Thinking About Asset Allocation in 2013

Resource Description

The global financial crisis has led to unprecedented valuation displacements across asset classes, particularly in regard to stocks versus bonds, as well as across markets, especially within equities. Current allocations suggest that investors are investing for a tail event with a low probability, one that assumes a very disorderly world unfolding.

We present analyses based on historical data that suggest investors would do well to reconfi gure their asset allocation to shift assets from fi xed income into equities and, within equities, to increase allocations to non-US developed and emerging market equities. The large valuation discrepancies we currently observe point to numerous highly attractive investment opportunities.

Although we do not see infl ation on the horizon at present, it is a risk down the road. Given this, we suggest investors adopt a truly balanced portfolio approach that includes real assets, particularly commodities that act as an infl ation hedge and capitalize on stable and rising long-term demand. We demonstrate the performance benefi ts of this approach using a model portfolio.

It is unfortunate but true that crises of all kinds — fi nancial, economic, political — are the jarring events that create the conditions for investment opportunities. It is no less true today than it was in John D. Rockefeller’s day, when he said, “The way to make money is to buy when blood is running in the streets.” Crises create large valuation distortions across asset classes, which in turn lead to investment opportunities. In times like these, investors typically abandon risky asset classes, driving down prices, and pursue perceived safe-haven asset classes, driving up these prices. The global fi nancial crisis is no exception. We currently see enormous valuation displacement between major asset classes, stocks and bonds in particular, and we also see these valuation discrepancies across markets within each asset class, especially equities.

This investment commentary will focus on some of the asset allocation opportunities we currently see, including a view on how one can build a truly balanced portfolio, one that includes real assets such as commodities, in the face of current market uncertainties.