Blog | Burney Wealth Management

The Evolution of Our Asset Allocation Models

Written by Andy Pratt, CFA, CAIA | 6.18.2024

Table of Contents:

Part 1: A Look Back

Jack Burney never owned a bond.

Jack was our founder, establishing the Burney Company in 1974 to satisfy his lifelong curiosity in investing following a career as a Brigadier General in the Army, whose mission statement could be distilled down to one idea: performance matters. Jack believed that this performance could be achieved primarily through stock investing. Even into his 90s, Jack never wanted to trade the return potential from the stock market for the “safety” of an investment in bonds. 

While most investors are not Jack and require a less risky asset allocation, this culture that investment performance matters is a core tenant at Burney Wealth Management and has implications for the way we invest our asset allocation models.

It is common today to find advisors well versed in the financial planning aspects of their job but much less confident in recommending investments. Due to this lack of confidence, many advisors recommend vanilla portfolios rooted in rule-of-thumb investment advice. A common portfolio is a simple mix of stocks and bonds, using low-cost index funds to gain broad index level exposure. And while we agree that index funds have been a win for retail investors who can gain market exposure at virtually zero cost, we question why such an investor would pay an advisor for such a simple portfolio mix.

This mix leaves potential returns on the table while also failing to take advantage of the benefits from other diversifying asset classes. There is an ever-growing catalog of alternative investments available to investors, but advisors need to possess the investment expertise to evaluate and recommend these investments to their clients.

When Burney Wealth Management was established in 2017, we strived to be different. We wanted to deliver the planning experience that clients today expect from their financial advisor while also delivering on Jack’s mantra that “performance matters.”

As a result, our asset allocation models have evolved through the years, incorporating our active US equity strategies carrying decades-long track records with international investments, alternative asset classes, and, yes, even bonds. 

In this blog we will share the history of our asset allocation models, how they have performed, and where we see opportunity next.

The Evolution of Our Asset Allocation Models – The Initial Mix

Jack Burney never owned a bond because he believed the lower volatility of bonds wasn’t enough to overcome the lower returns. In 2017, the risk-reward tradeoff for bonds looked especially unattractive.

In its efforts to stimulate a stubborn economy following the 2008 Financial Crisis, the Fed cut interest rates to near zero, but was receiving pressure to start normalizing rates as the economy regained strength. The relationship between bonds and interest rates is inverse, meaning that rising rates cause bond prices to fall, so the outlook for bonds was for low yields and falling prices. 

An argument could be made that bonds would act as a buoy in a portfolio, smoothing out stock market volatility, but the cost for that benefit was large. Our asset allocation models looked different in two ways:

  1. The allocation to fixed income was lower than the standard “60-40” stock/bond mix. 
  2. Alternative investments were added to the investment mix for their diversification benefits

The key difference between our asset allocation models and the standard advice was the substitution of alternative investments for a significant portion of the fixed income allocation. The specific type of alternative was managed futures, a liquid alternative that uses futures contracts to go long or short a wide variety of asset classes based on trend following or macro conditions. 

The problem with relying on bonds alone to diversify the risk of stocks is that bond correlations tend to rise when there is market distress. This means bonds often see their prices fall at the time when their diversification benefits are needed most, with recent examples being the bear markets in 2008, 2020, and 2022. 

Managed futures, however, exhibit near 0 correlation with stocks and bonds and, crucially, this non-correlation generally holds up even during market downturns (although there is no assurance that this will occur in every instance). A great example of this is the most recent downturn in 2022. Stocks and bonds both entered bear markets at the same time, but managed futures don’t need markets to go up, they just need a trend. The two managed futures strategies we deploy in client portfolios went up double digits during this time when it felt like everything was down.

Addition of Private Credit

One of the fastest growing asset classes is an alternative asset class called private credit. Private credit refers to loans that typically small- to mid-sized companies will take from a non-bank lender, often a large asset management firm. Firms look to private debt when they can’t or don’t want to receive loans from traditional lending sources like banks.

From an investor’s perspective, private credit serves as a complement to public bonds. The risk profile is higher than investment grade fixed income, more akin to high yield bonds, but yields are higher to compensate for the risk. Many loans in the private credit space are floating rate, which makes these investments less susceptible to interest rate moves. This floating rate feature really paid off in 2022 when public bonds fell as the Fed aggressively hiked rates.

The 2020’s serve as a great stress test for any asset class as we’ve already seen almost any market scenario you can imagine: two bear markets, two recoveries, economic contraction, economic expansion, a growth phase, a value phase, a pandemic, peace times, war times, and both a falling and rising interest rate environment. This was an especially volatile environment for fixed income and the standard stock-bond portfolio, but private credit offered a smoother experience than public bonds with more return. 

