From Financial News:
Climb away from the glide path, says blue-sky thinker
Few understand the ways of the herd better than Robert Arnott, founder of index provider Research Affiliates of California. A 1977 triple major in economics, applied mathematics and computer science at the University of California, he developed skills in tactical asset allocation that helped him to build not one, but two, asset management firms....MORE
His first, TSA Capital Management, oversaw $3 billion when he left in 1987. His second, First Quadrant, ran $18 billion by 2002.
Arnott manages Pimco’s $34.3 billion All Asset strategy fund, as well as RA, whose strategies underpin assets worth $169 billion.
Arnott could have become a hedge fund manager worth billions. But his passion still lies in academic research.
Where hedge fund managers shrink from the world stage, Arnott strides across it. Over the years, he has published more than 100 scholarly articles, often poking fun at the folly of accepted wisdom, and in 2008 co-authored a book, The Fundamental Index: A Better Way to Invest.
Research Affiliates has earned renown for its fundamental smart beta indices, which rank companies according to their sales, cashflow, book worth and dividends, as opposed to traditional indices, which use market values.
Traditional indices tend to lag RA’s fundamental series by two percentage points a year because they are weighted towards overpriced growth stocks pushed up in value by the thundering herd which then plunge.
Arnott said: “Fundamental indices work because they break the link between price and weight in the portfolio.”
More recently, Arnott has been delving into target-driven defined contribution plans. He has discovered the way managers choose to invest on behalf of their clients is badly flawed.
He said: “We have allowed a $1 trillion business to be built on the basis of zero research. We need a political debate to try to put sense into the way people save for their retirement.”
Arnott’s beef concerns the way money gets invested on behalf of people using target-driven and lifestyle DC plans.
The precise mechanics of each vary, but they both invest in equities early on, switching to bonds over time so clients can get a fix on the size of their pensions.
So far, no good, says Arnott, whose analysis of performance data has proved, time and again, that people are investing the wrong way round.
Rather than switching from equities to bonds, he said, they should move from bonds to equities: “The inverse glide path beats the standard approach relentlessly.”
He has analysed different styles over 40-year periods, equivalent to the length of a DC plan, since 1871, to compare how the switches between bonds and equities performed in different cycles.
In each case, he assumes that an individual is contributing $1,000 a year to a plan in real terms.
The conventional switch from an 80% equity weighting to 20% produces an average retirement pot of $124,460. But an inverse switch from a 20% equity weighting to 80% would generate $152,060.
The worst outcome for conventional DC would be $49,940 against $53,000 for inverse DC. The best would be $211,300 for conventional against $287,000 for inverse....
HT: Barron's Focus on Funds who notes:
...What to make of this? Morningstar’s veteran fund-watcher John Rekenthaler wasn’t convinced by a similar study, but he writes that he views the argument as “an approach that might make sense under some conditions, given certain assumptions.”...And attorneys.
Lots of attorneys.
