Allocation Without Borders

When Ranji Nagaswami spoke at our Wealth Advisor Summit last December about an equities portfolio strategy that produces long-term outperformance along with reduced risk, we had to know more. Nagaswami, vice chairman and CIO of Alliance Bernstein Investment Research & Management, articulated a strategy that includes domestic and international equities from all capitalizations, split between growth and value to diversify the equities portion of a portfolio. Staff Editor Kate McBride spoke to Nagaswami in New York in January.

Would you talk about the portfolio strategy of all-cap, global, value and growth equity that you had mentioned before? How long have you been using that kind of thesis for a portfolio? Quite honestly, forever, over three decades. What do I mean by that? Alliance and Bernstein only came together five years ago–in 2000–and for the first time we had the ability to offer growth and value in every capitalization in every geographic region around the world. Neither firm could have done it on its own, but in terms of being advocates for a broad array of capitalization to select from, and globalization, those themes have been in our firm for a very long time. Before we merged with Alliance, [as part of] the Bernstein legacy since 1967 we had a history of encouraging private clients to give us the broadest discretion. In fact, the roots of this firm [were in] the audacity of Zalman Bernstein. He founded this firm at a time when the corporate scandals of the ’60s had soured people on investing, and there were brokers who had absconded with peoples’ money. He started a business in which he would only manage money with complete discretion. It was a complete break from what everybody was doing, because investors were taking discretion back. This idea of wanting discretion, and saying, “Ask us to find the best investment opportunities,” is in our DNA.

Do you have a portfolio that uses this strategy? A globally allocated portfolio, and we have three mixes: conservative, balanced, and aggressive–all-equity would be the aggressive one. Let’s take the balanced mix, 60% stocks, 40% bonds. We will always recommend that the equity component be diversified in U.S. and non-U.S., with 70% U.S. and 30% non-U.S. In the U.S. portion, we allocate 80% large cap and 20% small cap, and the large cap has a broad range; it has the Russell 1000, and if you take the Russell 200 versus the Russell 800 you get into mid cap. All of these pieces–U.S. large cap, U.S. small cap, and non-U.S.–would be 50-50 growth and value. We think of this as multiple levels of diversification. The beauty is whether you are a $10,000 retail investor or a $50 million private client, and this is the right mix for you, you get that stock. We spent a lot of years researching this mix and we believe that over time for most investors who have a balanced outlook–again the 60%-40% [stocks-to-bonds ratio] is very, very important. Should it be for a private client, we have the ability to tailor this to a 70%-30% or a 50%-50% mix, but for most investors we think a 60%-40% mix is a very useful way to think about this, and [that's where] much of the alpha comes from. In fact, we believe that investment advisors massively underestimate the importance of sound allocation within equities, and that doing this wisely [with] U.S., non-U.S. style, and capitalization mitigates many of the worst behaviors of investors because it provides a much more consistent return. Good returns with reduced volatility.

SIMULATIONS*

The Holy Grail of investing? It is the Holy Grail. I was talking to [an employment] candidate, a very senior guy, who said, “How come you don’t do alternatives?” Since I’ve been in retail I’ve been virtually assaulted by some of my friends about ‘You guys have all this research, why don’t you launch a commodity fund, or an adjustable rate fund?’ My job as a CIO is to create investment services that should be sold, not investment services that can be sold. Many things can be sold; quite frankly very few things should be sold. Once you get the core right, the rest of it is value added from an advisor–which some do quite well, but our central thesis is that style timing–like market timing–is very hazardous to building clients’ wealth.

So you want to participate in all those allocations so that when they are doing well you are doing well? No. Because the way capital markets work, nothing works all the time; something always is not working. The whole job here is to identify a group of asset classes that have as low correlations as you can possibly get, so that when something is not working, something else always is. By pulling together these negatively correlating assets you actually improve the risk-return tradeoffs. You can get above the so-called efficient frontier. The efficient frontier itself gets most people pretty close to a good solution, but we think being a little bit more thoughtful by style, geography, and capitalization can get you above the efficient frontier. That’s our goal, right? In an environment where you were getting 16% returns in the equity market, getting to the efficient frontier was enough. But in an environment where you’re getting 8% returns in the capital markets, which is closer to our longer-term forecast, getting an additional 150 basis points matters a great deal. And never mind fees, right?