Book Review — Global Asset Allocation: A Survey of the World’s Top Asset Allocation Strategies
One of the most fundamental choices for any investor is their approach to strategic asset allocation. What are the major asset classes to consider, and how much should be allocated to each asset class? For example, at a simplistic level, how much should one invest in stocks versus bonds? The decision quickly becomes much more complex since there are so many different asset classes and subclasses one can reasonably allocate to – commodities, real estate, different types of bonds, private equity, so-called “alternatives,” and so forth.
Many talented people have thought about strategic asset allocation, and if you look out across the world of investment management, you will find a wide range of opinions. One sensible way to assess this landscape is by comparing and contrasting various alternatives proposed by people who represent different approaches.
In “Global Asset Allocation: A Survey of the World’s Top Asset Allocation Strategies,” Meb Faber takes stock of a number of such approaches, providing a good overview of asset allocation techniques of some leading thinkers, and how they have performed over time.
Meb Faber, who runs a great blog, and manages portfolios for Cambria Investment Management, has a deep background in strategic asset allocation, which allows him a broad perspective. In 2009, he published alongside Eric Richardson, “The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets,” (a copy is here) which described an approach retail investors can use to mimic the portfolio construction of big university endowments. We were so impressed with the Ivy Portfolio concept, Alpha Architect has leveraged the concepts from the book and now uses Faber’s framework as a building block for what we call “Robust Asset Allocation,” which is essentially a souped-up version of the baseline Ivy Portfolio concept.
This book examines the baseline “Ivy” strategy from the Ivy Portfolio, but this new book provides additional perspective by showing what has happened to other portfolios that are constructed in sometimes radically different ways.
What I like about the book?
Charlie Munger has talked about the importance of developing a “latticework of mental models.” A key benefit associated this idea is that if you understand a few basic concepts accurately, and at a very deep level, they can be drawn on and applied in combination to solve many different kinds of problems.
So it goes with core elements of asset allocation.
Faber begins by building up levels of granularity by examining the long-term results of holding cash, T-bills, and stocks, and then generates insights through the accretion of the long-term evidence. This is a hallmark of Faber’s style – to reveal successive layers of detail and complexity, and then to draw simple, sensible conclusions based on his observations.
Next up is a review of the traditional 60/40 benchmark portfolio, consisting of U.S. stocks and T-bills. Faber provides a nice 114 year backtest, but concludes that today, given lofty stock/bond valuations, the opportunity set is unpalatable, with arguably 0% expected real returns for U.S. stocks/T-bills going forward (and negative expected real returns for holding cash). One must also consider the potential survivor bias associated with the United States, which over the past 100+ years, has been on an exceptional economic run, which may or may not continue in the future.
So where else can investors turn? Faber takes us through some asset class alternatives, including foreign stocks and bonds, corporate bonds, commodities, REITs, and gold, and others. Faber reduces these to a manageable list of 13 assets classes, and now that he has laid the groundwork, he begins examining how some well-known approaches might be expressed using these asset classes.
Over the next few chapters, Faber takes us through some of the best-known approaches to strategic asset allocation. Ray Dalio and Bridgewater’s “Risk Parity” and “All Seasons” portfolios, which are based on risk-weighting of asset classes. Harry Browne’s “Permanent Portfolio,” which is based on an equal weighting to U.S. stocks, gold, and long- and short-term government bonds. The “Global Market Portfolio,” which uses global market cap weightings. The “Rob Arnott Portfolio,” which uses weights from an Arnott paper from 2008. The “Marc Faber Portfolio,” which uses an equal 25% weighting across gold, stocks, bonds and REITs. The “Endowment Portfolio,” a broadly diversified approach, as seen through the lenses of David Swensen, Mohamed El-Erian, and Faber’s own “Ivy Portfolio.” The “Warren Buffett Portfolio,” which is a simple 10%/90% weighting to government bonds and U.S. equities, based on a 2013 shareholder letter.
