investment advice for a friend of mine who has c. €1m to invest in an ARF.

[North Star]

Hi Dan,

Do I take it that you didnt find our asset allocation strategy convincing?

Though being serious, the fixed income/bond challenge is going to be very difficult for us all to navigate through at some point in the near future, and especially so for the more cautious investor who may not realise that bond investments especially long duration ones can go significantly under water, before gradually gliding back to par at effective maturity.

 

[Dan Murray]

Sincere apologies Vincent - my last post was inexcusably sloppy - worst thing is that I kind of knew it but I was trying to multi-task!!

I am genuinely impressed by and grateful for your post. What I was trying to get across in my last post is that whilst both of us believe, to an extent, that there is some place for absolute return strategies; others in this debate do not share this view for various reasons. That's all I meant by "convincing" (....it was linked - in my mind - to the reference of "dividing the jury"). I started off wanting to believe in absolute strategies but Sarenco, in particular, made some points that didn't suit my argument which I am struggling to discount! Also, I am having a hard time understanding the nature of the risk involved in absolute return funds and if I can't understand it, I can't honestly evaluate it. AAAaaaggghhh!!!!

Though being serious, the fixed income/bond challenge is going to be very difficult for us all to navigate through at some point in the near future, and especially so for the more cautious investor who may not realise that bond investments especially long duration ones can go significantly under water, before gradually gliding back to par at effective maturity.

Now - that's CONVINCING.........nobody can argue with that

 

[Marc]

Dan,

I would have to sack myself as a Financial Planner if I was to agree that I thought you are asking the right question here. Hence all my observations around this being more complex than the question you are asking.

However, as I'm giving a lecture on this tonight at DBS let me put on my asset management hat for moment.

Here is a graphic from Asset Management Company Vanguard which I think gets to the crux of your question.




This is simply saying that the average return of a portfolio between 2000 and 2012 has been lower than the average return between 1926 and 2012. In other words investors should prepare themselves for lower returns in the future than they have received in the past. I think it is helpful to put some real evidence in to support statements that are fundamental to the debate.

The real question is surely this: "well, how much lower and how do we estimated it?"

So, again I produced a guide which I have already referenced called "realistic expectations" and in this I turned the question on its head and asked these questions:

Do I know what the average return from "cash" (I'm using the German 3 Month Money market rate as a proxy for the risk free rate) has been over some long time horizon? - answer yes
Do I know what the equity risk premium has averaged? - answer yes
Do I know what cash is paying today? - answer yes

So, if I am willing to assume that the equity risk premium will stay reasonably constant over time (happy to debate this), then all I need to do is assume a lower risk free rate going forward and solve for the portfolio that matches my expected return given a lower risk free rate.

Now in reality these assumptions are fed into the Black Litterman model to generate the actual asset allocation, but in order to simplify the problem a lot, let's work with historical data to calculate the realized excess return of a given portfolio and simply work out what part of that can be considered risk premium and what part is risk free rate and we are in business.


Assumptions:
We are willing to use some proxy for the Euro prior to 1999. I am using the German Mark in order to extend my analysis back to 1970.
We know our costs from my earlier post are around 1.25%. (Happy to debate paying extra in fund management fees in order to buy Ferraris for fund managers. )
Your target is 3% nominal (I see no reference to inflation in your question - another huge concern)

So your target gross nominal return needs to be 4.25%pa and gross real needs to be 6.25% assuming ECB inflation target of 2%pa.

The following table takes a range of portfolios from 80% Bonds/20% Equities to 98% Equities for the period 1970 to 2014


Source: Dimensional Fund Advisers

How to read the chart
1) Ignore everything except the first column
2) First Column has the Euro short term rate at the top. This is the return you would have earned from "cash" between 1970 and 2014. Over this period the return was 5.18%pa (source Deutsche Bundesbank) So, this is the "risk free rate" you could have had this for "free". Note that over this period inflation averaged 2.73%pa
3) What we are interested in is this. Cash isn't paying 5% today - more like zero. So, if I start with a lower interest rate, what should I expect from an investment portfolio.
4) The number shown in bold in the table is the risk premium for the portfolio above this "base" number. So top left hand corner, the number is 1.889.
That means that the conservative portfolio (80/20) averaged 1.889% above the Euro Short term rate of 5.18%pa over the period.
Note that the period include high inflation in the 70s, poor market returns, good market returns and both falling and rising interest rates.
5) The second number (T Stat) is 2.137 this is a measure of statistical significance and measure how confident we should be in the average premium (it was developed in Dublin incidentally) the test looks at the mean, the standard deviation of the mean and the number of observations. A T stat of 2 or more is generally taken to be statistically significant.

