Casting my eye over Investors Chronicle's 10-asset portfolio, I questioned whether the strategy was inherently any less risky than investing in a bog standard 60:40 split between FTSE 100 shares and UK gilts. With 10 per cent portfolio allocations made to emerging market shares, global real estate, commodities and smaller UK shares, I reasoned that the rather high exposure to volatile assets was unlikely to diversify away risk.
Performance data for the complete set of 10 indices we suggested in January 2014 is only available from the end of June 2002. Reviewing from that date, the total returns performance of the 10-asset portfolio was superior to just the shares and bonds. During the last financial crisis, however, the high correlation in price movements between constituent indices saw the 10 assets suffer far worse drawdown and, since 2007, the 60:40 would have achieved higher total returns.
Rebalancing act
This initial assessment did not take into account the effects of rebalancing the portfolio each year. The 10 indices tracked have just a short period of time behind them and it is only even more recently, thanks to a range of exchange-traded products (most of which have been live less than five years), that it has become easy to trade the system and restore the 10 per cent allocations annually. Undertaking the hypothetical rebalancing back to 2002 does have a considerable impact both in terms of performance and mitigating periods of drawdown.
Given that there is not a long track record and that the improvement is down to a trading strategy (the underlying assets are potentially volatile), I am wary of giving the impression that the system makes investing less risky per se. However, if one considers the rebalanced 10-asset portfolio as a strategy for diversification of exposure rather than of risk, there is plenty to recommend it as a way to capture upside from a range of asset classes.
Without following the rebalancing methodology (which would have proven complicated and costly pre-ETFs), the hypothetical portfolio would naturally have become overweight in the assets that performed well in the run-up to the financial crisis but then suffered worse drawdown in 2007-09. Restoring the equal weighting of the indices – every June from the inception of the portfolio in 2002 – solves this issue and, up to the end of March 2015, would have delivered a total returns performance of 197 per cent. Volatility was 8.68 per cent and the worst drawdown, between November 2007 and February 2009, was -25.12 per cent.
Comparison of 10 asset system without rebalancing
| 10 asset indices | 60:40 (FTSE 100: gilts) | |
| Total returns since June 2002 | 180.76% | 131.36% |
| Maximum drawdown (Nov 2007- Mar 2009) | -33.71% | -22.40% |
| Total returns since Nov 2007 | 22.59% | 46.69% |
Performance of 10 asset system rebalancing every June from 2002
| Total returns | 197.01% |
| Compound annual growth rate (CAGR) | 8.91% |
| Volatility | 8.68% |
| Maximum drawdown (Nov 2007- Mar 2009) | -25.12% |
| Total returns since Nov 2007 | 38.14% |
More pertinently for investors, an actual portfolio constructed using ETFs (where possible selected from Investors Chronicle's Top 50 ETFs) and cash has delivered a solid performance over the past 14 months. Starting at the end of January 2014 and rebalancing in January of this year, the overall gain of the ETF portfolio to the end of March 2015 is a more than decent 9.7 per cent. That narrowly beats the 8.93 per cent total returns from only investing in the iShares FTSE 100 UCITs ETF, which replicates the index of blue-chip shares with all dividends reinvested.
10 Asset ETF portfolio (equal weighted)
| Date of inception | 31.01.14 | Total returns performance since 31.01.14 | 9.70% |
| Frequency of rebalancing | Annual | Volatility | 5.74% |
| Last rebalanced | 30.01.15 | Biggest drawdown (Sep 2014) | -2.99% |
Taking costs into account, in 2014 investors may have been better off just tracking the total returns of the FTSE 100. Of course, the FTSE 100 has recently hit highs last seen at the peak of the dot-com boom and the hope over the longer term is that, with exposure to a range of investments, the portfolio will benefit if different assets outperform periodically. So far, the 10-asset system has certainly not disappointed and, with just one set of rebalancing trades annually, it is hardly expensive.
