Two weeks ago Barron’s published an
interview with Cliff Asness, one of the founders of AQR Capital Management and
the former director of Quantitative Research at Goldman Sachs. Barron’s asked Mr.
Asness what kind of return investors could expect from a traditional 60/40
stock/bond portfolio. While noting that his answer referred to US stocks and
bonds, he stated that the answer is not that different for a global portfolio.
Mr. Asness said that while a 60/40 portfolio has historically produced a real
return, i.e. after inflation, of about 5%, investors should expect about half
of that going forward.
He went on to explain that while US equities have been cheaper than they are today over about 80% of their history, bonds have been cheaper about 90% of the time. However, because both stocks and bonds are at the upper end of historical valuation ranges at the same point in time, the valuation of a traditional 60/40 stock/bond portfolio has been cheaper about 98% of the time.
While these traditional portfolios have worked extremely well year-to-date, the fact that their valuations are in the top 2% of historical observations is a very strong indicator that they will not perform well in the future. Markets can stay over or undervalued for significant periods of time and we do not know when the valuations will revert to historical norms. However, such reversion will result in significantly weaker performance than a 60/40 portfolio has produced over the last three to four years. As such, portfolios should be positioned ahead of this change.
The information above strongly suggests that long/short strategies, many of which have lagged significantly this year, are likely to perform better than traditional, long only, strategies going forward. Additionally, we would note that the sell-off in emerging debt has made the asset class attractive once again (see our blog posting Why We Like Emerging Markets Bonds). Finally, despite the dramatic sell-off in the US bond market, PIMCO Total Return and Baird Core Plus are only down about 3% YTD. In short, it’s very likely that correcting the relative overvaluation in equities will result in far greater price declines than correcting the over valuations in bonds.