The financial gurus are always looking for a new “alternative” asset class that both reduces the risk in your portfolio and increases returns. Longboard Funds looked at data from the past 15 years and examined what happened when you added 20% of various asset classes to a traditional 60/40 stock/bond portfolio. Below is a chart of the results based on two factors:
- Did the asset class have a lower or higher correlation in declining markets? This reduces maximum drawdown.
- Did the asset class improve overall historical return?
The 6 asset classes that both lowered max drawdown and increased overall return were:
- Trend Following (SG Trend Index)
- U.S. Treasuries (Barclays 1-3 Yr US Treasury TR Index)
- MLPs (Alerian MLP TR Index)
- Municipal bonds (Barclays Municipal TR Index)
- Gold (S&P GSCI Gold Index)
- TIPS (Barclays Gbl Infl Linked US TIPS TR Index)
I would add that your next consideration should be to research each asset class and determine which ones you have strong faith in over the long term. As diversifiers, these asset classes will have long periods of poor performance during bull markets. You must be able to hold onto these asset classes so that they can eventually help you in a bear market.
Personally, I do not have faith in trend-following, I don’t understand the fundamentals of gold (seems heavily based on speculation), and I don’t like the various complexities of Master Limited Partnerships. You may feel differently. That leaves me with the classic high-quality bonds: US Treasury bonds, Municipal bonds, and TIPS (also backed by US Treasury). Munis seem to be the best relative deal right now depending on tax bracket (and perhaps also I Savings Bonds?). None of these offer a ton of yield, but most importantly I’m okay holding them through these lean times.