More on the Global Asset Portfolio

Last Friday I linked to an article from Cullen Roche arguing that investors shouldn’t be focused on the S&P 500 as a benchmark. Instead, they should focus on the global financial portfolio of assets. Now here’s someone else arguing much in the same vein. The Philosophical Economics blog takes a look at all the media headlines asserting that all types of investors underperform. He says that it isn’t possible for everyone to underperform, yet we can’t identify people who are beating the benchmark. He also argues that investor should be focused on the global portfolio, not the S&P 500, as the standard allocation and their benchmark.

Part of the problem here is that we arbitrarily treat the S&P 500 as “the market”, the benchmark for evaluating performance.  But the S&P 500 is not a reasonable benchmark to use, since investors in aggregate do not allocate the entirety of their portfolios to U.S. equities.  Indeed, investors in aggregate cannot allocate the entirety of their portfolios to U.S. equities–if they tried, prices would go to infinity.  The strategy of devoting an entire portfolio to U.S. equities, which may look brilliant right now given the recent performance, would necessarily become a bad idea (if it isn’t already a bad idea).

The appropriate benchmark for performance evaluation is the global asset market, which includes all global assets: stocks from all countries, bonds from all countries, real estate in all countries, and, importantly, cash from all countries (commercial paper, government bills, bank deposits, and so on).  Over the long-term, some groups will surely outperform this market.  If the efficient market hypothesis is true, we should expect it to be those groups that choose to accept the most risk in the choice of what they own.  If the efficient market hypothesis is not true, then we should expect it to also include those groups that possess skill, that manage to own the right assets at the right prices at the right times.