Portfolio Design: A Modern Approach to Asset Allocation

EXPANDING THE PORTFOLIO TO INCLUDE OTHER BONDS AND STOCKS

What if the portfolio choice is expanded to include other U.S. stocks and bonds? One simple way to diversify the portfolio is to replace the Treasury bond and the large-cap index with broader aggregates. In place of the Treasury bond, the Barclays Capital Aggregate Bond Index (formerly the Lehman Aggregate Index) will be used. The Barclays Aggregate has less than a 25 percent weight for Treasury bonds with the rest concentrated on U.S. agency debt (including issues by Fannie Mae and Freddie Mac) and investment-grade corporate debt. Because the average maturity of the Barclays index is less than six years, the Treasury bond used in the comparison will be the five-year Treasury rather than the 20-year long-term Treasury bond used in the previous analysis. In place of the S&P 500, the Russell 3000 all-cap U.S. stock index is used. As explained in Chapter 3, the Russell 3000 has an 8 percent weight on small caps and a 10 percent weight on mid caps.

Figure 8.3 displays the two sets of portfolios. Since the Russell indexes begin only in January 1979, the comparisons are done from 1979 through 2009. The first set of portfolios consists of stock and bond combinations, ranging from all bond to all stocks, using the medium-term Treasury and the S&P 500. The second set consists of a similar range of portfolio combinations using the Barclays Aggregate index and the Russell 3000 index. It’s not necessary to analyze these portfolios in ...