Rethinking What Is Safe

This will be fun.

Meb Faber posted a short white paper titled What Is The Safest Investment Asset? The context is someone who has enough money to be able to avoid a normal allocation to risk assets with general idea underlying the piece is that it would be easy to just say T-bills and in nominal terms, that would be true but factoring in the loss of purchasing power due to inflation, that would not be the case. 

The table assumes 2.94% annualized inflation to yield the following real returns.

 

 He devised what he calls the Global Asset Allocation (GAA) which takes in equities, fixed income, commodities, REITs and a couple of others, built out as follows.

The white paper plays with the following mixes of GAA and T-bills.

As I look at GAA, I feel like it might be more reliant on bonds than I want to be. I've been saying for a while that I think any sort of duration in the fixed income market will be a source of unreliable volatility for the foreseeable future and I would rather avoid that or at the very least, be very underweight that potential volatility. 

I played around with GAA, a portfolio that I thought might be competitive with GAA and Portfolio 3 is just 100% in Vanguard Balanced Index (VBAIX) which is a proxy for a 60/40 portfolio. 

Meb is very consistent about global equities so I used ACWI. Using a domestic equity index ETF for Portfolio 2 would have resulted in the CAGR being higher because of how well domestic has done versus foreign but Meb seems to be neutralizing that bet so I did too. The results.

 

Year by year, it is a flip of the coin between GAA-Portfolio 1 and the allocation I concocted for Portfolio 2. We can get nine and half years to look at and in that time we certainly had some stuff happen. Where the focus is real returns, equities tend to out pace inflation. TIPS are meant to keep up with inflation and managed futures which own commodities that are in an uptrend should keep up with inflation if not get a little bit out in front of it. BTAL and ASFYX tend to have negative correlations so they often go up when equities go down (no claim of infallibility) which has the effect of lowering the net allocation to equities. STPZ has a very low correlation to equities so no meaningful equity beta there and it is not a long duration product. Longer duration TIPS funds got hit very hard last year.

GAA has less net exposure to equities but has kind of a lot of exposure to longer duration fixed income and allocates to commodities in a simpler long only manner. 

Obviously I'm inclined to favor Portfolio 2 because it has provided 150 bps of additional CAGR with only 9 more basis points of standard deviation which seems like a good tradeoff. 

A key point to not get too far from is that while cash will lose purchasing power, some sort of allocation to cash will still be important in a year like 2022 when just about everything went down a lot. The consequence of sequence of return risk is a short term threat, a couple of years or so versus erosion caused by inflation which is a longer term threat. It's important to discern between the two.   

BTAL, ASFYX and STPZ are personal and client holdings. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.