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June 24, 2010 at 08:00 PM
“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.
