Introduction
I thought it was time I posted something for my subscribers who are invested in passive multi-asset funds, most likely via the very successful Vanguard Lifestrategy range.
Readers may know that if one picks these funds, one is accepting the well established (but arguable – See Multi Asset Academy) idea that equities add volatility to a portfolio and fixed income investments add a stabiliser. With a well thought out asset allocation to various parts of these high level asset classes, one can build funds with more or less equities and therefore more of less volatility. Volatility is one way of looking at the risk of capital loss.
So Vanguard market funds with anything from 20% to 100% invested in equity index trackers. The non equity element is invested in a range of fixed income trackers. One would expect the funds to all perform about the same in terms of market direction (because although the asset allocations are different, they invest in the same indices), but not degree. Over the long term, the 100% equity fund ought to make you more money, but the ride will have been a lot bumpier.
However, the relative directional movements of equity and fixed income markets may not be what the textbook would have you believe in the short term.
The fact that Vanguard, for sensible marketing reasons, offer funds differentiated by 20% changes in equity content can result in the sort of strange results that any fixed algorithm will output when several variable inputs change at the same time.
A coming together of returns over 3 years
Here is what I am working up to:
If you look at current data from Morningstar for 3 year annualised returns from the Vanguard Lifestrategy 20%, 40%, 60% and 80% equity funds, the results for all 4 are within a few basis points of 4.7%.
More recent returns favour the funds with more fixed income (because of the Covid pandemic) and the 3 year average volatility is reported as increasing with the equity exposure.
The interesting point, applicable now and maybe rarely in the future, is that one cannot buy investments and expect that a given asset mix will always deliver a predictable return and perhaps more relevant for portfolio builders, at times the inverse relationship between equites and fixed income assets breaks down.
Over the last 3 years, a wholly unpredictable event has meant that cautious investors have made as much money as adventurous investors.
Knowing what we do about recent events, we might think that is intuitively what should have happened. But it is not what mechanistic risk modelling software tools would have predicted.
Implications
Does that probably rare coming together of fund returns mean we ought to change our portfolio design methodology.? I think not – for me it just confirms that in building portfolios we should be allowing for as many unforeseen possibilities as possible and undertake reviews based on what we actually know at the moment.
So, taking that to its logical conclusion, fixed income investments have recently performed as well as equities for less volatility. That implies central banks are predicting a recession. At current ultra low interest rate levels, it also makes fixed income assets look super expensive.
Bearing in mind that we have drawn this data from passive asset allocated funds with no bias to US tech (where there have been big jumps in equity valuations) , it also suggests that ordinary global equities in general are cheap. That brings us back to my suggestion that looking for value might be a rewarding use of research time.