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I RECENTLY READ AN article in Barron’s that inadvertently revealed two more reasons investing in broad-based index funds is the only sensible course of action.
The article, titled “This ‘Crazy’ Retirement Portfolio Has Just Beaten Wall Street for 50 Years,” touted the “All Asset No Authority” (AANA) portfolio. This “simple portfolio” consists of splitting your money equally among U.S. large-company stocks (S&P 500), U.S. small-company stocks (Russell 2000), developed international stocks (MSCI’s Europe, Australasia and Far East index, or EAFE), gold, commodities, U.S. real-estate investment trusts and 10-year Treasury notes, with the portfolio rebalanced annually.
This brainchild of Doug Ramsey just marked its 50th anniversary. During that time, it’s earned a 9.8% average annual return, which is about 0.5 percentage point a year less than the S&P 500 but 0.7 percentage point more than a standard 60% stock-40% bond portfolio. Its main benefit is it had substantially less volatility, with no “lost decades.”
Sounds great, doesn’t it? Not to me. I have two big issues with AANA.
As I read the article, which also appeared on MarketWatch, the first thing I noticed about the portfolio’s 50-year-old record wasn’t its performance, volatility or catchy name. It’s that I wasn’t sure that Mr. Ramsey was, in fact, that old. After a little research, I determined the article was referring to Doug Ramsey, not the renowned financial radio host Dave Ramsey.
Doug is younger than Dave and, at 56 years old, it would mean that he created AANA when he was in the early years of grade school. All this quickly led me to realize that AANA was manufactured by back testing—data-mining numerous permutations of different asset classes until one was found with superior risk and return numbers.
It reminded me of hedge fund manager Ray Dalio’s All Weather Portfolio. It consists of 40% long-term U.S. bonds, 30% U.S. stocks, 15% intermediate-term U.S. bonds, 7.5% gold and 7.5% commodities, all rebalanced annually. It also had superior historical performance numbers, which have lately been rather underwhelming, averaging about 8% annually since February 2006.
Hey, what if I came up with an All Flack Fund that significantly outperformed the S&P 500 since 1973 and consisted of investing 13% in stocks starting with the letter “F,” 10% in stocks with dividend yields between 2.2% and 3.3%, 17% in AA-rated bonds with a maturity of 6.2 to 8.88 years, 29% palladium and 31% betting on the National League to win the All-Star Game, rebalanced triennially? Would you invest?
Such nonsense is more akin to alchemy than investing.
The second big issue: Barron’s mentions various performance figures for the portfolio and then says, “And it’s done so with way less risk.” The writer adds, “While Wall Street floundered, AANA has earned respectable returns.” And there’s this: “According to Ramsey’s calculations, it has earned an average annual return of 9.8% a year.”
It all sounds so wonderful. But since there is no reference data, there’s no way for me to corroborate any of the performance figures. I guess I could just take Barron’s or Ramsey at their word. But hey, can’t they at least throw me a bone?
I’m reminded of the Beardstown Ladies, who ran what appeared to be a very successful investment club in the 1980s, notching 23.4% average annual returns since inception. They were so successful that they wrote numerous bestselling books and became minor celebrities. It was resounding proof that active investing could beat the market—until a PricewaterhouseCoopers audit revealed that the ladies’ performance was grossly overstated, and their actual results were just a little less than the S&P 500.
Beating the market may not be impossible, but it’s mighty difficult. Investors need to overcome fees, taxes, psychology and some pretty smart people who work 80-hour weeks on Wall Street. And just when you think you’ve found a formula that works, you could discover it might be based on dubious back-testing.
Michael Flack blogs at AfterActionReport.info. He’s a former naval officer and 20-year veteran of the oil and gas industry. Now retired, Mike enjoys traveling, blogging and spreadsheets. Check out his earlier articles.
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Still, 50 years is a decent amount of time to smooth things out and give a reasonable expectation of relative performance, is it not? We could look at 45 years thru 55 years, too, and see if 50 just happened to be exceptional. If its volatility is what they say, this AANA seems like a reasonable way to diversify part of one’s money along with index funds. Wrong?
Will, I think you might be. There are 1000 “investors” flipping a coin. After the first toss, everyone with tails sits down, then after the second toss everyone with tails sits down. This continues until only one “investor” is left standing. She then asks if you would like to invest in her coin tossing fund as “look at my past record”.
