What You Might Not Know About Asset Class Returns

If you were to choose a word to describe short-term returns among components of international markets, “noisy” might fit the bill. This is exactly what we see in Figure 1. There’s considerable variability year to year between global stock and bond asset class returns.

While we often hear claims of which asset classes should be “in favor” or which may soon meet their demise, the data highlights both the difficulty in predicting short-term winners and how quickly the picture can change.

Take 2022 as an example. Cash —the lowest returning asset class over the last 15 years —was the top-performing asset class over the year, besting U.S. large-cap growth stocks by more than 30%. U.S. large growth stocks were the worst-performing asset class over the year after topping the charts in two of the prior three years.

With the benefit of hindsight, it’s easy to say that cash did well relative to stocks and bonds over a period of rising interest rates and heightened uncertainty. But on the first day of 2022, did you think this would be the result? Even if this had been your view, to achieve returns like those in Figure 1 would have required the conviction to buy and hold this investment throughout the entire year —no easy task.

The upside for those who invest over the long term in broadly diversified portfolios that spread investments among global asset classes is that total portfolio returns become less reliant on any single component, thereby reducing “idiosyncratic” (i.e., diversifiable) risk.

By holding a classic mix of 60% global equities and real estate and 40% global bonds, for example, you can have confidence that your portfolio will neither have the highest nor the lowest return compared to the market’s components. That’s the beauty of diversification, which we believe should be a foundational principle of building sound asset allocations.

To peel back the onion a bit further on asset class returns, a perhaps lesser-known fact is that there’s no single, absolute definition of each asset class. As Figure 2 shows, while high variability exists across asset classes over time, there’s also high variability within asset classes when we examine different indexes designed to represent each one.

In panels A through E of Figure 2, we show calendar year returns for each of the last 15 years and annualized returns over the full period for indexes from well-known providers representing various U.S. equity market segments. The results highlight that these different measures of an asset class can yield meaningfully different returns despite labels that might suggest little difference between them.

To demonstrate the variability of returns among indexes within each asset class, we show the difference between the highest and lowest return index in each year and the full period. The largest single-year difference in each asset class ranges from about 9% to nearly 24% (highlighted in black at the bottom of each asset class panel). If you look at the maximum differences over the full 15-year period, the range narrows but is still sizable at about 1.75% to 2.50%

Why are Index Returns within an Asset Class So Variable?

The reality is that splitting the market into pieces requires making decisions about how each component will be defined. These decisions can be subjective and vary from one instance to the next.

For example, how does one define a small-cap company? A “value” company? A “growth” company? Different definitions lead to differences in the securities selected, differences in characteristics, and, as shown, differences in returns.

Index holdings are also typically rebalanced (or updated) periodically. In between rebalance dates, company prices and fundamentals are disregarded. Decisions about how often to rebalance an index, such as once a year or quarterly, and on what dates can be arbitrary. Different decisions between index providers can lead to further differences in outcomes.

We believe this highlights the importance of looking beyond a name and understanding whatyou own —another sound principle for designing asset allocations. Building broadly diversified portfolios that harness the potential of global markets is a solid starting point. Still, when it comes to your choices within an allocation, it would be helpful to remember that a name can only tell you so much.

It may let you know you’re in the right vicinity but focusing on a more precise location may benefit overall portfolio returns. Taking a closer look before making an allocation can help avoid unexpected results. When investing, we know we will sometimes be disappointed, but we should try to avoid surprises wherever possible.