a different name. That is until they get restless and decide to add new furniture to the mix.
Asset allocation was fairly straight forward in the 80s and 90s as most funds had allocations to equities, fixed income and cash. As the Yale Model grew in popularity in the 2000s, the new mix was equities, fixed income, cash, hedge funds and private equity. Investors finally realized that hedge funds and private equity aren’t really asset classes, but fund structures. So next came some variation of equities, fixed income, cash, absolute return and real assets (and many other odd offshoots of this as well).
Following the 2007-09 financial crisis many institutions decided to stuff as many hedge funds as they could into their portfolios by adding equity-oriented funds into their equity bucket and fixed income-oriented funds into their bond bucket. This changed the nature of their fund’s risk and return characteristics as it’s a completely different ball game in terms of fees, liquidity, leverage, market exposure and blow-up risk. Add to this the fact that there’s no such thing as funds that can consistently deliver absolute returns and you end up with a huge mismatch between a fund’s goals and its asset mix.
I’ve found that the more money involved in a portfolio the easier it is for investors and committees to overthink things and make them more complex than they need to be. Consultants and investment offices are constantly trying to prove their worth by changing risk buckets and asset allocation guidelines to make it look like they’re being innovative and hands-on.
Yet the only thing that really matters are the expected risk and return characteristics of the given investments and asset classes in a portfolio. Calling something by a new and exciting name is not going to change the performance of your portfolio. Most of the time it’s just an additional layer of complexity in an already complex world. It makes things harder to understand and easier to see subpar performance.
There’s no substitute for understanding what you own and why you own it. You have to be able to understand the behaviors of the investments in your portfolio and how they generally work together. In my mind this is the only way you can survive periodic market disruptions like the one we are currently experiencing.