Ibbotson: Asset Allocation Did Not Fail

Christine Benz: Hi, I'm Christine Benz for Morningstar. I'm here at the Ibbotson Conference. It's early in the conference, but we already have lots of exciting takeaways. I'm here today with Roger Ibbotson. Roger is chairman and chief investment officer for Zebra Capital. He was also founder of Ibbotson Associates. He's also a professor at the Yale School of Management.

Roger, thanks for being here today.

Roger Ibbotson: Great to be here.

Benz: You posed a very important question in your keynote presentation this morning about whether asset allocation is still a viable concept. Did it fail us during 2008 when pretty much everything but long-term Treasuries went down and went down by a lot? What's your answer to that question?

Ibbotson: The answer is no, it did not fail. I think it actually did quite well, in the sense that stocks and bonds actually behave very differently from each other. Stocks went down, but bonds went up.

Also, cash was the other big part of the equation. Stocks, bonds, cash. Cash, of course, was stable over the whole period. So I think it actually worked. And certainly diversification worked, because individual stock portfolios were really volatile, whereas the more [bonds] you had in the portfolio, you ended up with a much less risky portfolio.

I must say, I'm frankly pretty confused as to why they could even think it failed. But it actually mostly stems from the fact that most of the equity markets all dropped in 2008.

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Benz: So, perhaps, too many investors had too much in equities during the 2008 period, given their time horizons.

Ibbotson: They may have had too much in equities. They also perhaps had unrealistic expectations because they thought that just being in, say, value/growth, large/small, international/U.S. would protect them.

In fact, all those markets fell in 2008. In that sense, diversification didn't do so well. But that was an unusual period. It is true that the individual markets usually behave differently from each other. They did behave similarly in 2008.

Benz: I know you made a case in your presentation that you actually think stocks should strongly outperform bonds over the next couple of decades at least, given what we've seen in the market recently. Can you just discuss the underpinning of that thesis?

Ibbotson: It starts out with people thinking that because bonds did so well over the last few decades that in fact that they would maybe do well again.

But bonds did very well over the last two decades for a very specific reason. And that is, the yield started out so high, you actually get a return from that big yield.

You also get a return from the drop in yields. You get a capital appreciation. Stocks actually did fine, too, over the last several decades. They did about the same as bonds, in fact. What I would think is not going to happen is, bonds are not going to repeat.

Stocks will repeat, but stocks behaved normally over the last several decades. They had their up decades, they had their down decades. But bonds did artificially great. It won't happen again, especially today when they start out at 3% yields. You can't fall much more.

Benz: So, given the combination of very low yields currently, plus the potential for future interest rate hikes, that's not a happy picture for bonds. Whereas, you think stocks will return more normal returns, which will lead them to strongly outperform bonds.

Ibbotson: Yes, it's pretty much inevitable that stocks will outperform bonds over longer periods. Of course, shorter periods will be harder to predict.

Benz: OK, Roger, great. Thanks, great information, terrific presentation. Thanks for being here.

Ibbotson: OK, great.

Benz: For Morningstar, I'm Christine Benz.