Which Asset Classes Offer True Diversification in Bear Markets?

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During times of market volatility, people often start looking for other options. There is always a new “alternative” asset class being pitched that in theory 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:

  • Managed Futures (Trend Following) (SG Trend Index)
  • U.S. Treasuries (Barclays 1-3 Yr US Treasury TR Index)
  • Master Limited Partnerships (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)

Not coincidentally, Longboard Funds offers a managed futures mutual fund. The expense ratios for are 2.87% and 2.88% for the two share classes. I would be concerned that a 3% drag on the the SG Trend Index might change up the real-world results?

My take. Your next consideration should be to research each asset class on your own 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 believe that managed future are too complex and the available products too expensive. I feel the same about MLPs. I don’t own gold myself, but can understand why others might include some in their portfolios.

This leaves me with the classic high-quality bonds: US Treasury bonds, Municipal bonds, and TIPS (also fully backed by the US government). I do indeed own these in my personal portfolio. Hopefully you’ve owned these for a while, as the interest rates just keep getting lower (and the value goes up, for now). Ah well, I’m still buying as needed even though the yields are tiny.

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Comments

  1. Any early predictions on TIPS going into the next cycle? It looks like yield will take quite a hit with $28 a barrel oil among other things?

    • Predictions are tough. In my bond portion, I hold roughly 1/3rd muni, 1/3 Treasury, 1/3 TIPS. I’m diversified whether inflation is higher or lower than expected by the markets (and I break even if it matches expectations) so if either happens I’m not completely caught. Keeps my bonds side even safe, in my view.

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