Structuring Real Asset Portfolios -...

Structuring Real Asset Portfolios 2012 Wilshire Consulting Client Conference

Mike Dudkowski, Managing Director Jim Neill, CFA, Managing Director

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• Real Assets Overview

• Case Study Part 1: Asset Allocation

• Investment Structure

• Case Study Part 2: Investment Structure / Implementation

• Summary

Agenda

Real Assets Overview

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• Public Markets

– Treasury Inflation Protected Securities (TIPS)

– Commodities

– Real Estate Investment Trusts (REITs)

– Other “listed” investments

Infrastructure and natural resource stocks

Master Limited Partnership (MLPs)

• Private Markets

– Real Estate, Farmland, Infrastructure

– Timberland

– Oil and Gas

Opportunity Set


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• Real assets capitalize inflation in their returns over time – therefore provide a hedge against inflation

• Real assets are represented in both public and private markets

• Wilshire generally supports a diversified approach to increase the beta (sensitivity) of investments to unexpected inflation shocks

– Investments capitalize inflation at different rates

– Investments have varying sensitivities to economic forces and are also driven by unique, asset-specific characteristics

A diversified inflation hedge is the best inflation hedge


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Data sources: Wilshire CompassSM, Bridgewater Associates

Broad Asset Class Correlations to US CPI-U over Multiple Holding Periods, 1971-2011


-1.0

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

US Stocks US Bonds Private RE Public RES TIPS Commodities

Corr

elat

ion

to U

S CP

I-U

3 Months 6 Months 12 Months 36 Months 60 Months 120 Months

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• Perfect correlation to US CPI-U is unlikely to exist. Instead, we focus on asset classes with positive correlation as being beneficial components for real asset portfolios.

– Financial assets such as stocks and nominal bonds demonstrate negative correlation to inflation over most holding periods.

– Among the four real asset types shown in the chart (private real estate, public real estate securities, TIPS and commodities), the level of correlation varies according to holding period for all but commodities.

– Intuitively, commodities’ behavior is explained by the fact that commodities represent inputs to production and commodity price increases are reflected in US CPI-U very quickly.

• In general, real assets demonstrate positive correlation, particularly over long periods as assets re-price. For example, private real estate may show little immediate reaction but then demonstrates a meaningful valuation change when an automatic rent bump is taken into account.

Correlation to Inflation


Asset Allocation

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Historical Return Environments

High Inflation Bull Market "Lost Decade" Wilshire1802-2011 * 1926-2011 1970-1979 1980-1999 2000-2009 Forecast (%)

Total Returns:Stocks 8.0 9.8 5.9 17.8 -1.0 7.5Bonds 4.9 5.7 7.2 10.0 6.3 2.9T-bills 4.2 3.7 6.4 7.2 3.0 1.5

Inflation: 1.5 3.0 7.4 4.0 2.5 2.0

Returns minus Inflation:Stocks 6.6 6.8 -1.5 13.8 -3.5 5.5Bonds 3.5 2.7 -0.2 6.0 3.8 0.9T-bills 2.7 0.7 -1.0 3.1 0.5 -0.5

Stocks minus Bonds: 3.1 4.1 -1.3 7.8 -7.3 4.7* Returns for 1802-2001 are from "Stocks for the Long Run" (Siegel, 2002) and S&P 500 Index and Barclays Capital Aggregate Index after.

Historical Returns (%)

Case Study Part 1: Asset Allocation

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Wilshire Real Assets Basket

Asset Allocation

• Our “Baseline” allocation is balanced from both a capital and risk perspective

• Publicly traded assets comprise:

– 50% of the capital allocation

– 38% of the risk allocation

• Private assets comprise:

– 50% of the capital allocation

– 62% of the risk allocation

22%

10%

10%8%

20%

15%

15%

Capital Allocation

TIPS

Commodities

Global REIT's

MLP's

Real Estate

Timberland

Oil & Gas

7%8%

12%

11%

25%

16%

21%

Contribution to Risk

TIPS

Commodities

Global REIT's

MLP's

Real Estate

Timberland

Oil & Gas

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Impact on Frontiers – 40% Max allocation

Asset Allocation

• Real Assets can meaningfully improve portfolios that otherwise have no allocation.

• For moderate risk portfolios, less than 8% risk, the diversified basket is an attractive approach.