We started adding private credit to our asset allocation models in 2020 as interest rates were again near zero, making forward looking returns in the bond market bleak. It proved to be a great asset class to pair with bonds to offset the struggle that was to come.  

Being Active with Fixed Income

As mentioned earlier, bond prices and interest rates carry an inverse relationship. This is why bond performance in 2022 was so bad. The Fed, to fight rising inflation, hiked interest rates quickly and by a lot. This created an unusual situation where short-term interest rates were higher than long-term interest rates. Essentially, investors were (and still are) getting paid more for lending money for short periods of time vs longer periods of time. This is unusual because an investor would normally seek additional compensation to have their money locked up longer.

We reacted to this changing fixed income environment by rebalancing from our standard fixed income mix, leaning from intermediate-term bonds to short-term Treasuries. In doing so, we were able to avoid some of the bond drawdown and achieve higher yields

The fixed income environment today is an interesting one. The yield curve remains inverted, so it is tempting to continue holding short-term T-Bills paying 5%+. At the same time, the Fed is expected to begin cutting rates as soon as September, so there is no guarantee that such high rates will be available when it is time to roll into a new T-Bill. 

A Charles Schwab research report issued in 2024  concluded  that the best time to switch from short-term fixed income to intermediate-term fixed income is soon following the last Fed interest rate hike and before the Fed starts cutting rates. The logic here is simple: you want to have locked in higher rates in longer dated bonds before rate cuts start to pull down yields. For this reason, we shifted fixed income allocations back to intermediate term duration in late 2023 after the Fed signaled that its next move was more likely to be a rate cut than a hike.

Performance Matters

As outlined, What distinguishes our firm from others is that we employ an active asset allocation approach to investment management that involves the careful selection of diversifying asset classes and moves beyond run-of-the-mill stocks and bonds allocation advice. This strategy has resulted in strong performance for our clients. 

Investors in our moderate risk asset allocation portfolios achieved better returns than the Morningstar benchmark with lower standard deviation, a common measure of portfolio risk. The 2020’s have been a challenging decade to navigate as the simple 60-40 stock-bond portfolio that achieved stronger than average results in the 2010’s failed to deliver. Reacting to forward-looking return assumptions and investing in a broader set of investments was necessary to avoid disappointing results.

The investing landscape is constantly changing, and our risk models are changing with the times. Today’s forward looking return assumptions imply that there are opportunities for investors in longer duration bonds, emerging markets, and expanded use of alternatives. We will close out this blog diving into our current recommended investment mix.

Part 2: A Look Ahead 

Our philosophy on allocating client assets emphasizes diversification via multiple asset classes and not generic formulas, as discussed. It’s not only about the merits of a single investment or asset class, but how that investment or asset class will interact with the other pieces of the portfolio. This requires frequent review and debate by our experienced team. 

Our investment committee meets quarterly to review these asset allocation models and discuss potential changes. 

During these quarterly meetings we review the following key questions:

  • Are the current asset classes and managers performing according to our expectations?
  • Are there any additional asset classes or investments that should be considered?
  • Do we need to adjust the percentage allocation toward a particular manager or asset class? 

In many cases we leave these meetings energized with interesting ideas to research for further discussion. Often, we will also make small adjustments to our models but not significant changes, as we deploy a strategic asset allocation approach that emphasizes intermediate to longer-term decision making. This approach provides predictability for our clients and allows us to make decisions with a full market cycle in mind, and not just a quarter or year. 

Of course, there are times when larger changes are warranted. Over the past six months, we’ve considered more significant adjustments to our models as we believe the investment landscape is materially different compared to the last model iteration in 2017. Interest rates are much higher, the case for US equities to outperform the rest of the world has strengthened, and we’ve grown increasingly comfortable with our lineup of alternative investments as diversifiers, especially as we expect overall equity returns to be lower going forward.  

Effective immediately we are implementing the following changes to our allocation models: 

  1. We’ve increased our allocation to fixed income 
  2. We’ve introduced emerging markets debt as an asset class 
  3. We’ve increased our allocation to alternative investments, specifically private credit 
  4. We’ve reduced our exposure to international developed markets 

The magnitude of these changes will vary by risk level and other restrictions, such as capital gains, client preferences, and the size of the portfolio. Our advisors will work closely with clients to make sure these changes are aligned with the client’s goals, objectives, and risk tolerance. 

Below is a deeper dive into these changes and the thought process behind them. 

