20/06: Upside Down Investment Strategy
Elliott Farr, a former colleague of mine, was a leader in the Philadelphia investment community for many years. He spent most of his career at Girard Trust and at WH Newbold’s where he distinguished himself as a Value Investor.
Farr’s special genius was the ability to see what most others could not. Like a good puzzle master he could see and understand relationships that eluded others. My favorite description of his talent was as the man who could look at a painting that others had been admiring (perhaps for a long while) and suggest that it was upside down! Oh, suddenly everyone could see much better. Now they understood!
I wonder what Elliott would see today?
Perhaps he might think some of the following are upside-down?
He might also see currently recommended asset allocations as being upside-down. Many faith-based investors and other endowments are sticking with the asset-class weights adopted in the 1990’s (many years into the bull market). This despite the growing imbalances described above and the expectation that financial market returns will be sub-par for the balance of this decade if not longer.
A New (Old) Model For Asset Allocation
Our work suggests that many faith-based investors might do better with asset allocations that look upside down to them (and their advisors). The Benchmark Survey suggests that current asset allocations are typically 60% equity, 30% bonds and 10% cash. We propose a flip to these allocations with a new Upside-Down Investment Strategy! Specifically we propose that for investors with a spending rate of 4% or more (expressed as a % of their asset values) that a more sustainable investment policy would produce an asset allocation with 60% bonds, 30% stocks and 10% cash. The ingredients might look like this:
30% Stocks
10% US Stocks
10% International Stocks
5% Emerging Market Stocks
5% Hedged US Stocks
60% Bonds
20% US Intermediate Maturity Bonds
10% US Short-term Maturity Bonds
10% US Long-term Maturity Bonds
10% US Inflation Protected Bonds (TIPS)
5% International High Quality Bonds
5% Emerging Market Bonds
10% Money Market Fund (cash)
Expected Risk and Return
The expected return of this allocation would be about 6% with an expected annual standard deviation (risk) of 6%. The typical current asset allocation would generate about the same return with significantly greater volatility (risk). The Upside-
Down Strategy would also provide significant downside protection in the event of a protracted stock-market decline.
Same return with less risk? Easy choice.
O. Sam Folin
June 20, 2005
Farr’s special genius was the ability to see what most others could not. Like a good puzzle master he could see and understand relationships that eluded others. My favorite description of his talent was as the man who could look at a painting that others had been admiring (perhaps for a long while) and suggest that it was upside down! Oh, suddenly everyone could see much better. Now they understood!
The Upside-Down Investment Strategy
I wonder what Elliott would see today?
Perhaps he might think some of the following are upside-down?
US consumption is growing (now 71% of our GDP) while saving is near zero
Serial bubbles - stocks, and now real estate - fueling that consumption
Tax cuts in the face of growing government spending (Iraq, etc)
US Government surplus replaced by deficits as far as the eye can see
Growing US debt funded by the Chinese and other Asian nations
Cheap money: negative real interest rates that discourage savings
The United States accused of running a Gulag-like prison
Serial bubbles - stocks, and now real estate - fueling that consumption
Tax cuts in the face of growing government spending (Iraq, etc)
US Government surplus replaced by deficits as far as the eye can see
Growing US debt funded by the Chinese and other Asian nations
Cheap money: negative real interest rates that discourage savings
The United States accused of running a Gulag-like prison
He might also see currently recommended asset allocations as being upside-down. Many faith-based investors and other endowments are sticking with the asset-class weights adopted in the 1990’s (many years into the bull market). This despite the growing imbalances described above and the expectation that financial market returns will be sub-par for the balance of this decade if not longer.
A New (Old) Model For Asset Allocation
Our work suggests that many faith-based investors might do better with asset allocations that look upside down to them (and their advisors). The Benchmark Survey suggests that current asset allocations are typically 60% equity, 30% bonds and 10% cash. We propose a flip to these allocations with a new Upside-Down Investment Strategy! Specifically we propose that for investors with a spending rate of 4% or more (expressed as a % of their asset values) that a more sustainable investment policy would produce an asset allocation with 60% bonds, 30% stocks and 10% cash. The ingredients might look like this:
30% Stocks
10% US Stocks
10% International Stocks
5% Emerging Market Stocks
5% Hedged US Stocks
60% Bonds
20% US Intermediate Maturity Bonds
10% US Short-term Maturity Bonds
10% US Long-term Maturity Bonds
10% US Inflation Protected Bonds (TIPS)
5% International High Quality Bonds
5% Emerging Market Bonds
10% Money Market Fund (cash)
Expected Risk and Return
The expected return of this allocation would be about 6% with an expected annual standard deviation (risk) of 6%. The typical current asset allocation would generate about the same return with significantly greater volatility (risk). The Upside-
Down Strategy would also provide significant downside protection in the event of a protracted stock-market decline.
Same return with less risk? Easy choice.
O. Sam Folin
June 20, 2005