• For higher risk portfolios, a tailored approach can help maximize returns at the expense of diversification within the Real Assets allocation.

Frontier - Individual Components Frontier - Separate Public/Private

Frontier - Wilshire Basket Portfolio A

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0

2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0

Risk

Constrained Efficient Frontier

* Compound Annual Return

Portfolio A

Asset Class Allocation

Global Equity 55%

Private Equity 5%

Core Fixed Income

30%

High Yield 10%

Investment Structure

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• Primary / Secondary Approach

– Primary exposures to largest and most established real asset classes / sub-classes (e.g. TIPS, public and private real estate)

– Secondary (complementary) exposures to markets limited in size, involve a higher degree of risk, or limited number of quality investment managers (e.g. timber, oil and gas partnerships)

• Identify constraints based on the above philosophy

Philosophy and Approach


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Asset Class Investable Market Size

Manager Opportunity Set

Risk (Absolute)

Implication(s)

TIPS Large Large Low Suitable for primary exposure

Commodities Large Small (except for index-tracking strategies with limited alpha opportunity)

Moderate to High

Potential for primary exposure

Global RE Securities Large Large Moderate Suitable for primary exposure

Master Limited Partnerships Small Small High Complementary exposure due to small opportunity

set / market

Private Real Estate Large Large Moderate Suitable for primary exposure

Infrastructure Small Small Moderate Complementary exposure

Timber Small Small High Complementary exposure, constrain due to small

opportunity set / market

Oil & Gas Medium Medium High Complementary exposure, constrain due to risk level

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• Customize according to unique investment objectives and portfolio requirements

– Seek to maximize correlation to inflation

– Seek to maximize yield

– Seek to maximize return

– Seek to maximize alpha opportunity

– Seek to maximize liquidity

– Seek to minimize risk

Philosophy and Approach


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Investors should establish expectations regarding the effectiveness of asset classes in meeting their objectives.


Manager Type Short-term Correlation

to CPI

Long-term Correlation to

CPI

Higher Yield Opportunity

Higher Return Opportunity

(Beta)

Higher Alpha

Opportunity

Liquidity

TIPS X X X

Commodities X X X X

Global RE Securities X X X X

MLP X X X X X

Diversified Public RA X X X X X

Private Real Estate X X X X

Infrastructure X X X

Timber X X X

Oil & Gas X X X X

Diversified Private RA (e.g. FOF)

X X X

Case Study Part 2: Investment Structure /

Implementation

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Example: Alternate Liquidity Scenarios

Case Study Part 2: Investment Structure / Implementation

Frontier w/ 10% Liquidity Frontier w/ > 50% Liquidity

Portfolio A

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0

Risk

Constrained Efficient Frontier

* Compound Annual Return

• Less liquid structure allows for greater enhancement to risk and return.

• A more liquid allocation still provides meaningful portfolio improvement.

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Example: Alternate Yield Scenarios


Real Assets Classes

Expected Yield

Public Basket

Private Basket

Real Assets Basket

Maximum Yield

Balanced Yield

PublicTIPS 1.7% 45% 22.5%Commodities 1.5% 20% 10.0%Global REIT's 4.0% 20% 10.0% 25%MLP's 6.0% 15% 7.5% 50% 25%PrivateReal Estate 4.0% 40% 20.0% 25%Timberland 0.0% 30% 15.0%Oil & Gas 6.0% 30% 15.0% 50% 25%

Total Yield 2.7% 3.4% 3.1% 6.0% 5.0%

Yield of Alternative Allocations• Real Assets provide investors the opportunity to increase the yield in their portfolios.

• Yield can be maximized at the expense of diversification within Real Assets.

• The balanced Real Assets Basket is expected to generate a yield that is similar to Investment Grade Fixed Income.

