Rob Arnott Portfolio: Allocations, Performance, and Returns Overview
Rob Arnott is the founder and chairman of the board of Research Affiliates — a giant in wealth management with $193 billion in assets under management. Research Affiliates is famous for publishing seminal research and investing based on that research. It created the Rob Arnott Portfolio. Let’s see what the portfolio strategy is about.
The Rob Arnott Portfolio is a medium-risk investment strategy with a 30% allocation to stocks, 60% to bonds, and 10% to commodities. It aims to balance returns and risks by diversifying globally with international stocks and bonds, including emerging market bonds. It was referenced by Rob Arnott in an article in 2008 as an example of a simple portfolio that performs comparably with expensive hedge funds.
In this post, we take a look at the Rob Arnott Portfolio. At the end of the article, we have provided a backtest.
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Rob Arnott’s Investment Strategies
Rob Arnott is the founder and chairman of Research Affiliates, a wealth management company known for its innovative investment strategies. He is widely recognized as a pioneer in the field of smart beta investing, which seeks to enhance traditional index investing by incorporating various risk and return factors. He has published over 130 papers in financial journals, discussing different investment methods.
One of Rob Arnott’s key strategies is the Fundamental Indexation approach, which seeks to address the flaws in traditional market capitalization-weighted indexing. This approach weights securities based on their economic importance, such as sales, dividends, and earnings, rather than their market value. This results in a more diversified and less overvalued portfolio, leading to potentially higher returns and lower risks.
Another strategy developed by Arnott is the RAFI (Research Affiliates Fundamental Index) methodology, which uses a multi-factor approach to construct indices. The RAFI methodology seeks to improve upon traditional market capitalization weighting by considering factors such as earnings, sales, dividends, and book value in its index construction.
In addition to the RAFI methodology, Arnott also developed the Smart Beta ETFs, which use the principles of smart beta investing to offer low-cost, passive investment options to investors. These ETFs provide access to portfolios constructed based on the RAFI methodology, offering an alternative to traditional index-tracking ETFs.
However, the popular Rob Arnott Portfolio flying around the internet is a simple, diversified portfolio used as an example in Rob Arnott’s article in 2008 to show the arguable suboptimality and expensiveness of hedge funds as a vehicle for most investors. The strategy is based on a 30% allocation to stocks (US stocks, international stocks, and REITs); 60% to bonds (including investment-grade corporate bonds, international bonds, emerging-market bonds, and various Treasury bonds); and 10% to commodities.
Rob Arnott’s Performance Metrics
Rob Arnott and Research Affiliates are known for their innovative approach to performance metrics and evaluating investment strategies. Some of the key performance metrics used by Rob Arnott include:
- Total return: Total return measures the combined effects of price changes and income generated by an investment, including capital gain, dividends, and interest. The total return is an important metric for evaluating the performance of a portfolio, as it considers both capital appreciation and income generated.
- Risk-adjusted return: Risk-adjusted return measures the return of an investment relative to the risk taken to generate that return. Rob Arnott uses a number of risk-adjustment metrics, including the Sharpe and Sortino ratios, to evaluate the performance of portfolios and make investment decisions.
- Value: Rob Arnott is a proponent of value investing, which seeks to identify undervalued securities with the potential for future growth. He uses ‘value’ as a key performance metric, as value stocks tend to outperform growth stocks over the long term.
- Momentum: This refers to the tendency of securities to continue moving in the same direction they have been moving in the past. Rob Arnott uses momentum as a performance metric, as securities with strong momentum tend to perform better than those with weak momentum. Momentum strategies have proven to work.
- Diversification: This refers to spreading investments across different asset classes, industries, and geographic regions to reduce a portfolio’s overall risk. Rob Arnott uses diversification as a key performance metric, as a well-diversified portfolio can lead to more stable returns over time.
