Balanced investment vehicles: a skewed reality part 3

There remains two important points that I want to make regarding funds that provide a balanced allocation to equities and bonds.

The first is that many mutual funds still charge too high a fee, and that the positive returns we have seen from these vehicles to date, due to some pretty unique circumstances, has for many smoothed over the issue of high fees in low growth/low yield environments and high fees per se, irrespective.  There are a number of recent arguments in the media that appear to suggest it is not returns relative to the benchmark that matter, but positive returns irrespective of relative magnitude.  This is lazy!  

The second is that many commentators and presumably advisors are having their asset class risk/return expectations being impacted by the relative returns of bonds over equities during the last 13 years and since 2007 especially.  For some investors a balanced approach may well be appropriate, but I prefer to combine liability profiling (that is relating asset allocation to size and timing of financial needs) with valuation issues, and I have concerns that investors with long time frames or limited liability demands on their portfolios are going to be recommended a higher long term bond allocation because of the recent past and without regard to some of the disquieting dynamics that have built up. 

With regard to the first, it also important to address issues of inflation adjusted returns and situations where withdrawals exceed a given fund’s yield after management expenses and other costs.

The rest of this post provides additional graphical analysis of the modelling.  Again it is important to note that the modelling is used to highlight certain dynamics that have boosted returns of balanced funds, especially those with disciplined rebalancing over the recent past.

——————————

image

image

The bottom line in the above chart is the same as the dotted blue line in the first chart.   The MER on which fees are based is 2% per annum.

image

Highlights the impact of compound returns on bonds in a secular bond bull market relative to total equity return and bond capital return only.

And of course, dividends have been growing on equities since 2000:

image

image

image

image

image

The analysis that is being conducted in these posts is based on data drawn from the Shiller/Yale data set.   The market is the US equity market and the bond allocation is the 10 year US Treasury.  The coupon on the bonds falls throughout the period to replicate falling coupons on new issues.  Rather than reinvesting every year into a new 10 year bond, this analysis assumes that this is only done every 3 years.  The analysis is not meant to replicate the exact returns, but to replicate the structure and dynamics of return from balanced portfolios under a number of different scenarios over the period in question. 

Real life balanced portfolios may hold a shorter bond duration, may well hold higher risk corporate bonds as well as high yield non investment grade corporate bonds and other types of securities.   They are also likely to hold cash balances which at times may be significant.  Additionally, their allocation profile may be counter or pro cyclical, all of which will produce different results.  The important point however is what I consider to be unique dynamics affecting returns to date that pose significant risks to those expecting the past to repeat.

Leave a Reply