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Asset Allocation Recommendations* Individual InvestorEndowment/Foundation February 2013 * The ability to implement this recommendation depends upon investable assets. The appropriateness of this recommendation to any one portfolio depends upon tax and liquidity objectives as well as other considerations. This is for general educational purposes only
Citation preview
Challenges and Opportunities Facing Endowments and Foundations
The Pardoning of Sisyphus
Gordon B. Fowler, Jr.Chief Investment Officer
Economic and Market Outlook represents a review of issues or topics of possible interest to Glenmede’s clients and friends, and not as personalized investment advice. It contains Glenmede’s opinions, which may change after the date of publication. Information gathered from third-party sources is assumed reliable but is not guaranteed. No outcome, including performance, is guaranteed due to various risks and uncertainties. This document is not a recommendation of any particular investment. Actual investment decisions for clients are made on an individualized basis and may be different from what is expressed here. Clients are encouraged to discuss anything they see here of interest with their Glenmede representative.
February 2013
Key Economic and Market ViewpointsKey Economic and Market Viewpoints
• The world’s largest developed economies continue to experience modest and volatile growth as they work off excess debt accumulated over previous decades.
• Politicians in many nations are addressing these fundamental problems, albeit at the expense of near-term economic performance.
• The global economy is finding some offsetting support from emerging markets, the health of the corporate sector, and modest improvements in housing and employment.
• Long-term return prospects remain compelling for many risk assets, but investors should be selective, giving proper weight to shorter-term concerns.
• Turning the corner of negative debt dynamics will likely be negative for defensive assets that have become extremely expensive over the past few years.
Asset Allocation Recommendations*Asset Allocation Recommendations*
Individual Investor Endowment/FoundationFebruary 2013
* The ability to implement this recommendation depends upon investable assets. The appropriateness of this recommendation to any one portfolio depends upon tax and liquidity objectives as well as other considerations. This is for general educational purposes only
Moderate Risk Portfolio* Moderate Risk Portfolio*
Large Cap 29%
Small Cap 4%
Int'l Equity 16%
Real Estate 2%Private Equity
6%
Absolute Return 11%
Commodities 3%
High Yield 5%
Global Fixed 4%
Core Fixed Income 18%
Cash 2%
Large Cap 25%
Small Cap 4%
Int'l Equity 13%
Real Estate 3%
Private Equity 12%
Absolute Return 21%
Commodities 4%
High Yield 2%
Global Fixed 4%
Core Fixed Income 10%
Cash 2%
Deleveraging efforts have held back growthDeleveraging efforts have held back growthEconomic growth has been moderate since 2000
Questions before the house Questions before the house
1. Do the developed world’s long term financial problems present an insurmountable hurdle to good economic and market growth?
2. Is there a way to protect principal in a low to no yield bond market?
3. Can we generate enough return to meet rising needs?
Sisyphus by Titian, 1548-1549
In Greek mythology, Sisyphus was a wily and arrogant king of Corinth who angered the gods, Zeus in particular, and was punished to an eternity of rolling a boulder up a hill. He originally angered the gods by repeatedly breaking the code of hospitality, murdering guests and travelers, and was sent to be tortured in the underworld. He then successfully escaped the underworld several times through deceit and trickery, exhibiting a belief that he was more clever than the gods. In seemingly just return, Zeus displayed his own cleverness by personally selecting Sisyphus’ punishment and committing him to the unending and useless task of attempting to roll a boulder up a hill and perpetually failing.
Sisyphus’ punishment for trying to outsmart the Sisyphus’ punishment for trying to outsmart the godsgods
Sisyphus’ BoulderSisyphus’ Boulder
1960 1970 1980 1990 2000 2010
5050
100100
150150
200200
250250
300300
350350
Debt
, % o
f GDP
Data through Q1-13Source: Glenmede, FactSet
Household GSEs
Government Non-Financial Business
Financial
Monetary and fiscal efforts seek a pardon of Monetary and fiscal efforts seek a pardon of SisyphusSisyphus
Public Flogging(DeflationaryDeleveraging)
Examples:
US Great Depression (1930-1932)Japan (1990 – Present)US Pre-QE (Jun 2008 – Feb 2009)Spain (2008 – Present)
Pardon(Tolerable
economicand market
outcomes)
Examples:
US Reflation (1933 - 1937)United Kingdom (1947 - 1969)US Post-QE (Mar 2009 - Present)UK Post-QE (Mar 2009 - Present)
Examples:
Weimar Republic (1918-1923)Latin America (1980s)
Printing
Printing
Source: Bridgewater Associates
Depressive/
Deflationary
Stimulative/
Inflationary
Printing
Austerity/
Defaults
Austerity/Defaults
Austerity/Defaults
Private Flogging(Inflationary
Deleveraging)
The U.S. has moved its boulder another few The U.S. has moved its boulder another few feetfeet
The American Taxpayer Relief Act delayed some of the pain
w/o deal w/ deal Payroll tax cuts $95 (0.4%) (0.4%) Allowed to expire
Tax cuts - wealthy $52 (0.1%) (0.1%) Allowed to expire
Affordable Care Act $18 (0.1%) (0.1%) 3.8% Investment Tax
Budget Control Act 2011 $65 (0.4%) Delayed 2 months
Unemployment benefits $26 (0.1%) Extended 1 year
“Doc fix” $11 (0.1%) Extended 1 year
Tax extenders $65 (0.1%) Extended
AMT $103 (0.3%) Perm. Fix
Tax cuts – middle class $169 (0.6%) Perm. Extension
Total $435 (1.6%) (0.6%)
Comment
Source: Glenmede, Congressional Budget Office, ISI, Ned Davis Research. Economic impact based on output multipliers calculated by the CBO and/or estimated by Glenmede. The “Doc Fix” refers to the funds needed to prevent doctors’ pay from being cut under the Sustainable Growth Rate formula passed in 1997, due to shortfalls in Medicare funding. Tax extenders includes, among other things, accelerated depreciation.
