In this video, Research Affiliates’ John West discusses the shortcomings of traditional “60/40” portfolios, which he says are 98% correlated to the S&P 500. It’s the “dirty secret” of the industry, in Mr. West’s view. While mainstream stocks and bonds have generated an average annualized return of 10.3% over time, West is emphatic when he says, “We at Research Affiliates firmly believe that investors ought to expand their opportunity set when building robust asset allocation programs to look at things like real assets.”
What are real assets? Well, in addition to commodities, REITs, and TIPS, West cites emerging markets, high-yield bonds, and bank loans as “stealth inflation fighters.”
Diversification breaks down during periods of high inflation, according to Mr. West, who cites the 1970s as an example. With inflation at 10% and stock and bond returns averaging between 3% and 5%, there’s no combination of “traditional assets” likely to result in inflation-adjusted gains. Hence, investors need to consider alternative solutions in order to have meaningful diversification.