Relevant links:
His Risk Management Techniques
Rob Arnott and Research Affiliates are known for their innovative approach to risk management in investing. Some of the key risk management techniques used by Rob Arnott include:
- Maximum diversification: Diversification is a cornerstone of Rob Arnott’s risk management approach, as it helps to spread risk across multiple asset classes and industries. Arnott advocates for diversifying across multiple asset classes and countries to minimize the impact of any one region’s financial crisis. This can lead to a more stable portfolio, as losses in one sector can be offset by gains in another.
- Fundamental Indexation: The Fundamental Indexation approach seeks to address the flaws in traditional market capitalization-weighted indexing. This approach weights securities based on their economic importance, such as sales, dividends, and earnings, rather than their market value. This results in a more diversified and less overvalued portfolio, leading to potentially lower risks.
- RAFI (Research Affiliates Fundamental Index) Methodology: The RAFI methodology uses a multi-factor approach to construct indices. The RAFI methodology seeks to improve upon traditional market capitalization weighting by considering factors such as earnings, sales, dividends, and book value in its index construction. This results in a more diversified and less overvalued portfolio, leading to potentially lower risks.
- Smart Beta ETFs: Rob Arnott also developed the Smart Beta ETFs, which use the principles of smart beta investing to offer low-cost, passive investment options to investors. These ETFs provide access to portfolios constructed based on the RAFI methodology, offering an alternative to traditional index-tracking ETFs and potentially reducing risk through diversification.
- Tilting towards value and size: Arnott believes that value and small-cap stocks offer higher expected returns and that investors can increase their returns and reduce risk by tilting their portfolios towards these two factors.
- Dynamic asset allocation: Arnott suggests regularly reviewing and adjusting the asset allocation to adapt to changing market conditions, instead of sticking to a static allocation.
Rob Arnott’s Asset Allocation Methodology
Rob Arnott’s asset allocation methodology is centered around a value-oriented approach to investing, with a focus on risk management. Some of the key elements of Rob Arnott’s asset allocation methodology include:
- Factor investing: Rob Arnott uses factor investing as the foundation of his asset allocation methodology, which seeks to allocate investments based on their exposure to different risk factors such as value, size, momentum, and low volatility.
- Multi-dimensional diversification: Rob Arnott places a strong emphasis on diversification in his asset allocation methodology, seeking to allocate investments across multiple asset classes, geographic regions, and industries to reduce overall portfolio risk.
- Dynamic asset allocation: Rob Arnott uses a dynamic asset allocation approach, which allows him to adjust the weightings of different investments in response to changing market conditions. This helps to improve returns and mitigate risk over the long term.
- Evidence-based investing: Rob Arnott’s asset allocation methodology is grounded in evidence-based investing, which seeks to use data and research to make investment decisions. Rob Arnott uses a rigorous research process to identify the best investment opportunities and allocate investments accordingly.
These elements of Rob Arnott’s asset allocation methodology are used in conjunction with each other to provide a comprehensive approach to investing. For the popular Rob Arnott’s Portfolio flying around on the internet, the asset allocation uses an equal weighting for all the assets in the portfolio. Here’s how it looks:
- 10% Commodities
- 10% REITs
- 10% TIPS
- 10% High-Yield Bonds
- 10% Long-Term US Treasury Bonds
- 10% Emerging Markets Bonds
- 10% Unhedged Foreign Bonds
- 10% International Stocks
- 10% U.S. Stocks
- 10% U.S. Investment-Grade Bonds
Rob Arnott’s Impact on the Investment Industry
Rob Arnott has had a significant impact on the investment industry, particularly in the field of factor investing and asset allocation. Some of the key ways in which Rob Arnott has influenced the investment industry include:
- Shaping the investment landscape: Rob Arnott’s work has helped to shape the investment landscape, and his impact on the investment industry has been significant. He has been a leading voice in the industry for many years, and his work has helped to raise awareness of important investment concepts and to drive innovation in the field.
- Driving Innovation in asset allocation: Rob Arnott has been a driving force in innovation in asset allocation, and his work has helped shape how many investors approach asset allocation. He has been a strong advocate for using a value-oriented approach to investing and has been at the forefront of developing new and innovative approaches to asset allocation.
