Here’s a classic problem for schoolteachers: What do you do with a problem student? Kick him out of your class or nurture him toward his full capacity? There is no simple answer, although patience is a good starting point.

The same is true when considering the “problem children” in an investment portfolio — that is, the asset classes that are underperforming. In recent years, three particular laggards have been cash, commodities and non-U.S. bonds.

The Pecking Order table below compares the dispersion of performance among the 12 asset classes that I use as components in a multi-asset portfolio. The range over the past three years, as of Sept. 30, has been quite large — with non-U.S. bonds, cash and commodities bringing up the rear.

Cash (as represented by Vanguard Prime Money Market) has produced an anemic three-year annualized return of 0.02%; non-U.S. bonds haven’t been much better, returning 0.7%. Commodities (as represented by PowerShares DB Commodity Tracking ETF and, prior to its inception, the Deutsche Bank Liquid Commodity Index) have fared even worse, with a three-year annualized return of -3.4%.

By way of comparison, the U.S. large-cap stock sector has produced a three-year annualized return of 22.84%; mid-cap U.S. stocks, 22.01%; U.S. small-cap value stocks, 24.25%; and real estate, 16.54%.
In fairness, other asset classes have also shown weaker performance, although not as egregiously. Emerging non-U.S. stock produced a three-year annualized return of only 8.67%, U.S. bonds were at 2.3%, and U.S. TIPS at 1.2%. All of these figures ignore inflation.


Should advisors be dumping the weakest three asset classes — non-U.S. bonds, cash and commodities — from the portfolio mix? To assess the question, let’s look at what happens to the performance of a multi-asset portfolio over the past three, five, 10 and 15 years when certain asset classes are omitted.

First, kick commodities out of the portfolio. Instead of a portfolio divided between 12 asset classes — each accounting for 8.33% of the overall mix — I examined an 11-ingredient portfolio without commodities, with each other asset class allocated 9.09%. I then created similar 11-asset modifications to omit either cash or non-U.S. bonds.

The Portfolio Comparison table below shows the results.

As expected, based on recent performance, the three-year annualized performance for the 11-asset model without commodities was better than the full 12-asset model (11.13% versus 9.88%). Likewise, the model without cash produced a three-year annualized return of 10.78%, vs. 9.88% for the full 12-asset model; without non-U.S. bonds, the performance was 10.73%.

The five-year performance numbers showed similar results, although the differences were smaller — only a 60 basis-point improvement by eliminating commodities, 69 bps better if cash was omitted, and 57 bps better without non-U.S. bonds.

Over the past 10 years, all three of the 11-asset models had slightly higher returns than the core 12-asset model. Omitting cash offered the greatest advantage (7.75% vs. 7.31%), but even that was still worth only 44 basis points.

But we also need to consider a nuance of that higher 10-year return — namely, what happened in 2008. That year, the 11-asset model without cash had a return of -27.1% while the 12-asset model did slightly better, at -24.6%. The inclusion of non-U.S. bonds also helped reduce the damage; without non-U.S. bonds in 2008 the return was -27.24%.


Cash provided liquidity during the storm of 2008. In fact, cash had a return of 2.77% in 2008 — a lofty number for a category intended primarily to provide liquidity and an emergency backstop, rather than returns.

It’s easy to see why investors may want to abandon cash, but having a portion of one’s portfolio in cash is all about safety and liquidity. There are plenty of other ingredients to generate performance in a broadly diversified portfolio. The return generated by cash is far less relevant than the protection it provides.

While it’s true that cash has produced an annualized return of 2.11% over the 15 years ended Sept. 30, it has performed admirably during the four market storms over the same time period (2000, 2001, 2002 and 2008).

In 2000, when the S&P 500 lost almost 10%, cash cranked out a return of 6.29%. In 2001, the S&P 500 lost almost 12%, but cash gained 4.16%. In 2002, the S&P 500 lost 21.6% while cash gained 1.65%. At the end of 2002, the S&P 500 had a three-year annualized loss of 14.52% and cash had a three-year annualized return of 4.02%.

In 2008, meanwhile, when the S&P 500 lost nearly 37%, cash pumped out a positive return of 2.77%.
We should not forget this comparison between stocks and cash as we will probably see it again at some point in the future — which is exactly why we keep our commitment to cash.

The argument “What have you done for me lately?” isn’t one that makes sense when applied to assets in a broadly diversified portfolio. Indeed, using a diversified portfolio is based on the assumption that some asset classes will lag others in any given year.

Cash is a bear market savant: It’s not good in all situations, but it tends to excel in some other situations, most notably equity downturns. The value of having a portion of one’s portfolio that has a positive return during equity market meltdowns cannot be overstated — particularly in terms of the emotional relief.


What then about commodities? Are they countercyclical to U.S. stocks in the same way cash is?

The complicated answer here is yes and no. In 2000, when U.S. large-cap stocks performed poorly, commodities had a stellar return of 24.43%. Yet in 2001, commodities lost 8.7% — ouch. In 2002, commodities were up 24.6% while U.S. large-cap stocks were hammered, losing 21.55% for the year.
In 2008, commodities had a positive year-to-date return as of Sept. 30, but then were crushed during the fourth quarter, ending the year with a loss of 31.7%.

So, during the past four bear equity markets, commodities had positive returns half of the time.

Where commodities typically shine is during periods of higher inflation. The highest inflation over the past 15 years took place in 2007, when the Consumer Price Index registered a one-year increase of 4.08%. That same year, commodities were up 31.5% while the S&P 500 was up 5.1%.

To really see the value of commodities, one has to go back to the 1970s and 1980s. During the 10-year period between 1973 and 1982, the CPI registered a crushing average annualized increase of 8.7%. Over the same 10-year period, cash had a 10-year annualized return of 8.8%, while the S&P 500 had a 10-year annualized return of 6.7%. Commodities had a 10-year annualized return of 12.7%.

Non-U.S. bonds, meanwhile, deserve full-time inclusion in a broadly diversified portfolio based on the category’s ability to be countercyclical with many of the other asset classes — particularly U.S. equities. In 2002, for example, when U.S. stocks got clobbered at all capitalization levels, non-U.S. bonds cranked out a 21.33% return. And in 2008, non-U.S. bonds had a positive return of 4.21%.

It has been said that “the child who needs our love the most often deserves it the least.” The same may be true with asset classes, all of which seem to take turns disappointing us before they then pull it together and become star performers. If we tossed the problem asset class out during its period of misbehavior, we would miss a winner later.

And so it goes. We patiently evaluate the ingredients of our portfolio — through good times and not so good times.

Craig L. Israelsen, a Financial Planning contributing writer in Springville, Utah, is an executive in residence in the personal financial planning program in the Woodbury School of Business at Utah Valley University. He is also the developer of the 7Twelve portfolio.

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