Global Allocation Funds Underperform Benchmarks

Actively managed global allocation funds are designed to add value by shifting between asset classes and geographical regions based on the fund manager’s outlook for market conditions – they tactically allocate. Their marketing pitch is that skilled investment managers can produce a superior rate of return compared to traditional index funds. But the reality does not match the hype.

Srinidhi Kanuri and Davinder Malhotra, authors of the study “Evaluating the Performance of World Allocation Funds,” published in the Spring 2022 issue of The Journal of Wealth Management, analyzed the risk-adjusted performance of world allocation mutual funds over the period January 1994-March 2021 (including dead funds to avoid survivorship bias). They compared the performance of world allocation funds to the U.S. stock market (Russell 3000 Index), the U.S. bond market (Barclays Aggregate Bond Index) and the foreign stock market (FTSE All World Ex US Index). In addition, to check the robustness of their results, they formed three different portfolios to control for differences in the risk profile of world allocation fund investors:

  • Portfolio I: 50% Russell 3000/50% Barclays US Aggregate Bond Index
  • Portfolio II: 65% Russell 3000/35% Barclays US Aggregate Bond Index
  • Portfolio III: 40% Russell 3000/10% FTSE All World Ex US Index/50% Barclays

Aggregate Bond Index

They also compared performance to a six-factor model – Carhart’s four factors (market beta, size, value and momentum) plus the excess returns of the FTSE Total World Ex US Index and Barclays Aggregate Bond Index. Following is a summary of their findings:

  • The average allocation was 50% equities, 33.8% bonds, 9.9% cash (which creates a drag on returns) and 6.4% other assets. Of the equities, 26.4% were non-U.S. and, of the bonds, 15.5% were non-U.S.
  • World allocation mutual funds were highly correlated with benchmark indices.
  • World allocation funds had lower absolute- and risk-adjusted performance (Sharpe, Sortino and Omega ratios) compared to benchmark indices.
  • World allocation funds had a significantly (at the 1% confidence level) negative monthly alpha of 0.1 relative to the six-factor model.

Their findings led Kanuri and Malhotra to conclude that investors in world allocation funds would have been better off with passively managed index funds.