- Pioneering factor investing: Rob Arnott is credited with being one of the pioneers of factor investing, which has become a popular investment strategy in recent years. He was one of the first to propose that investments could be allocated based on their exposure to different risk factors, and his research in this area has helped to popularize the concept.
- Advocating for evidence-based investing: Rob Arnott has been a vocal advocate for evidence-based investing, which seeks to use data and research to make investment decisions. He has published numerous research papers on the subject and has strongly supported using rigorous analysis and research to inform investment decisions.
- Emphasizing Risk Management: Rob Arnott has strongly emphasized risk management in his investment approach, which has helped raise awareness of the importance of managing risk in the investment industry. He has been a vocal advocate for using diversification, factor investing, and dynamic asset allocation to manage risk and improve returns over the long term.
Backtesting Results
Backtesting results can provide valuable insights into the potential performance of an investment strategy, including the Rob Arnott portfolio. The results of backtesting the Rob Arnott portfolio have been generally positive. The portfolio has been found to have delivered strong returns over the long term, with relatively low levels of volatility compared to the broader stock market.
The portfolio’s performance has been driven by its exposure to different risk factors, including value, size, and quality, which have been shown to have delivered higher returns over time. Also, the Rob Arnott portfolio has been found to have delivered strong returns across a range of market environments, including both up and down markets. This has helped to demonstrate the resilience of the portfolio and its ability to perform well in a variety of market conditions.
Overall, the results of backtesting the Rob Arnott portfolio have been encouraging, and the portfolio has been shown to have delivered strong returns over the long term with relatively low levels of volatility. However, it is important to note that the backtesting results should be taken with a grain of caution, as past performance does not guarantee future results.
Relevant article about backtesting:
Rob Arnott’s Portfolio Optimization Process
Rob Arnott’s portfolio optimization process involves the following steps:
- Defining investment objectives: The first step in the portfolio optimization process is to clearly define the investment objectives, such as risk tolerance, investment horizon, and expected returns.
- Conducting market research: The next step is to conduct market research and identify trends, market conditions, and potential risks and opportunities.
- Selecting assets: Based on the investment objectives and market research, the next step is to select a mix of assets that are aligned with the investment objectives and diversified to reduce risk.
- Determining the asset allocation: The portfolio allocation is determined by allocating the portfolio assets to the different asset classes, such as stocks, bonds, commodities, and real estate.
- Managing risks: Rob Arnott’s portfolio optimization process also includes a robust risk management strategy to mitigate the impact of market fluctuations and ensure the long-term success of the portfolio.
- Monitoring and rebalancing: Regular monitoring of the portfolio and rebalancing is necessary to ensure that the portfolio remains aligned with the investment objectives and to take advantage of market opportunities and reduce risk.
- Evaluating performance: Regular evaluation of the portfolio’s performance helps to determine whether the portfolio is meeting the investment objectives and to make any necessary adjustments.
Arnott’s Contrarian Approach to Investing
Rob Arnott is known for his contrarian approach to investing, which involves taking a contrarian view of market trends and investing in assets that are out of favor or undervalued.
This approach is based on the idea that markets are often inefficient and that investors can generate superior returns by investing in overlooked or undervalued assets. This approach is effective over the long term and has helped to establish Arnott as one of the leading investment managers in the industry.
Arnott’s contrarian approach involves the following:
- Looking beyond traditional metrics: Arnott looks beyond traditional metrics, such as earnings or price-to-earnings ratio, to identify potential investment opportunities.
- Identifying market inefficiencies in undervalued assets: Arnott looks for market inefficiencies and opportunities to invest in assets that are undervalued or overlooked by the market.
- Investing in value stocks: Arnott focuses on investing in value stocks, which are stocks that are trading at a lower price relative to their fundamentals, such as earnings or book value.
- Diversifying the portfolio: Arnott emphasizes the importance of diversifying the portfolio to reduce risk and maximize returns.
- Being patient: Arnott’s contrarian approach requires patience as it can take time for undervalued assets to reach their full potential.
