Looking Beyond the 60/40 Portfolio in an Era of Low Returns

I wrote earlier this year that the 60/40 portfolio is dead. Well, rumors of its death were not greatly exaggerated. The 60/40 portfolio that served retired investors so well over the past 30 years is gone… and it’s not coming back any time soon. As investors, we have to move on.

Rest in Peace 60/40 Portfolio


While it’s true that a simple 60/40 portfolio of the SPDR S&P 500 ETF (SPY) and the iShares Core US Aggregate Bond ETF (AGG) is actually enjoying a nice run in 2016, up a little more than 3% for the year, don’t get used to it. The math simply doesn’t work out going forward.

Let’s play with the numbers. Back in 1980, the 10-year Treasury yielded a fat 11.1%, and stocks sported an earnings yield (calculated as earnings / price, or the P/E ratio turned upside down) of 13.5%. This implied a back-of-the-envelope portfolio return of about 12.5% per year going forward, and for much of the 1980s and 1990s that proved to be a conservative estimate. Both stocks and bonds were priced to deliver stellar returns, and both most certainly did.

But what about today? The 10-year Treasury yields a pathetic 1.6% and the S&P 500 trades at an earnings yield of just 4%. That gives you a blended portfolio expected return of an almost embarrassing 2.8%. [Note: The usual disclaimers apply here. These are not intended to be precise market forecasts.]

You know the refrain: past performance is no guarantee of future results. There is no guarantee, at least with respect to stocks, that expensive assets can’t get even more expensive. It’s possible that the great bull run in stocks could continue indefinitely, however unlikely it might be.

But I can’t say the same for bonds. Starting at a 1.6% yield to maturity (or even the 4% you might find on a mid-grade corporate bond) you cannot have returns going forward that are anything close to the returns of the past several decades. Bond yields would have to go negative, and I don’t mean the (0.15%) we see today on the Japanese 10-year bond. I’m talking (5%) or (10%) or even more.

That’s not going to happen. Or if somehow it did — if investors got so petrified that they piled into bonds to the extent that yields went negative to that degree — then I would assume the stock portion of your portfolio effectively fell to zero at that point.

The bottom line here is that even under the most optimistic scenario, investors are looking at disappointing returns in a standard 60/40 portfolio.

So, what are investors supposed to do about it? They can’t just stuff their cash in a mattress for the next 5-10 years. Most of us actually need to earn a return on our money.

I’d offer the following suggestions:

Consider taking a more active approach to investing.

To the extent you invest in traditional stocks and bonds, don’t be a buy and hold index investor. Yes, low fees are great. But the fact that you paid Vanguard only 0.09% per year in management fees won’t really matter if you’re returns are still close to zero.

Instead, try a more active strategy, perhaps focusing on value or momentum. Or perhaps try a dividend focused strategy. With a dividend strategy, you can realize a cash return even if the market goes nowhere for years at a time.

Consider investing outside of the market.

If you’re willing to get your hands dirty, consider starting your own business or investing in a cash flowing rental property. Yes, there is more work involved, and there is the risk of failure. But there is also risk in trusting your savings to a fickle market when both stocks and bonds are both expensive by historical standards.

Consider a truly alternative asset allocation.

This final point is really my specialty. To the extent I can, I am eliminating traditional bonds from the portfolios of most of my clients and replacing them with non-correlated (or at least minimally-correlated) alternative investments. A standard 60/40 stock / bond portfolio might instead become a 50/50 dividend stocks / alternative investments portfolio.

“Alternative investments” is a generic term that can mean just about anything. In practice, for me it has meant a combination of long/short strategies, options writing strategies, absolute return hedge funds, and liquid alternative portfolios. I’ve even incorporated a liquid alternative robo advisor into the mix.

Will a non-traditional portfolio like this outperform over time?

Frankly, I don’t know. No one does. We’ve never seen a market like today’s.

But to me, it’s the only move that makes sense. Taking the traditional path is a virtual guarantee of disappointment. Incorporating alternatives into the portfolio at least give us the potential for solid returns.

Charles Lewis Sizemore, CFA is the principal of Sizemore Capital, an investments firm in Dallas, Texas.

Photo credit: Pheonix149

In Defense of Hedge Funds…


Photo credit: Sean Davis

Hedge funds don’t get a lot of love these days. They’ve underperformed for years, and their fees — the standard is 2% of assets and 20% of profits — make them pariahs in the age of indexing and low-cost robo advisors.

Hey, I get it. The high fees and lousy performance of competing hedge funds was a major reason that I started a liquid alternative robo advisor with my partner, Dr. Phillip Guerra. We run a suite of risk parity portfolios that hold their own against comparable hedge funds… and we do it at a fraction of their fees.

Yet let’s not throw out the baby with the bathwater. While many — perhaps most — hedge funds add no real value and certainly don’t justify their fees, there are plenty of hedge funds that absolutely do add value and deserve every last cent. But how do you separate the wheat from the chaff?