Each of these approaches offers a different “flavor” of asset allocation. Some rely more heavily on stocks, while others might on, say, real assets. Some are U.S. focused, others are global. With such a wide variety of portfolio approaches, it becomes difficult to compare them in any kind of disciplined way. Faber’s solution is to simplify the recommended exposures by collapsing his 13 asset classes into 3 basic asset classes – stocks, bonds and real assets.
Faber shows results from the “simplified” asset allocations across the strategies, which allows them to be directly compared. While there are some differences at the margin, specifically during inflationary/deflationary periods for strategies that use real asset allocations, they all have remarkably similar results over time.
What should we make of this finding?
It’s possible that if Faber went to much greater lengths to try to get more detail on the strategies and allocations, we might see a bit more dispersion. But I bet Faber would argue that returns wouldn’t be very different. So perhaps this is the core insight of the book, i.e., that so long as you are reasonably diversified, no matter which specific approach you use, you are going to end up in roughly the same place over the long run.
What’s useful about this insight is that it suggests that the most important features of an approach may not relate to the specific asset allocation strategy you use, but relate instead to aspects that are within your control, such as fees and taxes. Faber shows how expensive fees can take the top performing strategy identified from his examples, and turn it into one that underperforms the worst strategy.
If you believe that strategic asset allocation strategies are roughly similar in the long run, then you can really help yourself by staying focused on fees and taxes.
Finally, Faber also includes a long appendix section. It addresses a number of issues related to asset allocation, including rebalancing, smart beta, sector rotation, and currency hedging. Later sections examine a few more strategies, including the “Tobias Portfolio,” consisting of equal 33% weight to U.S. stocks, international stocks, and bonds, the “Talmud Porfolio,” based on Judaism’s Talmud, and a few others that explore subtle differences in portfolio construction, such as “Swedroe’s Portfolio,” which allocates to small caps.
In general, the writing felt a little thin compared to the voluminous data provided, and I found it read a bit like more of white paper than a book. Faber’s “Ivy Portfolio” was over 200 pages, yet “Global Asset Allocation” might not crack 100 pages if it used the same font and layout. It feels as if Faber didn’t dedicate the time required to make this a deep read on asset allocation.
I wish Faber had provided more analysis of the returns on the well-known methods. After providing the returns from the various approaches, we are sort of left on our own to interpret them. For instance, the Permanent Portfolio seems to notably underperform the other strategies, but with low drawdowns and a fairly high sharpe ratio, due to a heavy bond allocation. Meanwhile, Arnott’s strategy seems to have the highest sharpe ratio of all. How are we to interpret these findings? Do these facts have any implications for how we should think about these strategies? More discussion would have been helpful.
Also, in the process of distilling data, Faber argues that he captures the essence of each manager’s style. That could be true from a big picture perspective. But certainly it may not be fair to David Swenson to reduce him to a mechanical allocation process.
Despite these limitations, “Global Asset Allocation” offers a good framework for thinking about asset allocation, along with a detailed look at the approaches of some of the best-established allocators in the world. We have a lot to learn from them, especially when they disagree. It’s instructive to see how these leading lights of the investment community can look at things so differently. How can it be that some have a huge allocation to bonds, while others have a very small allocation? How can some allocators pound the table on real assets, while others claim you can safely ignore them? In the end, as Faber implies, perhaps it doesn’t matter all that much.
Or maybe it does.
Certainly, some approaches are going to better insulate you from specific outcomes, for instance if the U.S. sees hyperinflation, a sovereign default occurs in a major developed economy, or gold experiences a 50% drawdown. If you have a view on the world, or even if you just want to prepare for any possibility, this book gives you some tools for thinking about the big picture.
Perhaps the next step for many will be how to think more specifically within a given asset class. Faber hints that a value tilt can increase risk-adjusted returns, and also mentions momentum, quality and volatility. We hope to see more work from Faber along these lines in the future.
Any investor looking for a long-term solution for portfolio allocation and a good overview of different ways to approach the problem can benefit from a review of these diverse allocation strategies. Faber undoubtedly delivers a comprehensive review of the opportunity set with “Global Asset Allocation.”
Overall, this is a great addition to the bookshelf for the educated investor.
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Definitions of common statistics used in our analysis are available here (towards the bottom)