His Approach to Factor Investing
Rob Arnott is known for his innovative approach to factor investing, which involves investing in factors that have been shown to have a persistent impact on returns. Factor investing is a type of investment strategy that seeks to capture the returns associated with certain characteristics or traits of securities, such as size, value, quality, momentum, and volatility.
Arnott’s approach to factor investing would involve:
- Identifying relevant factors: Arnott identifies factors that persistently impact returns and are relevant to the investment universe.
- Building his portfolio around those factors: Arnott incorporates these factors into the portfolio by constructing portfolios that systematically expose the desired factors. He often combines different factors to maximize the impact of the factor exposure on returns.
- Rebalancing the portfolio: He regularly rebalances the portfolio to maintain the desired factor exposure over time.
Arnott’s approach to factor investing emphasizes the importance of combining different factors to maximize returns and reduce risk. This approach has been shown to be effective over the long term and has helped to establish Arnott as a leader in the field of factor investing.
Rob Arnott’s Use of Backtesting to Analyze Risk
Rob Arnott is known for his use of backtesting to analyze risk in his investment strategies. Backtesting is a technique used to evaluate the performance of investment strategies by simulating the application of a strategy using historical data.
Arnott uses backtesting to analyze the risk of his investment strategies by:
- Simulating the application of the strategy over historical data helps him determine how the strategy would have performed in different market conditions.
- Evaluating risk-return trade-offs: This helps him determine the level of risk appropriate for each strategy.
- Assessing the robustness of the strategy: This helps him determine whether the strategies are effective in various market conditions.
- Identifying potential weaknesses: With this knowledge, he can modify their performance.
Rob Arnott Portfolio Backtest – Does It Work?
To backtest the strategy we need to find the appropriate ETFs and its ticker code. We chose the following:
- 10% Commodities (DBC)
- 10% REITs (VNQ)
- 10% TIPS (TIP)
- 10% High-Yield Bonds (HYG)
- 10% Long-Term US Treasury Bonds (TLT)
- 10% Emerging Markets Bonds (EMB)
- 10% Unhedged Foreign Bonds (BWX)
- 10% International Stocks (VEA)
- 10% U.S. Stocks (VTI)
- 10% U.S. Investment-Grade Bonds (BND)
When we put the tickers and weightings/allocations into our backtester program, we get the following performance and returns:
The annual return over the period is a low 4.4% including dividends reinvested. On the positive side, the max drawdown is 30%, significantly lower than for the stock market (55%).
We backtested by using daily rebalancing, but our simulations revealed that weekly, monthly, quartlerly, and even annual rebalancing returned the same.
To better understand the underperformance compared to S&P 500 we plot the difference:
Why has the Rob Arnott Portfolio underperformed?
Its’s threfold: low equity exposure, catastrophic performance of commodities, and internationl bonds and stocks have been weak. Even when we risk-adsjust the returns it’s lower than for stocks!
However, the portfolio might be suitable for very risk-averse investors who are happy with the huge allocations to bonds.
FAQ:
How does the RAFI Methodology work?
The Research Affiliates Fundamental Index (RAFI) methodology constructs indices using a multi-factor approach, improving upon traditional market capitalization weighting. Fundamental Indexation is one of Arnott’s key strategies, weighting securities based on economic factors like sales, dividends, and earnings rather than market value.
What are Smart Beta ETFs?
Smart Beta ETFs, developed by Arnott, offer low-cost, passive investment options based on the RAFI methodology as an alternative to traditional index-tracking ETFs. The portfolio comprises 30% stocks, 60% bonds, and 10% commodities, offering a diversified example highlighted in Arnott’s 2008 article.
How has Rob Arnott influenced the investment industry?
Arnott has shaped the investment landscape, driven innovation in asset allocation, pioneered factor investing, advocated for evidence-based investing, and emphasized risk management. Arnott’s asset allocation involves factor investing, multi-dimensional diversification, dynamic asset allocation, and evidence-based investing for a comprehensive approach.