How Asset Allocation Can Have a Huge Impact on Returns

I recently posted a chart detailing the investment performance at NYCERS over the last 14 years. I contrasted NYCER's actual returns with the market returns for a simple index(stocks)/core(bonds) portfolio. In both cases the asset allocation was an "aggressive" 70% for stocks and a 30% for bonds.

The comparision showed a large shortfall between actual and market strategies. NYCERS actual asset value as of 6/30/2013 was $47.2B. The market value was $58.2B.

Since then I have done some further analysis using different asset allocations. The results were truly startling. Higher stock allocations are assumed to be riskier but offer higher potential returns. Stated another way an 50%(stock)/50%(bond) allocation should have produced lower returns but less volatility. The numbers tell another story all together.

In a snap shot, the list below shows the 6/30/2013 closing balances for the market index/core strategy over the last 14 years using different asset allocations:

• 80%/20% : $53.2B
• 70%/30% : $58.2B
• 60%/40% : $62.9B
• 50%/50% : $67.6B
• 40%/60% : $72.3B
• 30%/70% : $76.9B
• 20%/80% : $81.5B

This experience is definitely tied into the last 14 years. Experts might question whether my simulations are refined enough. It is, however, clear to me that traditional thinking about calculating the efficient frontier curve is seriously flawed.

Over time NYCERS has scaled up its stock allocation. In 1985 it was at 30%. By 1990 it was at 50%. By 1995, NYCERS had shifted up to a 70%/30% position trying to catch the updraft of 1990's stock market. Since then NYCERS has never changed from this general allocation.

Not only have the trustees made very bad specific investment decisions over the last 14 years, they seriously misjudged the overall market.

No trustee could have been expected to push for 30%/70% asset allocation in 2002 but a 50%/50% position was well within the accepted range of prudent behavior. It would also have been much more successful. I light of the national pension crisis, we need to be more focused on the part that pension trustees have directly played in that crisis.

Blaming the benefit structure alone will miss the full extent of the disease. There are some who want the patient to die but we, as a society and a successful economy, will be far worse off without a healthy pension system in the United States.

This is a more detailed chart of NYCERS's actual June 30 closing balances and the simulated closing balances for the 70%/30% vs 50%/50% allocations over the last 14 years.

NYCERS - Actual Returns and Index/Core Returns (70%/30% vs. 50%/50%) from 2000 to 2013

Fiscal Year	Actual Close Balance	Actual Rate of Return	Index/Core Return (70%/30%)	Index/Core Return (50%/50%)	Index/Core Close Balance (70%/30%)	Index/Core Close Balance (50%/50%)
1999	$41.9B	%	%	%	$	$
2000	$42.8B	3.14%	5.52%	5.22%	$43.8B	$43.7B
2001	$38.1B	-11.86%	-7.58%	-2.09%	$40.0B	$42.2B
2002	$32.8B	-11.44%	-10.82%	-5.25%	$34.8B	$39.1B
2003	$31.5B	0.62%	2.36%	4.96%	$34.0B	$39.4B
2004	$34.2B	12.71%	12.08%	8.75%	$36.8B	$41.6B
2005	$35.5B	6.30%	5.56%	6.31%	$38.1B	$43.4B
2006	$37.3B	7.10%	4.23%	2.63%	$39.0B	$43.8B
2007	$42.5B	13.03%	14.75%	12.34%	$45.2B	$49.7B
2008	$39.7B	-7.32%	-8.10%	-3.59%	$41.9B	$48.3B
2009	$31.9B	-20.46%	-17.50%	-10.39%	$35.0B	$43.7B
2010	$35.4B	10.68%	11.63%	11.30%	$39.3B	$48.9B
2011	$42,4B	19.39%	20.94%	16.14%	$47.8B	$57.0B
2012	$42.7B	-1.14%	5.01%	6.25%	$51.0B	$61.4B
2013	$47.2B	8.81%	12.26%	8.49%	$58.2B	$67.6B