Arnott is opposed to indexing of all asset classes on a capital weighting basis because of the fact that when bubbles occur the biggest of the bubble assets within an index take over the index. For just one well-known example, the "internut" bubble stocks in 1999-2000 became a huge part of the NASDAQ. People holding the indexes got creamed. This can also happen in bond or commodity indexes. But this is just a minor part of Arnott's work. He has also done major work on stock and bond long term returns....I mean REALLY long term as in since 1801 in the US!
As readers know I switched from equity to fixed income and alternative assets from 2006 to present, and I am still there. Partly my thinking was to reduce actual and potential volatility as a retired investor. Partly also it was to increase actual income payouts from my assets, since payouts are more assured than possible capital gains on stocks. I did this in the somewhat generic sense of switching from stocks to bonds and commodity exposure as a inflation hedge. Largely I owe my outlook to years as a commodity futures speculator. In futures you learn to respect the price history of every asset and know what each can do. Equity-centric people are normally deficient in this regard. They may think of bonds or commodities as ways of reducing correlation or volatility but have no idea what their real characteristics and sector varieties are. An example is Marc Faber, whom I admire, but who is almost totally equity-centric except for a gold bias no doubt acquired at his mother's breast in Switzerland. Faber has recently announced the beginning of a 25 year bond bear market. And this is very probably true for intermediate to long term US nominal Treasurys. But there almost as many bond and bond-lke sectors as there are stars in the galaxy, so being anti-bond is not really helpful in the big picture.
Rob Arnott shows that over very long periods of US history, including current times, bonds have outperformed stocks. And even on their own, based on price alone, stocks can go for many decades without making a gain in real inflation-adjusted terms.
Seriously read Arnott's five part essay on these issues first and then his slideshow, both available here at this excellent site http://tinyurl.com/pknt69 . My personal view is that various bond and bond-like investments plus inflation hedges are the way to go in these perilous times.
http://screencast.com/t/Tg4uwGizyXd PAUIX is Arnott's vehicle at PIMCO for putting some of these ideas into practice. It has a rather high overhead as a fund of funds, and I think I can do as well or better on my own, but PAUIX, which can be long or short stocks and in a number of bond and inflation investments, is a long term package for some investors looking for simplicity amidst complexity.
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