Interestingly, a version of the 60:40 blue-chips and gilts portfolio started in January 2014 (rebalancing in January 2015) would have performed even better, making 11.22 per cent. In common with other fixed-income assets, gilt prices have risen thanks to the European Central Bank's quantitative easing programme. The iBoxx Gilts Overall Basket index, which reflects price as well as yield (and is tracked for the portfolio by the db x-trackers II iBoxx GBP Gilts ETF), has rocketed, making greater gains than the FTSE 100. Some commentators have flagged both UK shares and gilts as being in bubble territory and in light of such an assessment, the 60:40 allocation split towards the assets now seems imprudent. These concerns return us full circle to the discussion around diversification of risk as a benefit of the 10-asset portfolio.
Diversification dangers
While I would agree wholeheartedly that investors should be broadly diversified, owning a mix of shares, bonds, property and plenty of cash, I am not convinced that the 10-asset system, in its current form, is the best way to go about this. For me, the portfolio's main attraction is broader exposure to a mix of upside potential and I remain cautious of its ability to diversify risk away.
My primary concern is the lack of a long enough track record to reasonably assess the level of correlation between movements in the underlying indices. For example, were there to be a major stress event in bond markets the effects would be far-reaching, with serious implications to all constituents of the 10-asset system. True, the equal weighting would ensure that the pain of any drawdown would be the average experienced across the portfolio indices, but it is conceivable that property and equities, especially small-cap and emerging market shares, could suffer even more than the gilts index in such an event.
On a final note of caution, one should also consider how the vehicles used to invest in the 10-asset portfolio might be affected by a severe shock. Would a stock market collapse or a messy unwind in bond markets cause serious issues (for example, liquidity problems) for ETF traders responsible for replicating indices? I am a fan of exchange-traded products – without them it would be incredibly difficult for private investors to follow and trade methodologies such as the rebalancing 10-asset portfolio – and providers will point to the rigorous stress tests in the industry on the back of Ucits directives.
However, we should never kid ourselves that investing is without risk and it is important to consider even unlikely adverse outcomes; especially when many of the products have not been through a period of real stress since their inception. Going into it with eyes wide open, the rebalancing 10-asset portfolio is a cheap and simple method that has the potential to outperform the stock market over time, and it may also prove to suffer smaller losses in down periods (but we can't say this for certain).
In short, I would view the system as tactical asset exposure that should fall within a diversified wealth policy, rather than as a risk-reducing asset allocation strategy in its own right. The acid test will be the next crisis event. Nobody can be sure exactly when that will occur, but perhaps the iBoxx Gilts Overall Basket index provides us with a clue to the cause.
The 10 Asset indices
| Asset class | Index | Bloomberg ticker* | (since 31.01.14) |
| UK large cap | FTSE 100 | UCX | 9.18% |
| UK smaller cap | FTSE 250 | MCX | 12.60% |
| Developed market global equity | SG Global Quality Income | SGQI | 34.94% |
| Emerging market equity | MSCI Emerging Markets | MXEF | 7.23% |
| Property: global real estate | FTSE EPRA/NAREIT Developed | RUGL | 21.03% |
| Gold | Gold Spot | GOLDLNPM | -5.12% |
| Broad commodities | DBLCI-0Y Balanced Commodities | DBLCIX | -29.59% |
| Fixed income: gilts | iBoxx Gilts Overall Basket index | QX6A | 14.91% |
| Fixed income: index-linked gilts | FTSE Actuaries Govt Securities UK Index Linked | FTFIILA | 19.21% |
| Cash | Three-month Libor | BP0003M | 0.64% |
10 Asset ETF allocation
| Asset class | ETF | ETF ticker | |
| UK large cap | iShares FTSE 100 UCITs ETF | CUKX | 10.10% |
| UK smaller cap | dbx-trackers FTSE 250 UCITS ETF | XMCX | 10.36% |
| Developed global equity | Lyxor ETF SG Global Quality Income | SGQL | 9.99% |
| Emerging market equity | iShares MSCI EM UCITS ETF | IEEM | 10.35% |
| Global real estate | Developed UCITS ETF | HPRO | 10.55% |
| Gold | ETF Securities Physical Gold | PHGP | 10.09% |
| Broad commodities | dbx-trackers Balanced Commodities UCITS ETF | XDBG | 9.05% |
| UK gilts | dbx-trackers II iBoxx GBP Gilts | XBUT | 9.91% |
| UK index-linked gilts | iShares Core UK Gilts UCITS ETF | IGLT | 9.90% |
| Cash | na | na | 9.71% |