The table gives me the actual risk premium of each portfolio between 1970 and 2014 above the German Short Term Money Market Rate and my base currency is DMY/Euro. Note for the avoidance of doubt these are my research portfolios and not the off-the-shelf DFA portfolios referenced by Stephen earlier.

For forward planning purposes, if we assume a Euro short term rate of say 1% over the medium term then our Expected portfolio return is the Euro short term rate plus the average premium. So, putting it all together:

For a nominal target of 4.25%pa we need around 45%- 50% in Equities
For a real (inflation protected) return of 6.25%pa we need around 80% in equities.

Note that we also have T Statistics of more than 2 for each portfolio so we can be 95% confident that this is the real risk premium for the portfolio and not just background noise.

Caveats

Each portfolio is more complex than a simple MSCI or FTSE All World Equity portfolio and a much lower equity risk premium would be obtained running the same analysis using just a developed equity index. In other words, some of the heavy lifting is being done here by taking more equity risk and less fixed interest risk. Overall this gives the portfolios a better sharpe ratio and better downside protection.

 

[Marc]

Just to address the point on absolute return

Standard Life GARs has exactly the same risk characteristics as the 40% risk portfolio before costs and lower realised returns since Sept 2008 net of costs.

 

[Dan Murray]

Thanks Marc

I appreciate you are spending a lot of time on this. Frankly, I don't understand either chart. My strong belief is that if I don't understand it, others will similarly be left

For example, if we take the first one

View attachment 930

What's your point? Is it that, in the long run, equities beat bonds but that the performance is less predictable over shorter timescales? If so, this is not news - and it doesn't advance the debate; if I have misunderstood, please advise....

The second chart - I simply don't understand the layout. It would be helpful to explain what precisely 1.889 on the first row and 3.761 & 1.321 on the 4th row mean. From this, presumably, I'll be able to work out the purpose of the chart.

 

[Marc]

This reminds me of the Hitchhikers Guide to the Galaxy by Douglas Adams

"What is the answer to the ultimate question of life the universe and everything"
"42"
"42?"
"Maybe you didn't understand the question"

Let me go back over my post and add some notes

 

[Dan Murray]

This is simply saying that the average return of a portfolio between 2000 and 2012 has been lower than the average return between 1926 and 2012. In other words investors should prepare themselves for lower returns in the future than they have received in the past. I think it is helpful to put some real evidence in to support statements that are fundamental to the debate

Thanks for the clarification but in fairness Marc, my very strong sense is that every single poster to this thread is aware of this - and some have already said this explicitly. It's actually the genesis of the thread. Also, I have a strong aversion to over reliance of charting over randomly selected periods - i.e. the take-away from such charts would be different if you took a 5, 10, 20 and 30 year view to 2012. I take it you are ok with candid feedback.......not quite sure how to interpret your Hitchhikers reference?!

How to read the chart

1) Ignore everything except the first column

2) First Column has the Euro short term rate at the top. This is the return you would have earned from "cash" between 1970 and 2014. Over this period the return was 5.18%pa (source Deutsche Bundesbank) So, this is the "risk free rate" you could have had this for "free". Note that over this period inflation averaged 2.73%pa

3) What we are interested in is this. Cash isn't paying 5% today - more like zero. So, if I start with a lower interest rate, what should I expect from an investment portfolio.

4) The number shown in bold in the table is the risk premium for the portfolio above this "base" number. So top left hand corner, the number is 1.889.

That means that the conservative portfolio (80/20) averaged 1.889% above the Euro Short term rate of 5.18%pa over the period.

Note that the period include high inflation in the 70s, poor market returns, good market returns and both falling and rising interest rates.

5) The second number (T Stat) is 2.137 this is a measure of statistical significance and measure how confident we should be in the average premium (it was developed in Dublin incidentally) the test looks at the mean, the standard deviation of the mean and the number of observations. A T stat of 2 or more is generally taken to be statistically significant.

Thanks for the explanation. Still unsure what exactly you are saying so before commenting, can you clarify please?


1. Are you saying that based on historic returns between 1970 and 2014, a fund made up of 80% bonds / 20% equities would have beaten cash by 1.889% and that an all equity fund would have beaten cash by 8.446%?

2. What equity and bond benchmarks are you using?

3. How are you using past performance to project future returns - are you saying that future performance will broadly replicate past (chosen) performance figures as seems to be implied by this?

