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They did everything right \u2014 spreading out bets far and wide across bonds and equities in case things went south. Now, after heeding Wall Street\u2019s mantra to diversify for the long haul, these investors are watching with envy as the US stock rally leaves them in the dust yet again.\u00a0<\/p>\n
The numbers are stark. Money managers who obeyed the financial industry\u2019s age-old wisdom to divide investments across markets and geographies are on an epic losing streak versus those who simply bought the S&P 500 and sat still. In one example, out of roughly 370 asset-allocation funds tracked by Morningstar Inc., just one has managed to beat the index since 2009.\u00a0<\/p>\n
It\u2019s been a big lesson in futility, rather than a disaster per se. Diversified portfolios have still managed to return around 6% a year over the stretch, going by a model kept by\u00a0Cambria Funds<\/a>. Yet the streak of underperformance is getting historic \u2014 and could get worse as the AI-fueled equity melt-up endures. Broadly, diversified portfolios have trailed the US large-cap stock index in 13 of the last 15 years, a stretch seen only once before in almost a century of data, per Cambria.<\/p>\n \u201cIf your neighbor has all their money in the S&P, then you look like a moron,\u201d said Meb Faber, the founder of investment firm Cambria and a portfolio-theory expert. \u00a0<\/p>\n For small-fry investors and big money managers alike, the psychological toll of falling behind creates pressure, particularly for those sticking with the playbook. Institutions from pensions to endowments and foundations have $21 trillion stashed in conventional diversified strategies that spread money across a wide range of investments including bonds, stocks, real estate and cash, a recent study by Preqin showed.<\/p>\n Yes, betting the house on US stocks looks dangerous as Nvidia<\/a> Corp. and other technology megacaps dominate the world\u2019s largest equity market, posing an unprecedented concentration risk. At the same time, elevated Treasury yields offer a potential buffer if stocks stage a big crash. And yet, adherents of diversification are plagued with doubt. US shares remain the only game in town year after year, thanks to Corporate America\u2019s reliable profit engine. Owning anything else has been a route to underperformance.\u00a0<\/p>\n Faber calls the last 15 years a \u201cbear market in diversification.\u201d His $54 million Cambria Global Asset Allocation ETF (ticker GAA) has trailed the S&P 500 in all but one year since its inception despite an annualized 5% gain.\u00a0<\/p>\n While history has instances of similar drubbings that resolved in favor of diversification, the wait has been a particularly long one this time around.<\/p>\n These days, financial advisers like\u00a0Anthony Syracuse<\/a>\u00a0often find themselves having to restrain clients eager to chase the Big Tech rally given the juiced-up valuations versus the rest of the market. \u00a0<\/p>\n \u201cThis can be an extremely difficult conversation,\u201d said Syracuse, founder of Dynamic Financial Planning. \u201cEveryone wants to maximize their returns.\u201d\u00a0<\/p>\n American stocks have been on a blistering run since the global financial crisis, outpacing almost everything in a period when bond returns were suppressed during the zero-rate era while international stocks languished under the weight of a strong dollar. Up 14% annually, the S&P 500\u2019s gain is double that of stocks in developing countries and adds up to three times as large as investment-grade bonds.\u00a0<\/p>\n Against this backdrop, nearly everyone straying from US equities is subject to a sense of missing out. Over the last 15 years, the PIMCO StocksPLUS Long Duration Fund (PSLDX) is the one and only among the 372 asset allocation portfolios tracked by Morningstar that\u2019s ahead of the S&P 500.\u00a0<\/p>\n The data has emboldened those who say diversification \u2014 however sound in theory \u2014 is costing investors over the long run, by holding underperforming investments. The revolt got an airing last year when academics published a\u00a0study<\/a>\u00a0saying retirees would be better off eschewing bonds completely.\u00a0<\/p>\n Proponents of modern-day allocations pushed back, saying assets like fixed income allow individual investors to better match financial gains with future obligations. Moreover, diversified portfolios won out from 2000 to 2008, a period when stocks saw their values cut in half on two separate occasions.<\/p>\n \u201cDiversification is your best friend on your worst day,\u201d said David Kelly, chief global strategist at J.P. Morgan Asset Management. \u201cThe right asset allocation is a little bit like home insurance. You never know when you\u2019re going to need it, but you should never feel comfortable not having it.\u201d<\/p>\n That logic is partly what\u2019s behind the decision by many big-money pros, who periodically shuffle holdings in order to return to a desired level of asset allocation.<\/p>\n Of course, pure returns are not the only thing that matters. Another consideration is how much turbulence must be endured in order to earn the profit. Based on a measure of risk-adjusted returns known as the Sharpe ratio, Cambria\u2019s global asset allocation model has indeed done better than the S&P 500 since 1927.\u00a0<\/p>\n But things started to shift after the Federal Reserve rushed to the market\u2019s rescue during the 2008 crisis. Since then, the S&P 500 has staged an almost uninterrupted rally with largely subdued volatility, scoring a higher Sharpe ratio.<\/p>\n \u201cThe question everyone has is, does it make sense to diversify?\u201d said Mayukh Poddar, senior portfolio manager at Altfest Personal Wealth Management. \u201cA lot of people have become more focused on equity market returns in the post-Covid era.\u201d<\/p>\n Within diversified portfolios, many clients are growing skeptical over the benefit of investing in small-cap and non-US stocks, according to Que Nguyen, chief investment officer of equity strategies at Research Affiliates.\u00a0<\/p>\n \u201cWhat we\u2019ve seen over the last 15 years is that the big gets bigger,\u201d she said. \u201cYou don\u2019t want all of your eggs in one basket, but it\u2019s hard to keep the faith.\u201d<\/p>\n In some circles, fixed income\u2019s haven status is questioned too, after the asset class sank together with stocks during 2022\u2019s inflation-induced selloff.\u00a0<\/p>\n Inflation is likely to stay\u00a0sticky<\/a>, making bonds exposed at a time when the government ramps up Treasury supply to meet fiscal needs, according to David Rogal, a portfolio manager at BlackRock<\/a> Inc.<\/p>\n \u201cIt\u2019s very clear that the bond market has become less reliable as a hedge in a portfolio,\u201d Rogal said in a recent panel discussion hosted by MacroMinds Foundation.\u00a0<\/p>\n It\u2019s tempting to call an end to the equity rally, given the prospect of stretched valuations and restrictive monetary policy. Yet the S&P 500 has kept its leadership this year, delivering a gain that\u2019s again ahead of the rest of the world and contrasts with losses in Treasuries.\u00a0<\/p>\n There are signs that American investors are adapting to the new regime, including a deepening home bias and a willingness to let equity holdings swell to records, according to Cambria\u2019s Faber. Meanwhile, big-money managers are shifting to alternative assets such as privately held firms as a way to juice up performance.\u00a0<\/p>\n \u201cThere\u2019s no end-expiration date on this\u201d equity boom, Faber said. \u201cInstitutions have been leaning hard into this, but the savior that they\u2019re looking for is private equity, which is essentially US stocks.\u201d<\/p>\n<\/div>\n