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Example: Alternate Implementations for Funds of Varying Size


Total Fund Size ($mil) 500 1,000 10,000Real Assets Allocation @ 20% 100 200 2,000

Real Asset Basket Weight Allocation ($mil)PublicTIPS 22.5% 22.5 45.0 450.0Commodities 10.0% 10.0 20.0 200.0Global REITs 10.0% 10.0 20.0 200.0MLPs 7.5% 7.5 15.0 150.0 Public Total 50.0% 50.0 100.0 1,000.0

PrivateReal Estate 20.0% 20.0 40.0 400.0Timberland 15.0% 15.0 30.0 300.0Oil & Gas 15.0% 15.0 30.0 300.0 Private Total 50.0% 50.0 100.0 1,000.0

Hypothetical ImplementationPublicTIPS TIPS Manager Multiple TIPS ManagersCommodities Commodities Manager Multiple Commodities ManagersGlobal REITs Global REITs Manager Multiple Global REITs ManagerMLPs MLP Manager MLP Manager Multiple MLP Managers

Private

Real EstateDedicated Real Estate Manager Real Estate separate account or direct

partnership program

TimberlandTimber separate account or direct

partnership programOil & Gas Direct Oil/Gas partnership program

Diversified Public RA Manager

Private RA Fund of Funds Manager (includes Real Estate)

Private RA Fund of Funds Manager (excludes Real Estate)

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• Private Real Assets

– Consistent and disciplined commitment strategy over time with review and re-adjustment occurring annually

– Diversification according to asset class, investment style and strategy type (e.g. core, value added, opportunistic), fund vintage year

– Utilization of highest caliber investment management organizations and suitable investment vehicles - return spread from top quartile to median can be sizeable

• Public Real Assets

– Implementation approach / market volatility concerns

– Adhere to rebalancing policy

– Funding source for private investments

– Liquidity source for total fund

Commitment Planning


Summary

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• Perfect correlation to US CPI-U is not realistic. Instead, we focus on asset classes with positive correlation as being potentially beneficial components for real asset portfolios.

• It may be better to employ a real assets basket approach during the asset allocation process and leave the allocation to sub-classes as an investment structure activity. Numerous considerations at the sub-asset class level argue in favor of such an approach:

– Size of market

– Number of quality investment managers

– Complexity of asset class / sub-class

– Degree of risk

– Current valuation /attractiveness

– Other

• Implementation will vary according to each investor’s circumstances and objectives. Fund size will also influence the optimal implementation approach.

Summary

Appendix

Extended History of Real Assets Research

Sample Research Reports in the Wilshire Consulting Research Library:

• Investing in MLPs (August 2011)

• Commodities Market Price Spike: Are Index Investors to Blame? (July 2008)

• Real Asset Investments (August 2007)

• TIPS Correlations (July 2007)

• Timberland Investments (June 2007)

• Infrastructure Investing (2007)

• Private Real Estate Investing (August 2006)

• Global Real Estate Securities (April 2006)

• Commodity Index Comparison (May 2005)

• Commodity Futures Investing: Is All That Glitters Gold? (March 2005)

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Important Information

This material contains confidential and proprietary information of Wilshire Consulting, and is intended for the exclusive use of the person to whom it is provided. It may not be modified, sold or otherwise provided, in whole or in part, to any other person or entity without prior written permission from Wilshire Consulting. The information contained herein has been obtained from sources believed to be reliable. Wilshire Consulting gives no representations or warranties as to the accuracy of such information, and accepts no responsibility or liability (including for indirect, consequential or incidental damages) for any error, omission or inaccuracy in such information and for results obtained from its use. Information and opinions are as of the date indicated, and are subject to change without notice.

This material is intended for informational purposes only and should not be construed as legal, accounting, tax, investment, or other professional advice.

This presentation represents the current opinion of the firm based on sources deemed reliable. The information and statistical data contained herein are based on sources believed to be reliable. Wilshire does not represent that it is accurate and should not be relied on as such or be the basis for an investment decision. This Presentation is for information purposes only.

Any opinions expressed in this Presentation are current only as of the time made and are subject to change without notice. Wilshire assumes no duty to update any such statements. Any holdings of a particular company or security discussed herein are under periodic review by the author and are subject to change at any time, without notice.

This report may include estimates, projections and other "forward-looking statements.“ Past performance does not guarantee future results. Due to numerous factors, actual events may differ substantially from those presented.

This presentation is not to be used or considered as an offer to sell, or a solicitation to an offer to buy, any security. References to specific companies are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Wilshire, its officers, directors, employees or clients may have positions in securities or investments mentioned in this publication, which positions may change at any time, without notice.

Wilshire® is a registered service mark of Wilshire Associates Incorporated, Santa Monica, California. All other trade names, trademarks, and/or service marks are the property of their respective holders.

Copyright © 2012 Wilshire Associates Incorporated. All rights reserved.

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