Ibbotson Associates provides asset allocation guidelines that span the risk spectrum from conservative to aggressive. The moderate portfolio consists of roughly 42% in U.S. Stock, 18% in Non-U.S. Stock, 35% Fixed Income and 5% in Cash.
It follows that the static Ibbotson model might employ the following ETFs to achieve its moderate growth and income aim:
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With flat to slightly negative returns, one could make the case that diversification is working just fine. On the other hand, the more that one has minimized the downside risk of investment canaries in the financial mines – high yield credit, emerging markets and smaller corporations – the more one has been able to relax. An allocation of 60% in large-cap U.S. stocks (SPY) and 40% investment grade U.S. bonds (BND) improved performance to 1.6% – a swing of 240 basis points.
An argument in favor of diversification across asset class segments is that, if one holds recommended percentages for the next 20 years, recent underperformers will provide value down the road. Moreover, the combination of  the above-mentioned asset types performed better than an ethnocentric large-cap-only allocation (60% S&P 500, 40% Barclays Aggregate Bond Index) over the previous 20 years.
Here’s the problem: There are times when the breakdown in an asset grouping and/or an influential sector(s) of an economy is symptomatic of larger issues for market-based securities.
For instance, the collapse of the banking system in 2008 had been telegraphed by financial stock woes nearly a year beforehand. The SDPR Select Sector Financials ETF (XLF):S&P 500 SPDR Trust (SPY) price ratio had been highlighting the rapid-fire demise of financial stocks relative to the broader benchmark. (Note: Back in 2007, “ex Financials†was the popular excuse offered to dismiss S&P 500 overvaluation; in 2015, many are using “ex Energy†to justify S&P 500 overvaluation.)
