Equity/ Annualised Risk
80/20 11.2% 23.4%
60/40 10.2% 19.9%
40/60 9.2% 17.0%
20/80 7.9% 14.9%
0/100 6.5% 14.1% 1980-03 100/0 14.1% 16.4%
80/20 13.8% 14.4%
60/40 13.4% 13.0%
40/60 12.9% 12.2%
20/80 12.4% 12.2%
0/100 11.7% 13.0% 1990-03 100/0 7.7% 17.5%
80/20 8.3% 15.5%
60/40 8.9% 13.8%
40/60 9.3% 12.6%
20/80 9.7% 12.1%
0/100 10.0% 12.4% Risk and return figures for various asset mixes over periods shown. Source: Isis Asset Management
The table shows the returns that various asset mixes have generated over three different time periods in the past 50 years. The figures show an interesting trend: while increasing equity exposure has historically always increased returns as well as risk, this trend has been reversed over the past 13 years.
The period between 1980 and 2003 has proven the best period for portfolio diversification. For instance, increasing equity exposure from 20% to 40% would have increased returns, but at no extra risk to the overall portfolio. However, the advantages of diversification are clear across all periods. Even between 1990 and 2003, when returns increased in line with bond rather than equity exposure, the risk of having 100% in bonds was shown to be higher than having a 20% exposure to equities.
The last decade has been marred by the worst bear market for almost a century, but such an event is highly unlikely to be repeated in the near future. While the bear market has tainted the performance figures for equities, the longer-term numbers continue to highlight the strength of equities over other asset classes.
The risk to product innovators of creating new one-size-fits-all funds at such a time in the market cycle is that the result may end up being a little overcautious. Many in the industry believe that a 60% cap on equities for the new stakeholder products is unnecessarily conservative.
Just as the numbers above show the power of diversification, they also show that there is no magical formula for asset allocation. Indeed, rigidly sticking to a narrow asset allocation model could and is likely to penalise investors in the longer run as their needs and objectives change. Ultimately, the better-off investors will be those who have managers and fund strategists that can adapt their asset allocation to match their clients’ circumstances, as well as the economic environment.