Increasing our Allocation to Fixed Income

As we described in detail above, we were still under the Fed’s low interest rate policy regime at the inception of our original models. A few years later, the COVID pandemic and subsequent recession took rates from already being low to a historical bottom, with the 10-year Treasury yield reaching 0.318% on March 9, 2020. 

The post-pandemic inflation outbreak forced the Fed’s hand into aggressively raising rates 11 times from March 2022 through July 2023, taking the fed funds rate from near-zero to a range of 5.25-5.5%. While the path to these higher rates was volatile and unpredictable, our team was proud of the way we navigated the changes (as outlined above). 

This new, higher rate environment has several important implications for our clients and asset allocation decision making: 

  • Investors can now earn a reasonable yield on their fixed income and cash holdings.
  • The forward-looking return outlook for fixed income has improved compared to our previous expectations under a low-rate environment. 
  • The difference in yields on US Treasuries and other, higher risk fixed income investments has narrowed significantly. This means there is less incentive to take risk in high yield or corporate bonds. 

These changes have led us to make greater use of fixed income investments in portfolios, specifically US Treasuries, as a diversifier and complement to equities and alternative investments. 

Adding Emerging Markets Debt as an Asset Class

Investors have historically been underweight in emerging markets debt investments, likely due to its low credit quality and heavy allocation to only a handful of countries in the early days. According to the global asset manager Amundi, only 3% of European institutional investors’ fixed income assets were allocated to actively managed emerging market debt in 2022, while in the US, the allocation was even lower at 1-2%. 

These numbers are inconsistent with emerging markets increasing importance in the global economy.

  • EM accounts for 41% of global GDP and contributes 43% to each year’s global economic growth. Excluding China, these numbers are 23% and 38% respectively.
  • When controlled for liquidity, free-float, and issue size, EM equity accounts for 11% of global stock market capitalization and EM debt accounts for 12% of global bond market (8% for both if excluding China).

In the early 1990’s, four countries (Argentina, Brazil, Mexico and Russia) accounted for over 80% of the market. Today, Emerging Markets debt grew to cover more than 80 countries, offering diversification across geography, currency, industry, credit quality and maturity.

EM debt has seen significant improvement in credit quality over the years. In the mid-1990s, there were no investment-grade external sovereign issuers. Today, more than half of the emerging market opportunity set has investment-grade credit ratings.

EM debt diversifies a portfolio through higher yields, longer duration, and lower correlation. It provides exposure to emerging market economies, sectors, and credit cycles that are distinct from those domestically.

Increasing our Allocation to Alternative Investments

Earlier we detailed the diversification benefits of our two alternative asset classes, private credit and managed futures. Both categories have exhibited low correlation to traditional stock and bond investments and have helped improve the risk-adjusted returns of our models, especially in a world where bonds underperformed historical expectations. We believe these asset classes are well positioned to provide the same long-term benefits to our clients. 

Reducing our Exposure to International Developed Markets 

One consistent investment theme since the bottom of the Great Financial Crisis in 2008 has been the outperformance of the US equity market relative to the rest of the world. 

This is illustrated in the table below, which compares $100 million invested in various markets from March 2009 through the end of 2023.

The longer-term trend shows a back-and-forth dynamic between periods of US and international equity outperformance: 

 

You’ll notice several periods of time where one has outperformed the other for meaningful stretches. The cyclical nature of these changes has caught many investors off guard, especially in the past ten years as they’ve waited for what has historically been the case – for one (international equities) to finally take the lead over the other (US equities).  

We still strongly believe in the benefits of global diversification, and typically like to hold anywhere from 20-40% of overall equity exposure in international equities. Since the inception of our most recent models in 2017, we’ve maintained a 30% posture but have made the decision to reduce this down to roughly 20% for the following reasons:

  • The US continues to be the largest economy in the world, representing roughly 26% of global GDP. 
  • The US represents approximately 70% of global market capitalization – highlighting its position as the most robust and liquid financial market in the world.
  • The US has the highest labor productivity, supported by the largest technology sector that is currently leading in innovation and AI. 
  • Favorable demographics relative to most other developed countries. 

These key factors along with the general momentum of US equities has made our team comfortable adjusting our global equity allocation. We still believe in international diversification, but want to account for changing trends and their implications on asset allocation decision-making. 

Conclusion

After significant due diligence and discussion, our team is excited to move forward in implementing these macro changes for our clients. 

Reach out to our team for a complimentary analysis of your portfolio and to learn how we can help you be proactive in navigating complex asset allocation decisions in an evolving landscape in accordance with your personal risk tolerance, goals, and circumstances.