In nature, there are no straight lines and change is the only constant.
In investing, static asset allocations are like the straight lines that do not bend. Nature would reject such design but humans like it because of its simplicity.
Although it is the dominant approach, static asset allocation is an unnatural concept that almost no one truly adheres to. Here are some ways that investors deviate, with these most prominent examples:
Few are able to re-balance back to the static weights during extreme market moves. How many 60/40 investors whose portfolios went down to 45/55 by the middle of March of this year bought equities to get back to 60/40 weights?
Two unavoidable problems plague static allocations: large crashes and low returns. This causes asset owners to periodically change their frameworks, chase diversifiers or completely override the allocation and go to cash.
Finally, even the die-hard buy-and-hold equity investors add style timing with defensive stocks and sector bets. They also usually have a pile of cash - ‘dry powder’ somewhere outside their portfolio, and other diversifiers like real estate.
Traditional advice says “Don’t try to time the market.” As a result, investors first adopt a static buy-and-hold stock-bond allocation based on some average static risk tolerance assumption. But then hard times hit and investors lose their sleep as their portfolios plummet, and as a result their risk tolerance goes out the window. They naturally start looking to change something. And that ‘change’ ends up costing investors a huge amount of return, more than all the other costs of investing. In sum, investors begin by being static ex-ante, but in the face of inevitable adversity become dynamic ex-post.
I am not suggesting that individuals should start dynamically asset allocating by themselves (which is what they are already unintentionally doing with poor results). I am also not saying that everyone should invest in our Dynamic Asset Allocation model, although that would be nice.
What I am saying is that the part of the investment industry that is responsible for asset allocation design - academics, consultants, out-sourced CIOs, advisors, wealth-managers, and asset managers - should acknowledge that static design is broken. Although a U.S. 60/40 portfolio is a very prudent allocation, few investors earn its return, especially in dollar-weighted-terms. The industry should spend more time designing asset allocation solutions that clients can actually stick with. Perhaps we can learn from nature that deals with adversity by avoiding straight lines (although they might appear like the shortest path to get somewhere, in ‘real-life’ they do not work because they break under pressure).