Mebane Faber: Global Asset Allocation

Terms:

• Sharpe ratio: a measure of risk adjusted returns, and is calculated as: (returns – risk free rate)/volatility
• Risk parity is a term that focuses on building a portfolio based on allocating weights based on “risk” rather than dollar weights in the portfolio
• leverage (which is essentially borrowing money to invest more thus magnifying both gains and losses
• “real returns” refer to the returns an investor receives after inflation. If an investment returned 10% (what we call nominal returns) but there was inflation of 2% that year, the real return is only 8

Comparing asset allocations:

• While stocks typically suffer from sharper price declines, bonds often have their value eroded by inflation.
• [The All Weather portfolio] is as simple as holding four different portfolios each with the same risk, each of which does well in a particular environment: when (1) inflation rises, (2) inflation falls, (3) growth rises, and (4) growth falls relative to expectations
• The most venerable asset allocation model is the traditional 60/40 portfolio. The portfolio simply invests 60% in stocks (S&P 500) and 40% in 10-year U.S. government bonds
• Buffett and 60/40 allocations, with a lack of real assets, performed the worst during the inflationary 1970s
• you exclude the Permanent Portfolio, all of the allocations are within one percentage point.
• Investing is similar [to making cookies]. As long as you have some of the main ingredients –stocks, bonds, and real assets- the exact amount really doesn’t matter all that much

General advice:

• if you are going to allocate to a buy and hold portfolio you want to be paying as little as possible in total fees and costs
  • Fees are far more important than your asset allocation decision
• With a broad asset allocation you will never have the best returns of any asset class, but you will also never have the worst!
• First you need to get your emotions in check and have a plan. Then don’t do dumb stuff when it gets hard. Easier to say than do, but very necessary.
• When investing over the long run, all you can have confidence in is that (1) holding assets should provide a return above cash, and (2) asset volatility will be largely driven by how economic conditions unfold relative to current expectations (as well as how these expectations change). That’s it. Anything else (asset class returns, correlations, or even precise volatilities) is an attempt to predict the future
• Unfortunately for investors, there are only two states for your portfolio – all-time highs and drawdowns. Drawdowns for those unfamiliar are simply the peak to trough loss you are experiencing in an investment