Asset Allocation Diversification - Best and Worst
Diversification through asset allocation is still the “Holy Grail of Investing.” Uncorrelated assets tend not to move together, either directly or inversely. Successful investors generate consistent returns in uncorrelated assets while reducing market risks without lowering returns. A well-executed diversification strategy with uncorrelated assets can reduce your risk-to-reward return ratio.
Each year investors search for the best-performing asset class to buy. However, it is challenging to choose the best assets each year. Few are astute and disciplined enough to achieve this lofty goal. It is one of the primary reasons diversifications have worked over the long term.
The enclosed table by MFS Funds Distributors shows the 20-year annual returns for eight broad-based asset classes, cash, and a diversified portfolio. The best to worst assets, annualized returns, and standard deviation can help investors better understand the leadership shifts from one asset class to the next over the past 20-years.
As expected, the large-cap growth asset has produced the best-annualized return with 10.77%. REITs came in second with an annualized return of 10.77%, followed by small-cap/mid-cap (10.30%) and large-cap value (10.33%).
The diversified portfolio ranked toward the middle of the pack, generating an annualized rate of 7.78%.
The worst performers consist of cash (1.23%), commodities (1.78%), bonds (4.33%), global bonds (4.43%), and international (6.33%).
Based on the frequency of specific assets sustaining leadership or lagging roles, REITs dominated the best-performing assets list with six (6) first-place finishes (2004, 2006, 2010, 2012, 2014, and 2021). The large-cap asset also kept dominance with four (4) first-place finishes (2015, 2017, 2019, and 2020) and three (3) second-place finishes (2007, 2013, and 2021).
The worst performing asset class is cash, with seven (7) last-place finishes (2003, 2004, 2009, 2010, 2016, 2017, and 2019). It was followed closely by commodities with six (6) last-place finishes (2006, 2011, 2012, 2013, 2014, and 2015).
The diversified portfolio kept pace with middle-of-the-road performances by consistently ranking in eight (8) fifth-place finishes (2004, 2005, 2006, 2009, 2010, 2013, 2016, and 2017) and seven (7) sixth-place finishes (2002, 2003, 2012, 2014, 2018, 2019, and 2021).
The above analysis supports the case for investors to keep a balanced and diversified portfolio of asset classes, at least over the past 20-years. Finding the best balance of asset classes depends heavily on your risk tolerance level and investment comfort zone.
The mean reversion concept of regression back to the historical norm may also play a pivotal role in asset allocation and diversification in the years ahead. Poorer performing assets in the past 20-years, such as commodities, may move up the list to assume a market leadership role in the next bull cycle.
Does the current cyclical bear in stocks lead to a structural bear market?
Is this a cyclical bear trend within the confines of the prevailing longer-term structural bull trend?
The answer to the above will depend heavily on factors such as market internals, market sentiments, geopolitical conditions, and macroeconomic conditions such as interest rates, inflation rate, technical recession or deep recession, or the emergence of the stagflation economic cycle if any.