Ask yourself the following questions:

Does the fund do something unique that realistically cannot be replicated in a cheaper and more transparent vehicle, such as an ETF, mutual fund or managed account?

Really dig deep here. If the fund is a long-only large cap fund, you should be skeptical as to whether the hedge fund structure is necessary. If the fund employs sophisticated hedges that would be hard to implement in a smaller managed account, then the hedge fund structure is probably justified.

Does the fund deal in illiquid securities that would justify the lack of liquidity of the fund itself?

Years ago, a hedge fund in the DFW area made a fortune buying idled planes from the major airlines. Needless to say, that sort of thing would be impossible to replicate in a mutual fund, ETF or managed account. It’s virtually impossible (or at least impractical) to securitize an airplane. On a similar note, in the past I have placed accredited investor clients in a fund that finances medical accounts receivable that might take two years or more to pay off. It’s hard to see a strategy like that working in a mutual fund that promises daily liquidity.

Defaulted Argentine bonds… large macro bets with credit default swaps… I could go on all day giving examples of illiquid opportunities that wouldn’t make sense outside of a hedge fund. But an outsized bet on Apple or Valeant Pharmaceuticals? Not so much. You can do that on your own in a discount online brokerage account without having to pay the 2 and 20 to the manager.

Does the fund have a strategy that would be fundamentally undermined by investor redemptions?

Think about corporate raiders like Daniel Loeb or Carl Icahn. These guys are known for amassing massive stakes in companies and then using their clout to force change, including booting out management that is underperforming. That only works if you have a stable pool of capital. Imagine Loeb attempting to take over a company and then having to back away with his tail tucked between his legs because he had a wave of shareholder redemptions.

When your advisor pitches you a hedge fund, you shouldn’t necessarily recoil in horror. I regularly incorporate hedge funds into the portfolios of my accredited investor clients when they fill a specific niche I’m trying to fill. And to date (knock on wood), I have yet to have a major disappointment on this front. I’ve lost plenty of money for myself and clients in low-cost ETFs and mutual funds, though I’ve never lost money (again, knock on wood) investing in a good alternative manager or hedge fund. I probably will at some point. You know the drill, past performance is no guarantee of future results. But I can credibly say that it hasn’t happened yet.

Before you invest a single red cent in a hedge fund, ask yourself the questions above. Hedge funds are certainly not for everyone, but if utilized correctly they can reduce portfolio volatility without sacrificing returns.

Charles Lewis Sizemore, CFA is the principal of Sizemore Capital, an investments firm in Dallas, Texas.

Liquid Alternative Investments for Ordinary Investors


Barron’s did a nice special report this week on AQR’s liquid alternative investments. AQR, which is run by Cliff Asness, John Liew and David Kabiller, is a pioneer in the liquid alternatives space and manages an impressive $141 billion in assets. They also happen to be a competitor of mine. My partner, Dr. Phillip Guerra, has developed an entire suite of liquid alternative strategies based on many of the same principles used by AQR.

As Barron’s writes,

Since U.S. stocks peaked in July, few investments have produced strong returns. Global stocks, junk bonds, and most commodities have declined—in many cases, sharply. And many so-called alternative investments have failed to provide hoped-for diversification benefits. Just look at the big losses suffered by some notable hedge funds.

The situation hasn’t been much better among liquid alternatives, or mutual funds that use hedge fund strategies such as merger and convertible arbitrage, long/short equity, and trend-following in futures markets. Yet, against this tough backdrop, a bunch of academics are delivering. Their firm, AQR Capital Management (AQR stands for applied quantitative research), is a distinctive investment manager that seeks to translate academic insights about finance and the markets—such as the appeal of value and momentum investing—into winning quantitative strategies for institutional and retail buyers…

Indeed, the stock market selloff since the start of this year has shaped up as a key test of whether liquid alts can deliver the promised diversification and protect investors during downturns. Liquid-alt funds have been rightly criticized for generally disappointing returns during the recent bull market—and high fees, to boot.

During a raging bull market, alternative strategies will almost always underperform… as will most traditional long-only active managers. It makes sense to dump every last cent into an S&P 500 index fund and be done. But the kind of market we’ve experienced since 2009 isn’t normal. It was a product of low valuations following the 2008 meltdown and the loosest monetary policy in history from the Fed. But with the market now in expensive territory and with the Fed’s easy money policies slowly on the way out, an alternative strategy makes all the sense in the world, at least with a portion of your portfolio. You want returns that are uncorrelated to the market. You’re not betting against the market, mind you. You’re just looking for something that marches to the beat of its own drum.

I like what AQR is doing. But there’s a big problem with it: While they advertise that their alternative funds are liquid, they are all but unattainable for the vast majority of investors. The minimum investment on many of their mutual funds is as high as $1 million.

We can do it better. With an investment of just $100,000 (and actually less with our robo-advisor option), we can execute a comparable strategy and do so with far lower fees.

To see how our results stack up against AQR and the rest, take a look here.

