Diversified portfolios outperformed all others with less risk over the past 25 years.
Proclamations that passively managed portfolios will outperform all others over the long haul from investment guru Warren Buffett and others notwithstanding, analysis by Pensions & Investments showed that a portfolio constructed with active, passive and alternative investments produced superior annualized risk-adjusted return — 10.2% with 11.7% risk — over the 25 years ended Dec. 31.
P&I's diversified risk portfolio mimics the “endowment model” made famous by its progenitor, Yale University Chief Investment Officer David Swensen, with weightings of 30% to listed U.S. and non-U.S. equities; 20% each to hedge funds, private equity and real assets; and 10% to U.S. fixed income.
To test the efficacy of various portfolio construction approaches, P&I compared the annualized returns of three other portfolio configurations with the diversified portfolio over the same 25-year span:
npassively managed 60% U.S. equity/40% U.S. bonds returned 8.9% with 11.3% risk;
npassively managed 90% U.S. equities/10% U.S. short-term bonds returned 9.3% with 16.4% risk; and
ngrowth liability-driven — passively managed 60% U.S. corporate bonds, 20% passive U.S. and non-U.S. equities and 20% hedge funds — returned 8.3% with 8.2% risk.
The 60/40 U.S. portfolio is a classic pension fund asset allocation model, while the 90/10 passive portfolio is Mr. Buffett's allocation of choice. The LDI portfolio construction is typical of what is used by corporate defined benefit plans.
The historical return of the diversified, risk-managed endowment model also topped those of two of the other portfolios P&I analyzed.
The annualized composite return of the combined endowment/foundation category for the 25 years ended Dec. 31 was 9.3%, according to data from Wilshire Trust Universe Comparison Service. Over the same period, the corporate defined benefit annualized TUCS composite return was 9.1%, compared to 8.5% for public defined benefit plans. Risk measures for the same time period were not provided by Wilshire Associates Inc., which maintains the TUCS universe.
Click here for a chart with the results.
Aaron M. Cunningham contributed the data for this story and accompanying tables.