Item Economic Impact (% of GDP)2013 Costs
($ Billion)
The Taxpayer Relief Act does bring down the The Taxpayer Relief Act does bring down the deficit…deficit…
New policy now has the deficit narrowing to historical levels around 2015
2012
The Taxpayer Relief Act does bring down the The Taxpayer Relief Act does bring down the deficit…deficit…
New policy now has the deficit narrowing to historical levels around 2015
2012
The Taxpayer Relief Act does bring down the The Taxpayer Relief Act does bring down the deficit…deficit…
New policy now has the deficit narrowing to historical levels around 2015
2012
The Taxpayer Relief Act does bring down the The Taxpayer Relief Act does bring down the deficit…deficit…
New policy now has the deficit narrowing to historical levels around 2015
Average
2012
……and stabilizes the national debtand stabilizes the national debtUnder the new policy, debt-to-GDP declines to around 73% before increasing
again
2012
……and stabilizes the national debtand stabilizes the national debtUnder the new policy, debt-to-GDP declines to around 73% before increasing
again
2012
……and stabilizes the national debtand stabilizes the national debtUnder the new policy, debt-to-GDP declines to around 73% before increasing
again
2012
Projections always come with caveatsProjections always come with caveatsPotential flaws in Congressional Budget Office projections
• Assumes a return to trend GDP over 5 years
• Does not account for negative impact of unexpected economic shocks
• Longer-term debt levels start rising again due to entitlement spending
Growth 2013 –
2017: 3.3%
Growth 2018 –
2023: 2.7%
Protracted recovery in employmentProtracted recovery in employmentIf current trends hold, unemployment will reach 6.5% in October 2014
6.5% Unemployment
A Housing recovery could stabilize collateral valuesA Housing recovery could stabilize collateral values
01 02 03 04 05 06 07 08 09 10 11 12-60%
-40%
-20%
0%
20%
40%
60%
Data through 1/23/13Source: Glenmede, FactSet
Housing Units Authorized By Building Permits (YoY%)
01 02 03 04 05 06 07 08 09 10 11 12-20%
-15%
-10%
-5%
0%
5%
10%
15%
Data through 2/01/13Source: Glenmede, FactSet
S&P/Case-Shiller 20 City Price Index (YoY%)
Many housing statistics are showing signs of positive momentum
European Central Bank action has stabilized the European Central Bank action has stabilized the situationsituation
2010 2011 2012
1%
2%
3%
4%
5%
1%
2%
3%
4%
5%
6%
Data through 1/15/13Source: Glenmede, FactSet
Italy 10-Year Bond Spread Over Germany (Left)Spain 10-Year Bond Spread Over Germany (Right)
ECB action has provided a backstop in financial markets
2010 2011 20121,800
2,000
2,200
2,400
2,600
2,800
3,000
3,200
Data through 1/15/13Source: Glenmede, FactSet
European Central Bank Assets, € billions
Key long-term imbalances are being addressedKey long-term imbalances are being addressedLabor costs are converging…slowly
Europe has put more fiscal effort into rolling its Europe has put more fiscal effort into rolling its boulderboulder
…and more fiscal adjustments are still needed
Emerging markets never had a boulder to rollEmerging markets never had a boulder to rollEmerging markets generally have lower debts and deficits
Secular trends like the growth of the consumer remainSecular trends like the growth of the consumer remainEM consumption to grow four times faster than developed to 2020
06 07 08 09 10 11 12
30
35
40
45
50
55
60
65
70
ISM M
anuf
actu
ring
Surv
ey
Data through 1/15/13Source: Glenmede, Factset
06 07 08 09 10 11 1280
85
90
95
100
105
110
NFIB
Smal
l Bus
ines
s Opt
imism
Data through 1/15/13Source: Glenmede, Factset
Business confidence surveys show a divergenceBusiness confidence surveys show a divergenceLarge business sentiment steady, but small businesses are having difficulties
Strong Strong
WeakWeak
The gods are crafty and could yet throw up more The gods are crafty and could yet throw up more obstaclesobstacles
03 04 05 06 07 08 09 10 11 12
-2%
-1%
0%
1%
2%
3%
2.19
2.83
Data through 1/23/13Source: Glenmede, FactSet. Derived from TIPS spread data.
