Over the past year, I’ve been reading up on all kinds of investments and trying to determine where I can find some yield. So I enjoyed this New York Times story on Duke students who’ve come up with a “portfolio that pays.” The winning portfolio:
They were bullish on United States stocks, especially those of large companies, based on their predictions of a continuing recovery in housing, rising consumer confidence, strong retail sales and the continuing impact of the Fed’s quantitative easing program. They were also optimistic that Congress would avoid the so-called fiscal cliff and other threatened political calamities. But they were pessimistic about Europe and emerging markets, given the euro zone crisis and what they saw as slowing growth in countries like China and Brazil.
The team’s contest entry called for allocating 43 percent to United States stocks — 30.3 percent to a Russell 2000 index fund and 12.7 percent to a Russell 2000 fund that invests in midsize companies. They made no allocation to international stocks. Like more traditional models, they maintained a large allocation to fixed income, but weighted it heavily toward Treasury inflation-protected securities, or TIPS, whose yields rise with inflation. They allocated 32.1 percent to TIPS and 24.9 percent to an aggregate bond fund.
The result was a 9.7 percent projected annual return, with less volatility than the model funds they examined.
Personally, I think it’s a mistake they’re neglecting the international sector (especially emerging markets). I am also not as bullish on TIPS as these students. I do like the allocation to a more diversified Russell 2000 index than the broader S&P 500 index. Anyway, food for thought.
This is a must-read investment letter by Bill Gross, managing director of PIMCO, on the cult of equity:
The cult of equity is dying. Like a once bright green aspen turning to subtle shades of yellow then red in the Colorado fall, investors’ impressions of “stocks for the long run” or any run have mellowed as well. I “tweeted” last month that the souring attitude might be a generational thing: “Boomers can’t take risk. Gen X and Y believe in Facebook but not its stock. Gen Z has no money.” True enough, but my tweetering 95-character message still didn’t answer the question as to where the love or the aspen-like green went, and why it seemed to disappear so quickly. Several generations were weaned and in fact grew wealthier believing that pieces of paper representing “shares” of future profits were something more than a conditional IOU that came with risk. Hadn’t history confirmed it? Jeremy Siegel’s rather ill-timed book affirming the equity cult, published in the late 1990s, allowed for brief cyclical bear markets, but showered scorn on any heretic willing to question the inevitability of a decade-long period of upside stock market performance compared to the alternatives. Now in 2012, however, an investor can periodically compare the return of stocks for the past 10, 20 and 30 years, and find that long-term Treasury bonds have been the higher returning and obviously “safer” investment than a diversified portfolio of equities. In turn it would show that higher risk is usually, but not always, rewarded with excess return.
Gross points out that the long-term history of inflation adjusted returns from stocks shows a persistent 6.6% real return. But he argues that we should examine this real return with more scrutiny, going so far as to call the returns of the stocks a Ponzi scheme:
Yet the 6.6% real return belied a commonsensical flaw much like that of a chain letter or yes – a Ponzi scheme. If wealth or real GDP was only being created at an annual rate of 3.5% over the same period of time, then somehow stockholders must be skimming 3% off the top each and every year. If an economy’s GDP could only provide 3.5% more goods and services per year, then how could one segment (stockholders) so consistently profit at the expense of the others (lenders, laborers and government)? The commonsensical “illogic” of such an arrangement when carried forward another century to 2112 seems obvious as well. If stocks continue to appreciate at a 3% higher rate than the economy itself, then stockholders will command not only a disproportionate share of wealth but nearly all of the money in the world! Owners of “shares” using the rather simple “rule of 72” would double their advantage every 24 years and in another century’s time would have 16 times as much as the sceptics who decided to skip class and play hooky from the stock market.
Now, read the whole thing with a grain of salt, as Gross heads the largest bond fund in existence, the $270 billion Pimco Total Return Fund (so he’s got a fair amount of bias lambasting stocks). Still, the evidence he presents is eye-opening. I’ve read his investment letter twice.