Summary
- AOK is iShares benchmark ETF to track a "Conservative" asset allocation.
- As a traditional stock/bond allocation, AOK satisfies the definition of conservative. But I argue that the definition needs to change.
- AOK is one of the clearest long-term Sell ratings I'll give out. AOK's style is no longer the way to be a "conservative" investor.
By Rob Isbitts
What does "conservative investing mean?" Let's start with what I do not think it means. I don't think a conservative investor wants this:
That's a drawdown (peak-to-trough decline) of nearly 19%, which occurred last year in AOK (AOK), an ETF that has the word "conservative" in its name. Now, this has never happened in the 12-year history of this ETF. But it has happened in past inflationary periods, like the 1970s, when stocks and bonds also fell together. And AOK also had a 15% drawdown during the sudden market shock in 2020, thanks to the start of the Covid-19 pandemic.
My point is that while history has shown that the majority of the time, a 70% bond/30% stock asset allocation has offered modest volatility, that history is very misleading. The markets enjoyed a super-cycle, in which bond prices generally rose for 40 years, and the stock market had more boom than bust. But today's market climate, its obsession with the Fed's every word, the surging participation of retail investors, and the dominance of "price-insensitive" trading (index funds and algorithms are rules-based buyers and sellers) all conspire to leave me highly skeptical about the future of "traditional" asset allocation coming close to what investors received in the past. The easy, lazy times are over. Thus, I see AOK as a dinosaur of a strategy and rate it a Sell for the long run.
Strategy
AOK allocates among 7 iShares ETFs, making this essentially an ETF of ETFs. This fund is designed to offer investors a 1-stop shop to allocate assets in an allegedly conservative manner, using stock and bond ETFs that stretch across multiple capitalization sizes and geographies, and with the dominant allocation to bonds.
ETF Grades
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Offense/Defense: Offense
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Segment: Multi-Asset
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Sub-Segment: Conservative
Technical Ratings
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Short-Term (next 3 months): D
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Long-Term (next 12 months): D
Rating scale: A = Excellent, B = Good, C = Fair, D = Weak, F = Poor
For a detailed description of MII's proprietary technical rating system, see the disclosures at bottom of this report.
Holding Analysis
AOK is really a 4-ETF investment, with very small pieces of additional ETFs added, even though they really are not big enough to add value. iShares Core Total USD Bond Market ETF ( IUSB ) is 58% of AOK, and nearly all of the remaining bond exposure is through an iShares international bond ETF (10%). The equity side of the portfolio is primarily divided between an iShares S&P 500 ETF and an international stock ETF, which make up 16% and 10% of AOK's assets, respectively. Those 4 ETFs account for about 94% of the total portfolio. Large-cap stocks and investment grade bonds dominate the allocation.
Strengths
AOK is a very straightforward, and for some investors, a convenient ETF to own. One ticker, traded on the stock exchange, with instant global diversification. AOK is a liquid vehicle, with over $700mm in assets and an average dollar trading volume of over $13mm a day. When taken together, those 2 figures show that only about 2% of AOK's assets are traded on an average day. That tells me what I'd hope and expect from a long-term allocation ETF like this one: that its investor base is a buy-and-hold crowd.
Weaknesses
The issues I see with AOK are not based on how it did until about a year ago. As you can see in the chart above, for most of this ETF's life, it was a dream scenario for conservative investors. The graph shows that in nearly every 3-year time frame (monthly moving windows), AOK's annualized total return was between 3% and 10%. What conservative investor wouldn't sign up for that?
But among the many aspects of investing today that have been invaded by investor complacency, and fed by Wall Street's buzz-word-filled marketing (asset allocation, buy-and-hold, long-term investing, etc.), the most dangerous could be the growing gap between conservative allocation approaches and the realities of modern markets. AOK is the poster child for this predicament.
Adding to my concerns about this ETF is the fact that iShares, which is getting paid its management fee on each of the component ETFs in AOK, tacks on a 15 basis point annual fee to own AOK. That has caused this ETF to underperform its own benchmark by 1% cumulatively over the past 5 years.
Opportunities
I could be completely wrong about this. And that would potentially crank up the good old days for AOK, rather than my dire forecast for a 70% bond/30% stock allocation ETF in a changed investment era. If interest rates drifted lower or stayed at current levels for years, and the stock market resumed its double-digit returns over long time periods (as we saw with only brief interruptions from 2009-2022), AOK could be a gem. And, while I'm the type of investor that never assigns a 100% probability to any investment scenario, I think the likelihood that stocks and bonds together return to the days of yore (pre-2022) is a long shot.
Threats
What we saw in 2022 and so far in 2023 was inevitable. I wrote more articles than I can remember over the past decade (in other publications, before joining the Seeking Alpha community) about the threat of relying on high-quality bonds as a stock portfolio partner in asset allocation strategies.
Bond rates were going to eventually lift off from zero, and there's a strong possibility that inflation will remain elevated for quite a while. Maybe it won't remain anywhere near the 9% peak we saw recently. But even 3-5% sustained inflation will change the way the bond market and stock market operate. And I don't see evidence that investors are prepared for how that can make bond prices and returns look too much like volatile stock prices. That changes the whole approach to "conservative" investing. At least, it should.
What's the alternative for conservative investors? It starts with looking for alternatives to simply accepting bonds as the offset to stocks in a so-called balanced portfolio. I am a big fan of long-short investing using ETFs, except that the shorting is not done by actually shorting ETFs. I have profiled several single-inverse ETFs that can be used in combination with equity ETFs, and in today's market conditions, short-term US Treasury exposure, to create a conservative allocation mix that does not cause investors to press their luck regarding the future direction of the stock and bond markets. Even when conditions "normalize" again (if they ever really do), an all-in-one allocation ETF of this nature will likely fall short. Sure, AOK has suffered from low-interest rates in a bond-dominated ETF. But my point is, the style itself did not allow AOK to do anything about that. Stock/bond allocation the traditional way is at best on an extended vacation, and at worst a relic of history.
Conclusions
ETF Quality Opinion
Conservative investors have better choices than to accept the potential for drawdowns the likes of which we've seen from AOK. And with increased pressure building in global credit and equity markets, there is a real possibility that AOK, could break its own drawdown record. That would be a horrific outcome for investors who thought they were getting something that wouldn't drop much, even in tough markets. Welcome to the modern investing era.
ETF Investment Opinion
If you have read this far, you know that I am rating AOK a Sell, on a long-term basis. Stocks and bonds will rally together at times in the future, maybe even for a year or two. But thinking like AOK investors likely do (long-term), I think conservative investing today is more about setting up a portfolio that is truly structured to avoid big losses, take less credit and duration risk when the times demand and evolve with changing markets.
Modern Income Investor's proprietary technical rating system was created by the firm's founder, Rob Isbitts, a chartist for more than 40 years. The ratings emphasize risk-management, and the belief that while any investment can appreciate in price at any time, each investment carries a different level of potential for major loss. The balance of reward and risk is calculated each night for thousands of securities, using a formula that analyzes price trend, strength of that trend and key price levels. It analyzes data over multiple time frames to produce a short-term rating (looking 3 months out) and a long-term rating (looking 12 months out).
For further details see:
AOK: There's Plenty That Is Not OK With This Allegedly Conservative ETF