Next 5 Year Inflation Expectations (Years 1-5) Following 5 Year Inflation Expectations (Years 6-10)
Inflation expectations are tame for now…
Excess reserves have not yet led to loan growthExcess reserves have not yet led to loan growthFederal Reserve assets have
mushroomed… …but money supply and loans have
not
07 08 09 10 11 12
1,000
1,500
2,000
2,500
3,000
Data through 1/15/13Source: Glenmede, FactSet.
Federal Reserve Assets ($ Billions)
07 08 09 10 11 12
6,000
8,000
10,000
12,000
14,000
16,000
18,000
20,000
22,000
24,000
Data through 1/15/13
Source: Glenmede, FactSet. Money supply is M2, including but not limited to currency in circulat ion, checking accounts,and savings deposits.
Money Supply ($ Billions) Loans & Leases ($ Billions)
Annualized Growth Rate
Fed Assets: 22%
Annualized Growth Rate
Money Supply: 6% Loans & Leases: 3%
Perhaps the gods have enthralled the politiciansPerhaps the gods have enthralled the politiciansMarket volatility may have fallen, but policy uncertainty remains high
Europe has demonstrated that austerity reduces Europe has demonstrated that austerity reduces growthgrowth
Austerity has been, to the surprise of no one, contractionary
Spain: the show (refinancing) isn’t over yetSpain: the show (refinancing) isn’t over yetSpain has to pay for its maturing debt as well as fund its deficit
2013 Refinancing Needs € Billions % of GDP
Budget Deficit 54 5.7%Maturing Debt 151 16.0%
Total 205 21.7%
Core fixed income has seen huge asset flows…Core fixed income has seen huge asset flows…
2008 2009 2010 2011 2012
-200
-100
0
100
200
300
400
$ Bil
lions
Data through 1/23/13Source: Glenmede, FactSet
Net New Bond Fund Inflows, Last 12 Months Net New Equity Fund Inflows, Last 12 Months
Fear has driven money into fixed income products for years
……and accordingly offer paltry yields with little and accordingly offer paltry yields with little appealappeal
88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 120%1%
2%
3%
4%
5%
6%
7%
8%
9%
Data through 1/15/13Source: Glenmede, FactSet
10 Year Treasury Yield 3 Month Treasury Yield
Even longer-dated Treasuries have yields below the rate of inflation
Current bond yields suggest poor long-term returnsCurrent bond yields suggest poor long-term returnsStarting yields have a strong relationship with subsequent performance
Current Yield: 2%
Equity prices look more favorableEquity prices look more favorableCurrent multiples suggest good if not great performance
Subdued return projections may entail taking some Subdued return projections may entail taking some riskrisk
Source: Glenmede. Future results cannot be guaranteed, and all investments are subject to loss. Inflation is assumed to be 2.3%. As of 1/21/13.
Projected 10-year returns by asset class
Real returns may require taking some riskReal returns may require taking some risk
Source: Glenmede. Future results cannot be guaranteed, and all investments are subject to loss. Inflation is assumed to be 2.3%. As of 1/21/13.
Projected 10-year real returns by asset class
Expected returns and risks for strategy Expected returns and risks for strategy alternativesalternatives
Portfolio Expected Return RiskNominal Real Risk
Classic Portfolio (60% Equities / 40% High Quality Fixed Income & Cash)
4.8% 2.6% 11.3%
Source: Glenmed.e. S&P 500 is used as a proxy for equities, The Barclays US Aggregate Index is used for high quality fixed income. Expected return is annualized projected over 10 years . Expectations of return and risk are made in good faith, but actual results may vary depending on market conditions. This represents a purely hypothetical portfolio for the purpose of illustration. Hypothetical, expected returns do not include management fees or transaction costs which would lower returns.
Investment allocations for a yield challenged Investment allocations for a yield challenged marketmarket
• Underweight traditional fixed income and cash• Invest in higher return potential fixed income
• Global Fixed Income• Bank Loans & High Yield Debt
• Allocate money to risk-managed equity strategies with similar or better expected return than the market but with 20% to 30% less risk• High quality companies with dividend growth• Secured options/covered calls
• Overweight emerging and developed markets equity• Invest in cheap(-er) inflation protection• Identify lower correlation special strategies
• Private Secondary Opportunities • Catastrophic Reinsurance
• Not all strategies may be available to or suitable for, all investors.
