Asset Allocation in a Low Interest Rate World

1© 2016 Windham Capital Management, LLC. All rights reserved.

Confidential. Not for redistribution.

October 2016 1

Asset Allocation in a Low

Interest Rate World

Lucas TurtonWindham Capital Management, LLC

Managing Partner & Chief Investment Officer


AGENDA

Defining the opportunity set

Estimating risk

Estimating return

Constructing portfolios

Portfolio Analysis


AGENDA


Estimating risk

Estimating return


Portfolio Analysis


DEFINING THE OPPORTUNITY SET

Criterion for including asset classes

1. Independent

2. Improve Utility

3. Non-overlapping

4. Capacity

5. Representative of a broad factor



US Equity

Foreign Equity

Emerging Equity

US Bonds

Foreign Bonds

US Real Estate

Foreign Real Estate

Commodities

Major Asset Classes



Hedge Funds?

• Hedge Funds are intended to generate alpha by allocating to stocks, bonds,

commodities, and currencies.

• Return forecast should be above those estimated using a global CAPM

framework to incorporate manager skill

Private Equity?

• Private equity should represent similar risk characteristics to public equities.

• Return forecast should be above those estimated for equities due to the

illiquidity that an investor accepts.

• The global capitalization of private equity is small relative to public equities


AGENDA


Estimating risk

Estimating return


Portfolio Analysis


ESTIMATING RISK

Asset Class Historical Exponential Turbulent Regime

US Equities 16.97% 13.54% 18.81%

Foreign Equities 19.69% 15.75% 22.86%

Emerging Equities 25.52% 20.36% 34.13%

Global Real Estate 23.06% 16.53% 28.67%

Commodities 17.49% 14.85% 23.91%

US Bonds 3.34% 2.90% 4.91%

US Floating Rate Bonds 0.51% 0.21% 0.56%

Foreign Bonds 9.32% 8.33% 13.16%

Cash 0.46% 0.18% 0.55%

October 2006 through September 2016


AGENDA


Estimating risk

Estimating return


Portfolio Analysis


ESTIMATING RETURNS

Percent*

Value*

(billions)

US Equity 13.53% $25,068

Foreign Equity 7.65% $14,175

Emerging Equity 9.84% $18,226

US Bonds 19.54% $36,189

Foreign Bonds 27.42% $50,799

US Real Estate 4.37% $8,086

Foreign Real Estate 10.52% $19,495

Commodities 7.12% $13,194

Total 100.0% $185,230

*The current asset values are as of December 31, 2015

Global Market Portfolio Weights – 2016


ESTIMATING RETURN

Asset Class Historical CAPM View Confidence Bayesian Blend

US Equities 8.77% 7.26% 7.00% 50.00% 7.13%

Foreign Equities 4.46% 9.02% 8.00% 50.00% 8.51%

Emerging Equities 7.62% 10.74% 10.00% 50.00% 10.37%

Global Real Estate 6.67% 9.86% 9.00% 50.00% 9.43%

Commodities -4.50% 6.95% 5.00% 50.00% 5.97%

US Bonds 4.84% 2.18% 1.50% 50.00% 1.84%

US Floating Rate Bonds 1.28% 1.74% 1.25% 50.00% 1.49%

Foreign Bonds 5.59% 3.82% 3.00% 50.00% 3.41%

Cash 0.84% 1.75% 0.25% 100.00% 0.25%

October 2006 through September 2016


AGENDA


Estimating risk

Estimating return


Portfolio Analysis


CONSTRUCTING PORTFOLIOS

Mean-variance optimization remains



Asset Class 60/40

US Equities 13%

Foreign Equities 14%

Emerging Equities 11%

Global Real Estate 14%

Commodities 8%

US Bonds 10%

US Floating Rate Bonds 14%

Foreign Bonds 15%

Cash 1%

Expected Return 6%

Expected Risk 12%



Asset Class 60/40

US Equities 13%

Foreign Equities 14%

Emerging Equities 11%

Global Real Estate 14%

Commodities 8%

US Bonds 10%

US Floating Rate Bonds 14%

Foreign Bonds 15%

Cash 1%

Expected Return 6%

Expected Risk 12%

- Foreign equity exposure

- Hedged foreign bonds


EQUITIES

* Source: An Old Friend: Cliff Asness, PHD, “The Stock Market’s Shiller P/E”, AQR 3rd quarter 2012 letter to investors

