In a year defined by loss and grief, investors faced unprecedented volatility. In March, when the S&P 500 index was 34% below its record high, conventional wisdom held that active management was finally ready for its big moment.
Ostensibly, market turmoil triggered by the pandemic had created an ideal environment for nimble managers to prove their worth over dowdy passive funds. The “do-nothing” S&P 500, however, has done plenty, exceeding 64% of active funds in its category, putting it on pace for an 11th straight year of outperformance.
Though ultralow interest rates have increased skepticism of 60/40 (particularly on the bond side), and boosted interest in alternative assets, investors who stayed in a portfolio of 60% U.S. stocks and 40% bonds have been rewarded. Year-to-date the Bloomberg 60/40 index has gained 14.7%, outperforming the S&P 500’s 12.3% gain, while doing so with less volatility.
“Is 60/40 dead? That’s usually asked after it has beat others,” Robert Michaud, Chief Investment Officer of New Frontier Advisors, told RIA Intel in a recent Zoom chat. “The 60/40 portfolio is the institutional standard for a reason. You can never dismiss it.”
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When investors diversify out of bonds in favor of alternatives they are “likely to lose on average while adding risk,” said Michaud, who along with his father, Richard Michaud, Ph.D., co-founded Boston-based New Frontier Advisors in 1999.
RIAs commonly place clients with specific goals into pre-made portfolios that merely reflect risk tolerance, Michaud said. “Too often clients are simply placed into risk buckets. They’re the same buckets. Just more or less in stocks and bonds.”
“We take a different view. We think of the relationship between all asset classes,” said Michaud, whose firm constructs risk-targeted, global multi-asset portfolios using 27 ETFs that rely on scalable evidence-based research. The firm, which manages roughly $4 billion, also provides software and institutional research and advisory services. “RIAs know us as an ETF strategist.”
An obsessiveness with measuring risk informs everything that New Frontier does with its research, technology, and investments, which all focus on portfolio optimization. “The hypothetical optimal portfolio is always changing. Rebalancing is not done, say, every six months but when data says it’s warranted,” said Michaud, who co-holds four U.S. patents in portfolio optimization and asset management.
Historically, the firm hasn’t rebalanced “much more than once per year.” But this year saw four rebalancings – a record for the firm. Michaud explained that changes are not made based on a market-timing framework but rather when “the market environment has changed.”
The company rebalanced “near the bottom” in March, again in May during a historic rebound, at the end of July/early August, and again on Nov. 19. Last year, the firm rebalanced just once. “We provide long-term strategic attention, which is a much more intensive approach.”
Michaud emphasized that research dictates where capital should be allocated. “We don’t invest solely based on our convictions,” he said. “We try to measure and adapt to uncertainty when investing and optimizing portfolios. Deciding when to rebalance for an optimal portfolio requires examining its probability distribution. Is the portfolio statistically equal to a new optimal portfolio?”
With the year winding down, Michaud sees a clearer path ahead. “In the last few weeks, there was lots of new information as the election and vaccines reduced some uncertainty. China is much less risky than it has been. Europe has not had that benefit.”
Michaud said “gold is an important part of an optimal 60/40 portfolio, though not the miners. Real estate, too.” Bitcoin, up 151% year-to-date, is “far too volatile an asset class” that investors “can safely avoid.” It tested “strongly negative for enhancing risk-adjusted return.”
Michaud, who holds a master’s degree in mathematics from Boston University, and pursued a Ph.D. in finance from the Anderson School of Management at the University of California, Los Angeles, counts portfolio theory, risk models, empirical asset pricing, and international finance among his research interests. With his father, he co-authored Efficient Asset Management: A Practical Guide to Stock Portfolio Optimization and Asset Allocation.
Greg Bartalos (@gregorianchance) is editor of New York City-based RIA Intel.