For forward planning purposes, if we assume a Euro short term rate of say 1% over the medium term then our Expected portfolio return is the Euro short term rate plus the average premium. So, putting it all together: For a nominal target of 4.25%pa we need around 45%- 50% in Equities. For a real (inflation protected) return of 6.25%pa we need around 80% in equities.

 

[cremeegg]

I can't help thinking that I am not alone in suggesting that the Emperor has no clothes.

Can I ask two questions.

Why should the equity risk premium between 1970 and 2014 tell us anything about the equity risk premium for 2016 onward.

This is simply saying that the average return of a portfolio between 2000 and 2012 has been lower than the average return between 1926 and 2012. In other words investors should prepare themselves for lower returns in the future than they have received in the past. I think it is helpful to put some real evidence in to support statements that are fundamental to the debate.

Why is the second sentence in the above any more true than if it said. "In other words investors can expect higher returns in future because of mean reversion."

 

[Marc]

Dan,

I always work on the principle that Askaboutmoney posts are read by more than one person. This thread has now had over 1730 views!!

However, some people answer questions as if the only person on the thread is the original poster. I think that's dangerous as some people may infer that what is maybe right for one person may also be right for them.

Another one of my gripes is people posting "facts" without supporting evidence. If its a fact then provide the evidence.

I'm not disagreeing with you that many of the posters understand this debate. My concern is that many of the readers may not. I often get comments from people who read askaboutmoney and many of them point to the fact that many of the arguments are due to the failure to establish the difference between a fact and an opinion.

So, I included the data from Vanguard because it supports the main thrust of the argument. But it doesn't answer the question which is my second point. I also accept your point on data mining which is why my tests are both out-of-sample and over a longer period.

The reference to Douglas Adams is simply with reference to my point that I believe the thread is really asking the "wrong" question but I admire your tenacity to get an answer so happy to indulge.


To address your points


1. Are you saying that based on historic returns between 1970 and 2014, a fund made up of 80% bonds / 20% equities would have beaten cash by 1.889% and that an all equity fund would have beaten cash by 8.446%?

Yes, that's exactly what I'm saying. The average return of any portfolio is made up of the risk free rate plus the risk premium. I'm just isolating the part of the return that is made up of the risk premium, then taking a lower starting rate for cash and estimating the expected portfolio return going forward. I think this is exactly the question you are really asking.


2. What equity and bond benchmarks are you using?

These are our proprietary research portfolios. But they are comprised of robust index data. In other words the source of returns is simply market risk there is no requirement for repeatable fund manager skill to deliver these returns. This point is in the Caveat

3. How are you using past performance to project future returns - are you saying that future performance will broadly replicate past (chosen) performance figures as seems to be implied by this?

Yes, sort of. I am saying that the premium for taking equity risk should be fairly constant over time (not that the performance of a portfolio should be the same as in the past). They are different points. Again this is this point in my earlier post:

"So, if I am willing to assume that the equity risk premium will stay reasonably constant over time (happy to debate this), then all I need to do is assume a lower risk free rate going forward and solve for the portfolio that matches my expected return given a lower risk free rate."

 

[Marc]

Cremeegg,

1)Because it is consistent with the Barclays Equity Study from around 1900

If I came down from Mars and looked at the equity risk premium between say 2000 and 2008 I would probably conclude that people who invest in equities like to lose their money. Whereas in reality equities have a positive expected return so we need to be able to estimate how much more we should expect for taking on the risk

2) Because the issue at hand is not equity risk its low returns from defensive assets. In a conservative portfolio the dominant holding is cash and fixed interest. Therefore even if equities mean revert (my first point - what is a realistic equity risk premium) if you hold too little in equities you won't obtain the return you expect because the return on most of your money (the defensive part) is likely to be dire.

 

[Dan Murray]

Marc

I find your writing/communication style difficult to follow but I think what you are saying is that:
- you have in mind a bond portfolio and an equity portfolio that you believe can produce returns in excess of Cash
- you have defined Cash as German 3 month paper
- you have simulated the returns for your chosen equity and bond funds from 1970 - 2014 and have shown the composite return over Cash
- you believe that the proportion of equities and bonds will determine the composite premium over Cash
- you believe that the premium attained previously (i.e. 1970 to 1974) will broadly be replicated in the future and that this forms the basis in setting the equity / bond mix to achieve a given level of future return
- you are not prepared to state the asset make-up of your funds
- you believe that your equity fund has the same risk profile as say the MSCI but will produce greater returns

It would really be great if you could confirm each of the above as succinctly as possible please.