Starting P/E Average Real Worst Real Best Real Standard

Low High 10 Yr Return 10 Yr Return 10 Yr Return Deviation

5.2 9.6 10.3% 4.8% 17.5% 2.5%

9.6 10.8 10.4% 3.8% 17.0% 3.5%

10.8 11.9 10.4% 2.8% 15.1% 3.3%

11.9 13.8 9.1% 1.2% 14.3% 3.8%

13.8 15.7 8.0% -0.9% 15.1% 4.6%

15.7 17.3 5.6% -2.3% 14.3% 5.0%

17.3 18.9 5.3% -3.9% 15.1% 5.1%

18.9 21.1 3.9% -3.2% 15.1% 3.9%

21.1 25.1 0.9% -4.4% 13.8% 3.8%

25.1 46.1 0.5% -6.1% 6.3% 3.6%

Results For S&P 500 From Different Starting Shiller P/Es 1926‐2012


EQUITIES

* Source: An Old Friend: Cliff Asness, PHD, “The Stock Market’s Shiller P/E”, AQR 3rd quarter 2012 letter to investors

Starting P/E Average Real Worst Real Best Real Standard

Low High 10 Yr Return 10 Yr Return 10 Yr Return Deviation

5.2 9.6 10.3% 4.8% 17.5% 2.5%

9.6 10.8 10.4% 3.8% 17.0% 3.5%

10.8 11.9 10.4% 2.8% 15.1% 3.3%

11.9 13.8 9.1% 1.2% 14.3% 3.8%

13.8 15.7 8.0% -0.9% 15.1% 4.6%

15.7 17.3 5.6% -2.3% 14.3% 5.0%

17.3 18.9 5.3% -3.9% 15.1% 5.1%

18.9 21.1 3.9% -3.2% 15.1% 3.9%

21.1 25.1 0.9% -4.4% 13.8% 3.8%

25.1 46.1 0.5% -6.1% 6.3% 3.6%

Results For S&P 500 From Different Starting Shiller P/Es 1926‐2012

As of 9/30/2016 CAPE is 26.5


BONDS

5 Year Rate

ChangeYear 5 Rate

3 Year Annualized

Return

5 Year Annualized

Return

4% Rise 6.5% -2.1% -1.1%

3% Rise 5.5% -0.8% -0.1%

2% Rise 4.5% 0.4% 0.9%

1% Rise 3.5% 1.8% 2.0%

Flat 2.5% 3.1% 3.1%

1% Decline 1.5% 4.6% 4.4%

2% Decline 0.5% 6.1% 5.8%

2.5% Decline 0.0% 6.9% 6.5%

Hypothetical Returns for 10 year Treasuries*

* Assumes initial rate of 2.5% and linear rate changes and long term average yield curve slope


BONDS

5 Year Rate

ChangeYear 5 Rate

3 Year Annualized

Return

5 Year Annualized

Return

4% Rise 6.5% -2.1% -1.1%

3% Rise 5.5% -0.8% -0.1%

2% Rise 4.5% 0.4% 0.9%

1% Rise 3.5% 1.8% 2.0%

Flat 2.5% 3.1% 3.1%

1% Decline 1.5% 4.6% 4.4%

2% Decline 0.5% 6.1% 5.8%

2.5% Decline 0.0% 6.9% 6.5%



Since 1871, 77% of 5yr

rolling changes are within

this range

(of 1652 observations)


BONDS

5 Year Rate

ChangeYear 5 Rate

3 Year Annualized

Return

5 Year Annualized

Return

4% Rise 6.5% -2.1% -1.1%

3% Rise 5.5% -0.8% -0.1%

2% Rise 4.5% 0.4% 0.9%

1% Rise 3.5% 1.8% 2.0%

Flat 2.5% 3.1% 3.1%

1% Decline 1.5% 4.6% 4.4%

2% Decline 0.5% 6.1% 5.8%

2.5% Decline 0.0% 6.9% 6.5%



When rates are 2.65% or

below they have risen

69% of the time and

never fallen more than

1%

(of 180 observations)


AGENDA


Estimating risk

Estimating return


Portfolio Analysis


PORTFOLIO ANALYSIS

3 year horizon, 10% absolute loss, 10% relative loss

to 60/40 US equity/US bond


PORTFOLIO ANALYSIS

$1,000,000 portfolio over 3 year horizon


SUMMARY

Low return environment

Downside risk to equities and bonds

Valuations do matter

Know your risk

26© 2016 Windham Capital Management, LLC

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27© 2016 Windham Capital Management, LLC

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Asset Allocation in a Low Interest Rate World

Economy & Finance

Transcript of Asset Allocation in a Low Interest Rate World