“Is there a better way to allocate assets and construct portfolios?” he asks. The founder of Research Affiliates and manager of PIMCO All Asset and All Asset All Authority funds, Arnott is perhaps best known for his view that fundamentally-weighted indexes, those that use the fundamental investment metrics like dividends, sales, revenues and price-to-book value, do better than cap-weighted indexes, because in cap-weighted indexes you buy more of the “most expensive companies.” In Fundamentallly-weighted indexes, it’s companies with the best metrics–best value–that are weighted.
First, he wanted to dispel some myths: Arnott contends that in what he calls the “Noughties,” the “lost decade was only lost for [investors who were] equity-centric and anchored on cap weighting.”
“Are stocks priced to deliver a large risk premium? No!” Arnott asserts. While a decade ago they were “extraordinarily expensive,” now they are “moderately expensive.”
Do “stocks beat bonds by 5% over the very long run?” No, Arnott says, “real stocks beat bonds by 2.5%, not 5%.” But it matters when you buy; if you “buy when they are cheap, you don’t have to wait for the long run; buy when they are expensive–the long run could be very long.”
Arnott says that cap weighting on the bond side is a “mistake” too, fundamental weighting matters for bonds as well. Further, Arnott says, for “the last 41 years, bonds have had the same rate of return as stocks,” however in the last “decade, bonds materially outperformed” stocks, flipping the stocks outperform notion on its head.
He cautions investors about the “3-D Hurricane, deficit, debt and demographics.” He asked the audience of maybe 800 persons to raise hands if they were born in 1963 and before, then 1964 and after. Then he addressed the post-Boomer 1964 and beyond crowd: “Medicare is a promise we [Boomers] made to ourselves, and we expect you to honor it!” There was a lot of laughter but it subsided when he pointed out that the “public debt in the U.S. is 143% of GDP” if you count the state and local taxes and GSE’s (government sponsored entities) like Fannie Mae and Freddie Mac. “Greece is in trouble at 120% of public debt to GDP.”
But, he says, “there are always interesting investments–the challenge is identifying opportunities wherever they might be.” One of those may be “over the next 12 to 18 months,” when he predicts there will be a “generational opportunity to put inflation protection pieces in place when people aren’t worried about inflation.”
Comments? Please send them to [email protected]. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.