A Lie That Won’t Die: The 60/40 Portfolio

January always plays host to a wide variety of ideas about portfolio construction for the coming 12 months. Usually, we brace ourselves for a wide swath of regurgitated nonsense, and try not to let it get under our skin. Except, sometimes, the people talking should know better- a lot better- and we find ourselves in need of rant.

Today is one of those times. Frank Kinnrey, one of Vanguard’s principals, spoke with InvestmentNews, who reported:

Mr. Kinniry said he agrees that the performance of the 60/40 portfolio over the next 10 years isn’t going to come anywhere close to what it’s been historically, mainly thanks to the record valuations and low yields in bonds today. In fact, he warned it could return as much as 50% less than its historical average of around 8% or 9% a year.

But when it comes to managing risk, the 60/40 portfolio is still an adviser’s best bet, Mr. Kinniry said. Chasing after a hot new asset class sets advisers up for failure more often than not, he added.

Hmm, really? Because we’ve run the numbers on this about a million times over… and this is just wrong. In fact, if you go back to 1994, and calculate the efficient return of a portfolio consisting of 40% managed futures, 20% bonds, and 40% stocks, both the Compound ROR AND Volatility are substantially improved over the 60/40 portfolio split. And that includes the past year, where managed futures struggled and stocks rallied.

Managed Futures Efficient Frontier
Disclaimer: Past performance is not necessarily indicative of future results. Source: Managed futures = DJCS Managed Futures Sub-Index, US Stocks = S&P 500, World Stocks = MSCI ex USA

Obviously, past performance isn’t necessarily indicative of future results, and maybe we would have let the whole thing go, but the piece continued:

Managed futures funds, for example, have grown to approximately $9 billion in assets since the financial crisis — thanks primarily to their out performance during that period. Since 2008, however the average managed futures fund has lost money while stocks and bonds have rallied.

Ugh. First off, these folks should know better than to highlight managed futures mutual funds as managed futures proxies. We’ve been over this again and again (and again). Managed futures mutual funds are not the same thing as managed futures. But to add insult to injury, the piece concluded by saying:

Treasurys and investment-grade corporate bonds are the only two asset classes that consistently generated a positive return during the worst stock drawdowns since 1988, according to Vanguard.

Wait, wait, wait… WHAT? You’re saying that these investments are the ONLY assets that have done well in crisis periods?! Not only is that statement incorrect- it’s WILDLY INCORRECT. Crisis periods have not always been kind to those investments, but you know what asset class has done well during crisis periods? Managed futures:

Crisis Period Performance Managed Futures
Disclaimer: Past performance is not necessarily indicative of future results. Source: Managed futures = DJCS Managed Futures Sub-Index, US Stocks = S&P 500, World Stocks = MSCI ex USA.

Such is the benefit of allocating to an asset class that can take advantage of up AND down trends across a variety of markets. But let’s talk about consistency, since that seems to be the biggest beef with pursuing alternatives. Unfortunately, even in this realm, the 60/40 blend loses to a blend of 40% stocks, 20% bonds, and 40% managed futures.

To figure this out, we used a test we’d done on asset class performance consistency earlier this year. We compared 12, 24, 36 and 60 month windows of time from January 1994 to November of 2012 for both the 60/40 portfolio, and the 40/20/40 portfolio. We then measured what percentage of time achieved results greater than 0, 5%, 10%, 20% and 30%. For example, if we looked at 100 different 12 month windows (that isn’t 100 years, it is xx years, as each subsequent month creates a new 12 month window), and 50 of those windows were positive, and 50 were negative, we would find the index was positive 50% of the time across 12 month windows. The point of the experiment was to look at what percentage of the time you’d have achieved certain results had you held an investment in each asset class for a given amount of time. Here’s what we found in terms of positive results:

60/40 Portfolio Consistency
Disclaimer: Past Performance is not necessarily indicative of future results. Source: Stocks = S&P 500, Bonds = CitiWorld Bond Index, Managed Futures = DJCS Managed Futures Sub-Index. Bolded numbers indicate outperformance.

Those numbers are pretty impressive, particularly as the investment timeframe increases. Those figures are uniquely valuable,as they are are most aligned with the average investor’s goals. It’s not often that you hear someone say, “I’m going to prepare for retirement for two years.” When every 5 year window is generating positive returns, and over 72% of those windows generated returns over 20%, that’s not something to stick up your nose at.

To be fair, though, there’s more to investing than positive returns. We’d be remiss to not also consider the downside of things. So we ran the numbers, using the same parameters, for negative results within the same windows of time:

60/40 Portfolio Consistency 2
Disclaimer: Past Performance is not necessarily indicative of future results. Source: Stocks = S&P 500, Bonds = CitiWorld Bond Index, Managed Futures = DJCS Managed Futures Sub-Index. Bolded numbers indicate outperformance.