Also, at a point of detail, when you say that a 98% equity fund has an annual average return of 8.446% over Cash (where Cash = 5.18%)......do you mean this equity fund returned (a) (1.0518 + 0.08446)^45 or (b) (1.0518 * 1.08446)^45 ?

The above was just to confirm my understanding of what you are saying. Once I have this information, I will be better placed to comment on your posts.

 

[Marc]

Dan,

Apologies for your frustration but at this point most posters on askaboutmoney have already phoned me and called in for an appointment and are well on their way to getting sorted out.


you have in mind a bond portfolio and an equity portfolio (and real estate and cash) that you believe can produce returns in excess of Cash.

The evidence that these asset mixes have delivered an excess return since 1926 in the USA since 1955 in the UK and since 1970 globally is reasonably compelling, so yes I'm happy to say that i believe a portfolio of risk assets has an expected return greater than cash. However, I would also note that I need around 60 years of data to demonstrate with 95% confidence that I expect real assets to deliver a higher return than cash due to the inherent volatility of risk assets.

- you have defined Cash as German 3 month paper
I could use Libor or Euribor but we know that this data has been subject to price fixing. I also have a constraint that the Euro did not exist prior to 1999. So I'm not sure what other currency other than the German Mark we should use as a proxy for the Euro prior to 1999?

- you have simulated the returns for your chosen equity and bond funds from 1970 - 2014 and have shown the composite return over Cash

No, I have used commercial and research data for the various asset classes in a portfolio in order to estimate the expected risk premium over cash.

- you believe that the proportion of equities and bonds will determine the composite premium over Cash

No, I am trying to establish the realised return for different historic asset allocations over cash in order to be able to provide a rough estimate of the expected return for various asset allocations in the future. Remember that these estimated risk premiums also come with high levels of statistical confidence. I don't "believe", but rather the evidence strongly suggests.

- you believe that the premium attained previously (i.e. 1970 to 2014) will broadly be replicated in the future and that this forms the basis in setting the equity / bond mix to achieve a given level of future return

No, I said I was happy to debate this assumption. This was a necessary simplifying assumption in order to present the data in order to answer your question. As previously noted, in practice we actually use the Black-Litterman model to derive the actual asset allocation.

- you are not prepared to state the asset make-up of your funds

I didn't say that. The issue is (repeated elsewhere on askaboutmoney) that we individually customise each portfolio to the particular needs of each client rather than shoehorning them into a limited range of static models. I therefore can't answer that question as I don't know the inputs.

- you believe that your equity fund has the same risk profile as say the MSCI but will produce greater returns

No, I categorically didn't say that. I said that the equity strategy is taking more risk than the MSCI which is why it has a higher expected return


Also, at a point of detail, when you say that a 98% equity fund has an annual average return of 8.446% over Cash (where Cash = 5.18%)......do you mean this equity fund returned (a) (1.0518 + 0.08446)^45 or (b) (1.0518 * 1.08446)^45 ?

The table is the realised risk premium over cash
So the total return from the equity strategy was cash 5.18% plus risk premium 8.446 = 13.626%pa

Just to give this last point some context for example
The average annual premium of Emerging Markets over Developed Markets since 1988 has been just over 5.5%pa


Hope that helps

 

[Dan Murray]

Marc

One additional question - the returns on the table provided are not consistent over the various portfolio ranges.

For example, if you take the equity return quoted above of 13.626% and use it in the 80% bond/20% equity portfolio, it gives a bond return of 5.371%.

And when we average these 2 returns, we get 9.4985 or a premium of 4.318. This compares with the stated premium for a 50/50 split of 3.761

 

[Marc]

Dan

That's right the composition of the portfolios varies as you move up and down the curve consistent with investor preferences in general.

This reflects the fact that we are working in one dimension here when in fact the asset allocation decision process is multi dimensional.

So if I start at the conservative end of the spectrum clients are generally more concerned with capital preservation so I will tend to underweight say emerging markets to reduce downside risk.

However, the conservative portfolio also has lots of fixed interest so there is a substantial duration (interest rate) and inflation risk. So I will tend to overweight inflation linked bonds and hold shorter duration bonds.

Higher up the curves the equity allocations will dominate the risk characteristics of the portfolio and these will naturally tend to be selected by investors with higher risk tolerances. So I can include more Emerging Markets Etc

But I stress these are research portfolios not live investor portfolios.