I’m a big believer in the benefits of a long-term buy-and-hold strategy, particularly for younger investors. But I’m also realistic and realize fully that a long-only strategy will go through long periods of underperformance. From 1968 to 1982 — a period of 14 years — long-only investors in U.S. stocks wouldn’t have earned a single red cent.

Now, I have no way of knowing if we are about to enter a long dry spell like that. But if you are in or near retirement, doesn’t it make sense to have at least a portion of your portfolio in a strategy that zigs when the market zags?

If you’d like to hear more about our liquid alternative options, contact my office today.

Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas.

Photo credit: GotCredit

Investing In Recession Resistant Real Estate


My good friend Ari Rastegar of Rastegar Capital recently did an interview with the Houston Chronicle on investing in Texas real estate. I invest with Ari, incidentally, as do some of my clients. If you are an accredited investor and would like to know more, please contact me.

Here is an excerpt from the article:

Ari Rastegar, founder and CEO of Rastegar Capital, is in spending mode. His Dallas-based company is looking to buy Houston real estate, particularly self-storage properties, land, shopping centers and distressed assets…

Q: What do you own in Houston?

A: We have a big focus on self-storage. We own 10 different self-storage facilities in Houston. We started buying those facilities in Houston about three years ago.

Q: Why do you like self-storage?

A: When you have the big house and the economy is booming and you buy the new couch, where do you put the old couch? In self-storage. That’s what Americans do. We love our stuff. What happens when the economy goes down and we have another 2008, when people start losing their houses and temporarily need to downsize into an apartment? Where do you put all your stuff that was filling up your big house? Our answer to that is self-storage. Self-storage is recession-resilient.

Q: Are there a lot of self-storage assets to invest in?

A: There’s actually a very high barrier to entry to self-storage. Why? It’s not just buying bricks and mortar. It’s also buying an operating business. For the most part, you also have to operate that business, take the rent, make sure things are going without a hitch. That’s one of the reasons why it’s interesting. Look at the public REITs. There are about 2,000-plus in all different asset classes of real estate. In self-storage, there are only four major publicly traded REITs. Four big companies really control the vast majority of the self-storage market. It creates a good opportunity if you are a good operator.

Q: Are you concerned about investing in Houston?

A: No. I believe Houston has so much value. The job growth is there. We’re going through a little bit of a correction. There’s a lot of fear in the marketplace. Where you see fear, you see irrational behavior. You see irrational dips in value.

You can view the entire article here.

Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas.

Photo credit: Ron Kikuchi

The 60/40 Portfolio Is Dead. Here Is Its Replacement


Why Invest in Alternatives?

You probably have a good grasp of why diversification is important. Throwing out the financial jargon, it essentially boils down to not putting all of your eggs in one basket. But it also gets a lot more sophisticated than that. Many investors feel that they have adequate diversification because their assets are spread across several stocks or mutual funds. And to an extent, they are right. Owning multiple stocks reduces the risk of downside from any single position.

But there is also a major problem with this: Correlation.

If Apple and Microsoft stock prices were to move together in lockstep, you wouldn’t be getting much in the way of diversification by owning both. And in a real bear market, virtually all stocks drop together.

True diversification means owning assets that do not move together. Investment A can go up, down or sideways, and it should have little or no impact on Investment B.

This is where the beauty of an alternative portfolio comes into play. A carefully constructed alternative portfolio will have assets that are minimally correlated to each other and to the stock market as a whole.

Why the 60/40 Portfolio is Dead

Alternative assets weren’t particularly popular in 1980. There is a reason for that. Back then, traditional bonds offered a respectable return. A blended 60/40 portfolio of stocks and bonds offered a solid expected return.

Flash forward to to present day. At current bond yields, investors will be lucky to get a 2% return in bonds. And compounding the situation, stocks are also expensive by historical measures and priced to deliver sub-par returns.

Note: The Stock Earnings Yield is the inverse of the price/earnings ratio. The “Implied portfolio return” is a weighted average of the 10-year Treasury yield and the stock earnings yield. This is intended to be a rough approximation for future asset returns and is not intended to be a precise forecast. As always, past performance is no guarantee of future results.


Accepting a traditional asset allocation is accepting the possibility for disappointing returns in the years ahead. If you want better performance, we need to look elsewhere.

While ordinary investors have traditionally invested in stocks, bonds and CDs, wealthy investors and institutions have always had a broader allocation.Consider the case of the Harvard University endowment fund.

As of 2015, the Harvard endowment fund had only 33% of its funds in stocks. It has another 18% in private equity and 12% in real estate. The rest is spread across everything from timberland to absolute returns hedge funds. Let’s stop and ask an obvious question: If it’s good for trustees of Harvard, might it not also be good for you?

Source: Harvard Endowment Allocation http://www.hmc.harvard.edu/docs/Final_Annual_Report_2014.pdf


Not all of the alternative investments discussed will be appropriate for all investors. But we believe strongly that every investor can benefit from a proper allocation to alternative investments.

Charles Sizemore is the principal of Sizemore Capital Management.