60/20/10/10?

Deconstructing the asset allocation process.

Barry Ritholtz tweeted out the following;

I commented as follows;

I am taking "alpha strategies" to mean alternative strategies which would mean Barry is talking about 60% in equities, 20% in traditional fixed income, 10% in commodities and 10% in alternatives. I have been very consistent in my beliefs (and my blogging) that a little bit goes along way and that 10% in either alternatives or commodities is more than what I think is typically prudent.

Equities is the asset class that performs the best, the vast majority of the time and of course equity exposure has relatively high volatility. That should drive all other allocations decisions, which to my way of thinking boils down to all other asset classes being tools to manage equity market volatility.

The popularity of alternatives has come about for at least two reasons, they offer access to previously inaccessible, "sophisticated" strategies (this is the marketing aspect where fund companies see the chance to charge higher fees) and the very real possibility that higher rates make many segments of the bond market dangerous to hold. I think Barry's comment about underperforming is relative to equities. Most alternatives are not equity proxies. I would say that for the most part the story is about lower to negative correlations to equities and lower volatility. That is not universally true and not all funds seeking low correlation and low volatility can deliver that result and furthermore some take a lot of risk such that the risk taken exceeds the potential rewards, the inverse VIX products might be an example of this.

I am not a researcher or an academic, I am not in the whitepaper business but I do have almost 14 years of blog posts that chronicle how I have used alternatives (the terms alternatives was really used back then, I called them diversifiers) and commodities both in small doses for advisory clients over the course of a full stock market cycle. The triggers for using these for defense I got from other people (take bits of process from various sources to create your own process), not going full defense all at once but doing it gradually might be my own thing but either way certain strategies and asset classes will reduce volatility and will reduce correlation. I've disclosed my belief in gold. merger arbitrage, inverse funds (used tactically), I initiated a small position in BTAL a few weeks ago and I have an idea for one other alternative for bear market protection that I won't front run here.

The alternative exposure might make its way to 10% but is nowhere near there now. Gold is a low single digit exposure and it is certainly possibly that I would add a different commodity to take the total exposure to that asset 4-5%. One criticism to my approach I have seen is that 3% in gold won't do much if the stock market cuts in half but that misses the point of tactically increasing exposure to various holdings that provide the opportunity to offset a large decline in equities or just smooth out equity volatility.

Barry of course knows all of this and it is likely he understands it better than I do but chooses not to allocate this way. I do. Take the path that most resonates with you no matter what it is. Take bits of process from various sources to create your own process or hire someone and use their process.

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