Arnott Sees "Another Tough Slog" in Coming Decade

While many are predicting that the coming decade will feature some strong bounce-back gains for stocks after a poor 2000s, Rob Arnott of Research Affiliates says not to count on it.

In a piece written with John West for, Arnott says that the standard market-cap-weighted 60/40 stocks/bonds allocation “is likely to disappoint. Again. Net of inflation, it could even be worse than the past 10 years.”

Arnott and West, who last month showed how a portfolio diversified over 16 different asset classes could’ve produced returns of more than 8% in the last decade, say alternative asset classes like emerging market bonds, REITs, and TIPS aren’t nearly as attractive heading into the 2010s. “Today, yields on most of these diversifying assets are well off the rich premium levels at the turn of the century,” they say. “Back then, NASDAQ-induced neglect led to a whole spectrum of alternative asset classes, favorably priced for attractive long-term returns. Today, we aren’t so lucky, as many off-the-beaten path categories sport rock bottom yields (and, therefore, low forward-looking returns).”

To make hay in the coming decade, Arnott and West say investors need to practice “diligent tactical asset allocation”. In the current environment, they say, “when all asset classes are rich, shouldn’t we consider a more conservative posture? This approach isn’t market timing but risk budgeting. We choose to take long-term risk when risk-bearing is likely to be rewarded, and a conservative, well-diversified posture when it is not.”

Arnott and West reiterate that the fundamental indexing approach they advocate — and even equal weighting approaches — far outpaced traditional market-cap-weighting approaches in the past decade. And, they say non-cap-weighted indexes are still selling at major discounts to cap-weighted indexes, leading them to believe that non-cap-weighted indexes will outperform their cap-weighted peers in the coming decade.

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