In reality I might have a client say, look id like 40% equity exposure but I want to dial up the equity risk and at the same time take less fixed interest risk.

Each portfolio is individually customised.

 

[Dan Murray]

I didn't say that. The issue is (repeated elsewhere on askaboutmoney) that we individually customise each portfolio to the particular needs of each client rather than shoehorning them into a limited range of static models. I therefore can't answer that question as I don't know the inputs.

Marc,

As I stated, I had understood that you were not prepared to share the asset make-up of your "funds". I tentatively take it this is not the case - as per the above - although, frankly, it's very hard to decipher what you actually mean. At least, your reply to this post will clarify things, either way, for once and for all. I take it also that you have come to some form of acceptance that this is an investment thread - not a financial advice thread. Accordingly, you can make whatever assumptions you feel you need - (the wording is intentional as other contributors, professional advisers and others, were happy to contribute to the investment question on its own merits) - to enable you establish your recommended investment strategy for someone seeking to obtain a nominal net average annual return of 3% over the next 5 years. Remember the client's dual objectives are to attain this return with the least risk possible. I'm happy for you to include whatever warnings you feel necessary.

It will be informative to see what client variables you assume. If you want to choose 2 scenarios with 2 different suggested allocations, that would be great. The absolute key point is the client's investment goals. My belief is that the rest is just noise for current purposes - happy to acknowledge you have a different point of view. Also, please use current money market rates.

 

[Marc]

Dan,

I'm sure you are finding this process extremely frustrating. I have tried to engage you in a discussion about why you want this answer in order to establish if this is really the right question to ask. However, you are clear that you want the answer to this specific question rather than a discussion about your assumptions such as

why a 5 year term?
why 3%?
why not annuitise part of it as a proxy for cash and fixed interest?


Equally, I believe I have already answered your question with my analysis of Stephen's defensive portfolio which I agree with you is unsuitable to achieve the objective set.

I then set out an analysis of likely fees for managing an ARF - you have not commented on this analysis so I assume you are willing to accept the fee calculation as set out.

I then set out the required portfolio to meet the nominal target return of 3% net of fees i.e 4.25% Gross

I answered this here:
"For a nominal target of 4.25%pa we need around 45%- 50% in Equities" and provided statistical analysis to back up my statement.

I also highlighted the fact that you are ignoring inflation and that
For a real (inflation protected) return of 6.25%pa we need around 80% in equities.

I would also point out that my analysis is entirely consistent with Sarenco's post

I certainly agree with Jim that absolute return funds are hedge funds by another name and have no place in the portfolio of any retail investor, in my humble opinion.

However, I wouldn't necessarily agree that a real rate of return of 3% per annum, after fees and charges, is a particularly modest expectation from a balanced portfolio of stocks and bonds.

Obviously nobody knows what the future holds and forecasting returns on publicly traded securities is a fraught exercise. What we do know is that stocks are riskier (more volatile) than bonds and bonds are riskier than cash. Therefore, over the long term, the expected return on stocks is higher than the expected return on bonds and the expected return on bonds is higher than the expected return on cash - most of the time!

At current valuations, some of the more optimistic commentators are forecasting that the real (after inflation) return on large-cap developed market stocks, over a 30 year investment horizon, will be around 5% per annum and the real return on short term government bonds or cash will essentially be zero. On the basis of these forecasted returns, an allocation of 60% to large cap developed market stocks (with the balance of the portfolio in cash) would be required to achieve a real return of 3% per annum before fees and charges. If fees and charges (including portfolio trading costs) amount to 1% per annum, the required allocation to developed market large cap stocks jumps to 75% to achieve the desired 3% real rate of return.

A portfolio with a 75% allocation to equities would obviously be volatile - the pattern of returns from one year to the next is likely to be as smooth as sandpaper. A reasonable compromise might be to hold 50% of the ARF in a global equity fund and 50% in an intermediate term euro government bond fund and to simply accept whatever returns the market provides.

Ultimately, every investor has to balance his need or desire for return with his tolerance for the risk required to achieve that return. This is very much an individual decision that must be made with regard for an investor's overall financial circumstances. Investing is all about trading off risk and reward - there is no way around this simple fact.

In fact, Sarenco also agrees that asset allocation decisions cannot be made in a vacuum and that this is "a decision that must be made with regard for an investor's overall financial circumstances"

However, you are still looking for a more detailed answer

As previously noted I have virtually no information on either willingness or capacity for risk so the following cannot be considered advice and should not be relied upon for making personal decisions. The following analysis is for educational and information purposes only.

