Asset Allocation Strategies for 2025: Insights from Research Affiliates

Asset allocation is a critical component of successful investing, yet many investors struggle to optimize their portfolios effectively. In this comprehensive discussion with Jim Masturzo, Chief Investment Officer of Multi-Asset Strategies at Research Affiliates, we explore current market valuations, factor investing, and asset allocation strategies for 2025 and beyond.

The 60/40 Portfolio: Still Relevant?

The traditional 60/40 stock/bond portfolio has been a mainstay for investors for decades. However, with changing market dynamics, many are questioning its continued relevance. Masturzo notes that while the 60/40 portfolio has performed exceptionally well in recent years, investors shouldn't expect this outperformance to continue indefinitely:

"Since 2009, a 60/40 portfolio has had a Sharpe ratio above 1, which would make most hedge funds blush. Historically, people expect that to continue forever. I think the average historically may be 0.4 or something."

He cautions against complacency, suggesting that investors who are "fat, dumb, and happy" with their 60/40 allocation may be setting themselves up for disappointment in the future.

US Stocks: Overvalued and Risky?

One of the most striking observations from Research Affiliates' analysis is the current valuation of US stocks, particularly large-cap growth stocks. Masturzo explains:

"Cape ratios have been elevated in the US for quite some time. Right now, it's 36-37. If we just take the average over the last 30 years, that average is about 28. So if we look at 36-37 relative to 28, you're talking about 20-25% that has to give."

This overvaluation creates a sense of fragility in the market. Any negative news or sentiment shift could potentially trigger a significant correction. Masturzo suggests that investors should be prepared for the possibility of US stocks reverting to more reasonable valuations in the coming years.

International Opportunities: Emerging Markets and Value

While US stocks appear overvalued, Masturzo sees opportunities in international markets, particularly in emerging markets and value stocks:

"Emerging market value has that double tailwind of emerging markets being really well positioned, and then obviously value relative to growth, which is a global story where value companies have just been unloved for so long."

He notes that many emerging markets offer better dividend yields, higher earnings per share growth, and potential currency tailwinds compared to developed markets. Additionally, valuations in many of these markets are much more reasonable than in the US.

The Private Equity Myth

Masturzo takes aim at the often-inflated expectations surrounding private equity investments:

"Private equity relative to public equity shouldn't be that different. The fundamentals that drive the economy drive the economy. You can argue about illiquidity premium sort of things like that, okay, around the margins, but the idea that you would say you think public equities are 1% or whatever, 1% real, and private equity should be 10x of that - well, you're going to have to square that circle."

He criticizes the tendency of some private equity firms to understate the volatility of their investments, arguing that levered equity cannot realistically have the low volatility figures often quoted in marketing materials.

Fixed Income: A Return to Relevance

After years of ultra-low interest rates, fixed income is becoming an attractive asset class once again. Masturzo explains:

"We look at fixed income as being an opportunity again to actually earn a return. For so long, why did you own fixed income at 1% or half a percent? What's the point? But at 4%, 4 and a half percent - well, that's kind of a nice, interesting, low to no risk return."

However, he cautions against taking on too much duration risk, suggesting that investors focus on the middle of the yield curve (4-6 years) to balance yield and interest rate risk.

Commodities: An Overlooked Opportunity

While many investors focus on traditional asset classes, Masturzo sees potential in commodities:

"I am a believer in commodities. I think commodities have a place in everyone's portfolio. As we think about what the world needs going forward from a food perspective, metals - you talked about precious metals, and gold, but silver and platinum are also right there as well. And then things like copper, nickel, lithium - all of the green energy stuff that everyone admits we don't have enough of to meet even close to the goals that are set out."

He emphasizes the importance of active management in commodities, as many passive commodity ETFs have delivered poor long-term returns.

Trend Following: A Key Diversifier

Masturzo expresses enthusiasm for trend-following strategies as a portfolio diversifier:

"I've been doing a lot of work in trend following and thinking about trend and how you think about creating a trend following program. What are the trade-offs between - usually with trend following, it's a trade-off between do you want high Sharpe ratio, or do you want more positive skew? You can't get both."

He suggests that trend-following can provide valuable downside protection and positive skew to a portfolio, complementing traditional stock and bond allocations.

Key Takeaways for Investors

1. Diversification is crucial: Don't rely solely on US stocks or a simple 60/40 portfolio. Consider international markets, value stocks, and alternative assets like commodities.

2. Be cautious of overvaluation: US stocks, particularly large-cap growth, appear expensive by historical standards. Be prepared for potential mean reversion.

3. Fixed income is relevant again: With higher yields, bonds can once again play a meaningful role in portfolios. Focus on the middle of the yield curve for a balance of income and risk.

4. Look beyond traditional assets: Commodities and trend-following strategies can provide valuable diversification benefits.

5. Be skeptical of private equity claims: Don't assume private equity will magically outperform public markets or have unrealistically low volatility.

6. Stay informed: Utilize resources like Research Affiliates' Asset Allocation Interactive tool to stay up-to-date on market valuations and expected returns.

By considering these insights and maintaining a disciplined, diversified approach, investors can position themselves for success in the evolving market landscape of 2025 and beyond.

Article created from: https://www.youtube.com/watch?v=VOa8q_TgMPU