The example of the Beardstown Ladies is an excellent reason why I’m always skeptical of statements like “According to Ramsey’s calculations …”
I’ll always look for claims of superior portfolio performance to be verified by an independent third party.
Philip Stein, in their first column of every year, the stock picking columnists of Forbes magazine used to briefly review their previous year performance. And I never liked how we had to take their word for it, as they never provided an details. They could have easily provided a hyperlink that provided a detailed listing of investments, prices, dates, etc.
One of the columnists was Ken Fisher who had written a book, How to Smell a Rat, that specifically mentioned how money managers need to allow investors to be able to access the details of their results. It always made me wonder.
Michael: I’m calling b.s. on your All Flack Fund. Everyone knows the National League doesn’t win the All-Star Game!
Ben Rodriguez, please be advised that “The All Flack Fund” is only back-tested until 1963.
LOL!
“And just when you think you’ve found a formula that works, you could discover it might be based on dubious back-testing.”
Or, maybe, it actually works.
“In 1935, Lexington Corporate Leaders Trust bought 30 of the Great Depression’s major companies–that number, one suspects, being strongly influenced by the Dow Jones Industrial Index–and waited. And waited. Its first five holdings, listed alphabetically, convey its original flavor: 1) Allied Chemical & Dye, 2) American Can Company; 3) American Radiator & Standard Sanitary; 4) American Telephone & Telegraph (T), and 5) Columbia Gas & Electric.
One would think that this collection of yesterday’s businesses would have rattled along for a few years, perhaps even a few decades, and then expired. Quite the opposite. The fund not only continues to exist, but is faring quite well. In recent years, it has outgained the index more often than not. As I write this, the fund’s 15-year returns are an annualized 137 basis points above the index’s.”
https://www.morningstar.com/articles/960641/the-strange-and-happy-tale-of-voya-corporate-leaders-trust
I am not against indexing, but there is something to be said for zero fees, zero turnover, buying at value, never selling.
The Lexington Corporate Leaders Trust wasn’t originally assembled by backtesting historical stock market returns. It appears to be rules-based: Buy the stocks of 30 major companies and hold forever.
The Trust isn’t a counterexample to Mike’s thesis that winning portfolios established via backtesting don’t tend remain winners for very long.
Purple Rain, I just checked the fund’s Fact Sheet (4Q22) and its 10-year performance was 10.82% vs the S&P 500s’ 12.56%. I too like zero fees which is why I don’t like the 0.51% expense ratio. Quite steep for what appears to be a glorified index fund. Also the yield of 1.62% seems a little low.
For an opposing view, here is an article from Forbes:
https://www.forbes.com/sites/michaelcannivet/2023/02/16/the-sp-500-is-the-most-popular-and-overpriced-benchmark-in-the-world/
I follow this discussion with interest, as I invest my own way.
I agree with some of the points made in the article, if not the conclusion there is a passive “bubble” and a “reckoning” due for passive investors.
Has passive investing adoption led to higher stock valuations and decreased future return potential? Sounds logical, I’m sure it’s had an effect.
What I don’t really buy is something the author doesn’t say but seems to imply. That this future “reckoning” in passive investing will be the result of continued adoption, to the point that active investors are a small minority of investors.
Personally, I don’t think that will ever happen because the active investment industry, financial news media, etc. speak too powerfully to human nature. That we must pay for the best advice and that increased investment effort leads to increased returns.
The indexing-driven bubble narrative has been kicking around for a while — and somehow that bubble never pops! Remember this from three-and-a-half years ago:
https://humbledollar.com/2019/09/passive-stampede/
Unfortunately, bloviating pundits are rarely called to account for their failed predictions.
Ormode, thanks for reading and for the comments. The information provided by your link is a lot to digest. I did notice it was provided by Michael Cannivet, the President and Chief Investment Officer of Silverlight Asset Management. Mr. Cannivet has used back-testing to create his own “magic” portfolio called the Dobermans of the Dow.
Investing your “own way” sounds like a good idea. Remember though, that Mr. Cannivet wants to sell you on investing his way.
The S&P 500 may indeed be the world’s most overvalued index — I don’t have a strong opinion on that. But I would argue that buying solely an S&P 500 index fund isn’t a prudent way to index.