Asset Allocation
Jhunjhunwala illustrated the importance of asset allocation with the example of an investor, who bought gold in 1970, bought Nikkei stock in1981, and then bought Nasdaq stock in 1991, raking in returns in excess of 25% per annum, compounded for three decades.
from an article by Puru Saxena
But first, I want to start with an underlying philosophy. As an avid student of economic history, I have realised that all assets go through multi-year economic cycles commonly known as bull-markets (boom) and bear-markets (busts). These cycles surely follow each other as night follows the day. During a bull-market, an asset goes from depths of undervaluation to overvaluation. A bull-market usually ends with intense public participation, optimism and euphoria. On the other hand, a bear-market takes an asset on its long journey from extreme overvaluation to acute undervaluation. A bear-market usually ends with "blood on the street" or deep, dark despair. As a money manager, it is my job to identify, which assets are in a bull-market and those that are in a bear phase.
Looking back at history, it is now easy to see that if the above investor had to buy one asset in 1970 for the next 10 years, he should have bought commodities. For those who are not familiar, commodities went through an enormous boom during this period. Supply conditions were extremely tight, demand was rising and we also had the "Oil Shocks", which led oil to its all time high in 1980. During that period, the US economy was in a recession, inflation fears were running high and interest-rates were rising fast. The whole world was convinced that inflation would continue to escalate and that savings would eventually become worthless. Thus, everyone turned to hard, tangible assets to protect their wealth. The boom, which started off as a gradual bull-market (as they all do) erupted into an enormous mania in the late 70's as investors kept piling their cash in commodities whilst completely ignoring the prices they were paying. During the 70's, several commodities went up through the roof. Sugar went from 1.4 cents/pound in 1966 to 66 cents/pound in 1974 - a staggering rise of 45 times! Oil went from $2/barrel in 1973 to over $30 in 1980 and gold went from $35/ounce in 1971 to over $850/ounce in January 1980! Looking at the statistics now, commodities were an obvious choice in the 1970's but hindsight is always 20/20.
If our investor friend was looking for one investment theme in 1980 for the next 10 years, he should have bought Japanese stocks and real-estate. During that period, Japanese assets soared exponentially as the world became amazed by the "Japanese miracle". Money kept pouring in from around the world and the Japanese stock-market index (NIKKEI) rose from 6,500 in 1980 to 38,915 in December 1989. The future looked obvious: Japan's hardworking and focused society seemed unstoppable. In the 1980's, the Japanese economy was a sensation - the most dynamic economy the world had ever seen. Meanwhile, Japanese real-estate also surged. At the peak of the bubble in 1990, Japanese real-estate was worth four times the value of all property in the US! The Imperial Palace in Tokyo and the nearby park were valued more than the whole of Canada! So, it is obvious now that the land of the rising sun would have been the best option for investment purposes in 1980.
Let us now turn to the next decade - the roaring 1990's. During that period, our investor should have put all his money in American assets. During that period, the world's super-power came alive as the world fell in love with the US. As many will remember, the last decade saw the exponential rise of the American stock-market led by the NASDAQ. Stocks, bonds and real-estate soared as inflation was low and interest-rates were falling. In the 90's, you just could not go wrong. All you had to do was to buy any American asset and the bull-market would have done the work for you. The technology-heavy NASDAQ rose from almost 500 in 1990 to over 5,000 at the turn of the millennium. Everyone was convinced that the "New Era" had arrived. Companies like Amazon, Cisco Systems and Yahoo became the technology darlings of the investment world. Locally, people standing in queues for Tom.com and Sunday IPO's come to mind. Looking back, it is obvious now that America would have been the best investment destination in the 1990's.
After having gone through the various asset-booms of the past three decades, I would like to point out that they all had one thing in common - the eventual bust. Commodities peaked in 1980 and declined for two decades; Japanese assets peaked around 1990 and are still deflating after fifteen years; NASDAQ collapsed in 2000 and despite record-low interest rates, American stocks have failed to better their all-time highs recorded five years ago. The brutal truth is that no asset-class goes up or stays depressed forever. This is one fact that every investor must keep in mind when speculating or buying for the long haul. Our history is dotted with several "New Eras" and "Economic Miracles", which were supposed to change our world forever - American canal systems and the railroad boom in the 19th century, the auto boom at the turn of the 20th century, the commodity boom in the 70's, the Japanese boom in the 80's and the technology boom of the 90's. Yet, none of these booms lasted forever. The current housing boom will be no exception.
