The Argument for Bonds in Strategic Asset Allocation

Abstract

A number of well-known practitioners such as Warren Buffett and Jeremy Siegel have long advocated a strategic asset allocation in which investors hold a majority of their assets in equities. However, in this simple straightforward study of investable indices, the authors find that in order to maximize the well-known Sharpe ratio, most investors over the period 1995–2019 would have been better off holding a majority of their assets in bond indices rather than stock indices. While interest rates have decreased during this 25-year period and thus enhanced bond relative returns, their results are quite convincing. Even though the results are obviously ex post, investors very often make decisions on future investment based on past performance and thus our results could provide guidance to investors for future investing decisions. <b>Key Findings</b> ▪ In order to maximize the Sharpe ratio, most investors over the 1995–2019 period would have been better off holding a majority of their assets in bond indices rather than stock indices. ▪ For a portfolio at the 4% annualized standard deviation level, the percentage that should have been held in a US aggregate bond index over the time period studied is 79%, on average. As the risk level increases, the percentage held in the US bond index decreases substantially in favor of investing in an emerging market bond index. For a portfolio at the 10% annualized standard deviation level, the percentage that should have been held in an emerging market bond index is approximately 63%, on average. ▪ Bond indices, whether they be domestic or emerging markets indices, should have been a much larger proportion of one’s portfolio than is often stated by finance professionals and commentators.