Expected returns and risks for strategy Expected returns and risks for strategy alternativesalternatives
Source: Glenmede
Asset Class
Fixed IncomeCashTraditional High QualityHigh Yield / Bank LoansGlobal Fixed Income
EquityUS Large CapUS Small CapRisk-ManagedInternational
DevelopedEmerging
AlternativesCommoditiesPrivate EquityReal EstateAbsolute Return 15%
9% 12%
3%3%
14%10%4%
22%4%-
21%
21%2%11%2%6%
57%27%4%
13%9%4%
40%4%12%
2%4%
42%16%4%
% w/ partnerships% w/o partnershipsStrategy Portfolio Suggested Weights
18%2%10%
Expected returns and risks for strategy Expected returns and risks for strategy alternativesalternatives
Portfolio Expected Return RiskNominal Real Risk
Classic Portfolio (60% Equities / 40% High Quality Fixed Income & Cash)
4.8% 2.6% 11.3%
Strategy Portfolio 6.9% 4.7% 11.0%Strategy Portfolio (No P.E. or H.F. Partnerships) 6.5% 4.2% 10.7%
Source: Glenmede Expected return is annualized projected over 10 years . Expectations of return and risk are made in good faith, but actual results may vary depending on market conditions. This represents a purely hypothetical portfolio for the purpose of illustration. Hypothetical, expected returns do not include management fees or transaction costs which would lower returns.
Source: Glenmede
High yield bonds may be more volatile, risky, and less liquid than other securities of similar duration. Future results cannot be guaranteed and all investments are subject to loss.
Substitute some credit risk for equity risk by using high Substitute some credit risk for equity risk by using high yield debtyield debt
Expected returns are competitive High yield exhibits protection in downturns
High YieldBB
S&P 500
Yield 5.9% 2.1%
Earnings Growth -- 5.3%
Loss Rate -0.8% --
Valuation Change -0.3% -0.4%
Expected 10-year Return
4.8% 7.0%
Bank loans minimize duration risk with attractive Bank loans minimize duration risk with attractive yieldyield
Yields comparable to high yield, with less interest rate risk
Emerging market bonds offer more substantial yields…Emerging market bonds offer more substantial yields……even at shorter durations
International bonds may be more volatile, risky, and less liquid than other securities of similar duration. International bond investment involves additional risks including but not limited to currency, political instability, and accounting differences.
Seeking to control risk while still aiming for Seeking to control risk while still aiming for attractive returnsattractive returns
High quality has provided greater stability and absolute return over time
Secured options provide an opportunity to both Secured options provide an opportunity to both participate in and protect from market performance*participate in and protect from market performance*
Selling options against an equity portfolio provides protection
*Secured option strategies include covered calls and cash-secured puts. Protection cannot be guaranteed. Volatility can cause results to differ from expectations.
Secured Option (Covered Call) Strategies Secured Option (Covered Call) Strategies offer attractive risk/return characteristicsoffer attractive risk/return characteristics
0 5 10 15 20Annualized Standard Deviation
0
1
2
3
4
5
6
7
8
9
10
Annu
alize
d Re
turn
CBOE BuyWrite (Covered
Call )
Citigroup 3-M Treasury Bill
Barclays Aggregate
S&P 500 Index
Source: Glenmede, FactSet
01/1989 to 12/2012
Emerging markets are becoming more developedEmerging markets are becoming more developedLots of room to grow as their GDP per capita converges to developed world
levels
Real assets can provide a hedge against inflationReal assets can provide a hedge against inflation
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 121
1.5
2
2.5
3
Data through 1/15/13Source: Glenmede, FactSet
Gold ($/ozt) / Reuters CRB Continuous Commodity Index Median
A broad basket of commodities looks less expensive than gold alone
Special strategies can improve Special strategies can improve a portfolio’s risk and rewarda portfolio’s risk and reward
• Private Asset Secondaries
• Catastrophic Reinsurance
• Risk Parity
• Exotic Beta
Investment Strategy ThemesInvestment Strategy Themes
• Position portfolios to benefit from moderate economic growth• Favor a constructive but not aggressive asset mix given ongoing risk of
policy errors
• Maintain the middle: Investors should maintain a long-term focus on the middle of the investment risk spectrum, where the most attractive risk-reward opportunities lie.• Favor high quality and/or dividend growth within equities• Take credit risk: high yield bonds, bank loans, and emerging market bonds• Utilize alternative risk control: secured options and absolute return strategies
• Position to benefit from long-term growth opportunities• Emerging market consumer growth
• Maintain some protection against unexpected future inflation and currency devaluation• Global fixed income and broad/active commodity basket