Does an All-Equity Portfolio Make Sense for Retirement?

On this episode of The Long View, Ben Felix, chief investment officer for PWL Capital and co-host of the Rational Reminder podcast, discusses portfolio diversification, DFA, and what trends he sees in Canada and globally in the current volatile macroeconomic environment.

Here are a few excerpts from Felix’s conversation with Morningstar’s Christine Benz and Amy Arnott.

Does an All-Equity Portfolio Make Sense for Retirement?

Amy Arnott: I wanted to follow up on Scott Cederburg’s research, and I think he essentially concluded that if you’re saving for retirement, you want it to be exclusively in equities and a globally diversified equity portfolio. And I’m curious if you agree with that conclusion.

Ben Felix: Yeah. So his finding was not just if you’re saving for retirement. His finding, him and his co-authors finding, was that investors should be in 100% equity portfolios for their full lifecycle, saving for retirement right through to the end of retirement, right through until death, which is a big conclusion to draw. I think they did a good job with their analysis. And then of course, the international diversification piece. So they said 100% equities with a third domestic country and the remainder in international stocks, which is very different from the typical advice that you should start out in an equity-heavy portfolio and then transition toward a more bond-heavy portfolio over time. So that’s the headline result is that you should be 100% stocks all the time. But I think the real insight from their research, which I do agree with, is that nominal intermediate government bonds, which is what they’re looking at for bonds, are riskier for long-term investors than people generally think. And that stocks are maybe a little bit safer for long-term investors than people generally think. We do have some clients in 100% equity portfolios. I’m personally invested that way, not because of Scott’s paper; that’s how I was investing before his paper was even written. But I don’t think it makes sense for everyone. And I think Scott would agree.

Like their paper shows, within the specific data that they analyzed shows a certain result. But I don’t think Scott is going to go and tell everyone that they should be in 100% equity portfolios. People are constrained by their behavioral loss tolerance and their ability to take risk. So 100% stocks isn’t going to be right for everyone. And then the other big thing with Scott’s research is that they’re looking at a specific set of data. They’re looking at market-cap-weighted equities, intermediate-term government bonds for 39 countries for the period 1890 through 2023. Not all countries are there for the full sample. Some of them have shorter histories. And then they do this bootstrap simulation to create a million hypothetical scenarios. Anyway, that part doesn’t really matter too much. But the important thing is their conclusions hold within that specific dataset. But if we include things like factor tilts—like what Dimensional does—or corporate bonds, or maybe some other assets, and if we acknowledge the fact that future returns could be different from the past, I think we need to be careful taking Scott’s findings as precise advice, like literally taking it as everyone should be 100% equity with a third in their domestic country and so on and so forth. But I think the main insights from their paper that are useful are that international diversification is important, that home-country bias for countries like Canada is not a terrible idea. Countries like Canada being smaller market-cap countries. And then that stocks are a bit safer for long-term investors than people often think. And nominal bonds are maybe a bit riskier. Do I agree with the research? I wouldn’t use it as a prescription, but I think that it’s very insightful.

Why Nominal Bonds Have High Inflation Risk

Arnott: So the risk of nominal bonds is that mainly inflation risk? That’s the issue there?

Felix: Yeah. So that’s what they find in their research is that when inflation happens, nominal bonds get just absolutely smoked. And one of the problems is that stocks tend to have negative autocorrelation. So bad real returns for stocks tend to be followed by slightly better returns for stocks, which makes them a little bit less risky at long horizons. When you have bad real returns for nominal bonds, they tend to be followed by more bad returns, which makes them a little bit riskier for long-term investors.

Why Commodities May Not Be Worth the Trade-Offs

Arnott: I’m curious about commodities. Is that something that you use with your client portfolios?

Felix: No, that’s one of the things we’ve looked at as a possibility. We just didn’t love the trade-offs. Low expected returns most of the time, and they can pay off sometimes, but it just wasn’t a trade-off that we were interested in.

Why Crypto Is ‘More of an Ideological Innovation Than It Is a Technical Innovation’

Benz: We’re giving you kind of a lightning round on various assets, but we wanted to ask about crypto. What’s your opinion about the role it can play in a diversified portfolio, if any at all?

Felix: Yeah, so crypto is an interesting one. We did a whole podcast series on crypto because we really wanted to understand it. What had happened there actually is that we kind of ignored it, as I think a lot of people in TradFi, in the traditional finance did for a long time. Then we had Professor Cam Harvey on our podcast, who is a highly respected academic researcher—two-hour episodes, one of our longest episodes ever. We spent half that episode talking about traditional finance and his research in that area, and then we spent half of the episode talking about crypto. He was so passionate about it, and so excited about it that Cameron and I walked away from that interview and said, OK, we better take this more seriously and look into crypto. That was when bitcoin was at $60,000 for the first time, crashed soon after. Now, of course, it’s back up again. I would say that we don’t use crypto in portfolios.

After that whole podcast series, we came away from it thinking that it’s more of an ideological innovation than it is a technical innovation. You talk to people who know software and who understand that side of the technology. Satoshi did some interesting things to create bitcoin. I don’t want to minimize that too much, but it wasn’t a massive technical innovation. But I think ideologically, it represents something that’s very important to a lot of people. It caters to a certain worldview that some people find very attractive. To that extent, it’ll be valuable for people who hold those views. But I don’t think it’s an asset. Crypto in general is an asset class with positive expected returns. I think it will continue to be highly volatile. So, we don’t touch it in portfolios.

Are Investors Expecting Too Much From Gold as a Safe Asset?

Arnott: Another asset class that’s been attracting a huge amount of attention lately has been gold. As we’re taping this toward the end of April, I think it’s trading around $3,400 an ounce. Do you think that investors are expecting too much from gold as a safe haven asset? Is gold something that you use with your clients at all?

Felix: Gold is another one that we’ve looked at pretty closely and decided not to allocate to, which, as mentioned, has been a little bit painful recently, not having half of our portfolios in gold. That would have been great. But it’s not something that we do put in client portfolios. Its historical performance as a safe haven asset is mixed, which is one of the reasons that we didn’t use it. If it was a perfect hedge for market crashes or something, then maybe it’d be more interesting. But it has not been historically. My concern for investors right now, because as you guys know, as well as anybody, when an asset class performs well, all of a sudden investors get interested in it. But when the real price of gold is high, you can assume that gold maintains its real value at very long horizons, which it has done historically. If you believe that to be true, there’s this golden constant value for what gold should be worth. You can measure whether the actual price of gold is low or high relative to that gold constant value. Right now, the real price of gold is quite high. And historically, when the real price of gold is high, future real returns tend to be quite low. So hopefully, we don’t see the “Mind the Gap” report showing that investors underperformed in gold over the next few years.