For us, this is where the 60/40 portfolio loses all relevance. The portfolio with alternatives only faced losing periods in a one or two year window, and at a far, far lower rate than seen in the 60/40 blend. The traditional portfolio simply doesn’t come close.

In other words, the 60/40 portfolio is STILL a bad idea. It’s better than the 100/0 portfolio to be sure, but simply look at the numbers (all of them, not just the past few years) to see that it is less consistent and more risky than a portfolio containing managed futures.

6 comments

  1. Ok, but…

    “The Credit Suisse Managed Futures Liquid Index (Net) was launched on February 1, 2011. Simulations for the Credit Suisse Managed Futures Liquid Index were conducted to measure how a portfolio of securities designed to mimic a managed futures strategy would have performed in the period beginning December 31, 1997. Returns were simulated assuming various transaction costs per each instrument. Any invested or borrowed cash earned or paid interest at market rates. Index portfolio weights were computed daily and index rebalancing occurred on the day after the portfolio weights were computed and for which all instruments involved in the rebalancing process were available to be traded. The platform on which this testing was performed is a proprietary system developed at Credit Suisse. All simulations were conducted by Credit Suisse Asset Management. The Index does not represent that the hypothetical performance pre-dating February 2011 would be similar to actual performance of the Index. Hypothetical, back-tested or simulated performances have many inherent limitations only some of which are described as follows: It is designed with
    the benefit of hindsight, based on historical data, and does not reflect the impact that certain economic and market factors might have had on the decision or rule-making process. No hypothetical, back-tested or simulated performance can completely account for the impact of financial risk in actual performance. Therefore, it will invariably show positive returns. The information is based, in part, on hypothetical assumptions made for modeling purposes that may not be realized in the actual performance. No representation or warranty is made as to the reasonableness of the assumptions made or that all assumptions used in achieving the returns have been stated or fully considered. Assumption
    changes may have a material impact on the model returns presented. There are frequently material differences between hypothetical, back-tested or simulated performance results and actual results subsequently achieved by any investment strategy. Unlike an actual performance, hypothetical, back-tested or simulated results are achieved by means of the retroactive application of a back-tested model itself designed with the benefit of hindsight. The back-testing of performance differs from actual performance because the
    allocation rules may be adjusted at any time, for any reason and can continue to be changed until desired or better performance results are achieved. In fact, there are frequently sharp differences between hypothetical, back-tested and simulated performance results and the actual results subsequently achieved. The Index is not a security and cannot be purchased.”

    Is this the index in question?
    http://alternativebeta.credit-suisse.com/altbeta/documents/LAB_Performance%20Update_Managed%20Futures%20Liquid%20Index.pdf

  2. Thanks.

    I pulled it up here…
    http://www.hedgeindex.com/hedgeindex/secure/en/indexperformance.aspx?cy=USD&indexname=CORE_MGFUT

    (Assuming this is the one you’re referring to.)

    However, a few follow-ups:
    1. Where are you coming up with the pre-2006 data? (The linked page says that the sub-index incepted on 1/1/06.)
    2. This is what the notes say: “Statistics include hypothetical performance from January 1, 2006 to December 31, 2010 and actual performance from January 1, 2011. Please refer to the disclaimer for important information regarding simulated performance.” Since they didn’t start publishing the core indexes until 2010, I’m assuming they just simulated the performance of the initial set of managed futures funds going back to 2006, right? Might be actual managers, but it’s still hypo, no?
    3. I think I saw a half-dozen or so funds listed as constituents. Has the sample size always been so small? Couldn’t this amplify some of the biases that you mentioned in your discussion of managed futures index methodology?

  3. We agree with you that managed futures mutual funds are NOT the same animal as managed futures and perhaps the biggest fraud being perpetrated on the retail public.

  4. Sorry, the last link erroneously led you to the Core index. The Core index and its subindices have fewer constituents and a shorter track record because it offers daily reporting. When we cite the DJCS Managed Futures index we are using the broad subindex (http://www.hedgeindex.com/hedgeindex/secure/en/indexperformance.aspx?indexname=HEDG_MGFUT&cy=USD) which reports monthly, has a track record going back to Jan 1994, and tracks 34 managers as of this December. Hope that clears up the confusion.

  5. […] A Lie That Won’t Die: The 60/40 Portfolio (managed-futures-blog.attaincapital.com) […]

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Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, RCM's own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, RCM's own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.