In order to generate an asset allocation I need to make certain assumptions:

Inputs
Style? You seem to have a preference to absolute return so I will select an active/passive style
Asset class restrictions? We know nothing about the client's preferences eg existing property portfolio so let's select unconstrained
Portfolio bias? We have no information on preferences so let's tilt 50% towards active management
Investment term? We do know this is 5 years but not why. Maybe the client intends to buy an annuity in 5 years

So now I need to set my expected return to 4.25% assuming 1.25% fees to bring me to my target of 3%
That results in portfolio 54 on this solution curve
Expected return 4.25%pa

Hope that helps.

 

[cremeegg]

I firmly believe that the future is unknowable, and the guy who can tell you what stock will out perform is a charlatan.

Marc,

You are suggesting that through a series of backtested asset allocations you can provide given levels of return at lower risk. I am sorry but snake oil is snake oil no matter how impressive the charts used to sell it.

I asked a simple question which addresses a fundamental aspect of your approach and you were completely unable to answer it.

My question was

Why should the equity risk premium between 1970 and 2014 tell us anything about the equity risk premium for 2016 onward.

to which you replied

Cremeegg,
1)Because it is consistent with the Barclays Equity Study from around 1900

I'm sorry but the Barclays Equity study indicates that the real long term return for equities is consistently in the region of 6%. This DESPITE the significant change in equity risk premium that occurred in the 1950s.

Far for answering my simple question you are showing that you do not understand the basics of the sources you are relying on.

 

[Marc]

Cremeegg,

For the avoidance of doubt

Of course the future is unknowable. I'm not saying I can predict the future, but for planning purposes you need to make an assumption. But you are right, the one thing you do know for certain is that your assumptions will almost certainly be wrong with the benefit of hindsight.

I'm not saying I can identify which particular stock will outperform. I'm saying there is some strong empirical evidence that certain assets classes have higher expected returns. For example Emerging Markets are considered more risky than developed markets and have a higher expected return as compensation for higher risk. Do you disagree with this assumption?

I'm not saying I can provide given levels of return at lower risk at all. I'm saying that each allocation has an expected risk return characteristics. Just because the return is expected doesn't mean it is guaranteed. That is the nature of investment risk.

I did answer your simple question with a simple answer. Stocks have a positive expected return and a higher expected return than less risky assets. Of course we don't know for certain what the realised equity risk premium is going to be over any period. But again, we have to make some assumptions for planning purposes.

The observed risk premium for the Equity Portfolio was over 8% from 1970 to 2014. For planning purposes I am assuming a more conservative premium than this. Which is consistent with the long run average premium. What exactly is wrong with that approach?

You are perfectly free to hold whatever views you wish on that matter.

 

[Dan Murray]

Marc,

That's an excellent post. I had to be assertive earlier because I had felt that we had been going around in circles. I am very happy that you have answered my question (yes, uno!) very clearly and provided me with charts that didn't give my poor head a migraine! I understand your need to be similarly robust in the initial section of your reply - you know the DON'T TRY THIS AT HOME CHILDREN bits!!

Regarding the substantive issue, very broadly, my sense is that your proposed asset allocation is along the following lines:

High return seeking assets: 10% of portfolio with a target nominal return of 8% p.a.
Other return seeking assets: 43.2% of portfolio with a target nominal return of 6.5% p.a.
Defensive assets: 46.8% of portfolio with a target nominal return of 1.37% p.a.

I'll await your corrections/clarifications regarding this. I have overstated the total of the defensive assets by 0.1.% (compared with the pie chart) - presumably a rounding thing.

I will now reflect on what all this means. For the record, I am not saying that I agree with you - I just now clearly understand what you are saying! In the meantime, I just want to be sure we are being fair to Steven. We had used a much lower return on his Bond fund than is being assumed in your bond portfolio (if my sums are broadly accurate) and I don't have sufficient visibility of the fund suggested by Steven to consider if this differential is reasonable.

 

[Marc]

Thanks Dan,

Just a quick observation on your last sentence. I have worked with Dimensional for the last 10 years so I know exactly how their bond funds work.

I took the current Yield to Maturity of the Bond funds from the Dimensional website as my assumed return. The bonds are short 1-5, ultra short 1-2 or intermediate term inflation linkers so I'm happy that the assumptions I made are very reasonable.

The asset allocation of Stephen's portfolio is average AA+ and short duration whereas the comparison portfolio has more investment grade therefore (all things being equal) the assumed return will be higher.