The document discusses the volatility in markets at the start of 2016 due to falling oil prices and concerns about global growth. It then summarizes the performance of various asset classes in the first quarter, noting rebounds in March that helped offset losses. The document goes on to discuss risk parity strategies and their performance in recent years, noting headwinds they may face going forward in a rising rate environment. It concludes by discussing opportunities in emerging markets, shipping, timber, and other less popular asset classes that some investors are taking a closer look at.

1. Roger Beutler, CAIA rogerbeutler@yahoo.com 858-205-4244
Asset Allocation Viewpoints April 2016
Equity markets had a turbulent start in 2016. With the Dow down over 5% in the first 4 days, the worst start on record wasn’t encouraging
to say the least. China’s stock market seemed to find no bottom, falling 12% by January 7th
, 2016. The price of crude oil, on a downward
trend since June 2014, continued to fall rapidly, losing over 20% though January 20, 2016. New fears of a global recession, slowing
growth in China and the United States and crude oil prices at their lowest levels in 13 years provided a difficult environment for investors
at the start of 2016. Just as tumultuous as 2016 began, markets remained volatile and trades seemed to be more driven by fear or
speculation rather than fundamental factors. Crude oil prices magically recovered from their lows on February 11, 2016 and increased
a staggering 32% in just 12 trading days by March 1, 2016. After the bumpy start in 2016, it’s surprising that first quarter results don’t
look much worse, thanks to impressive returns in March. In the third month of the year, the Dow and the S&P 500 resurged, posting
returns of 7.22% and 6.78%, respectively. Emerging markets fared even better with the MSCI EM Index returning 13.23% in March and
5.71% YTD. With investors’ nerves rattled in January and February, investors sought safety in fixed income. The Fed’s Janet Yellen
signaled a slower interest hike than previously expected, calming the nerves of investors. While the Barclays US Agg is up 3.03% YTD,
the long term credit and treasury indices are up an impressive 6.82% and 8.15%, respectively. The volatility of the first 3 months left
many investors once again search harder for uncorrelated returns and take a closer look at the factors driving the performance in their
portfolio.
Risk Parity Revisited
After the initial fear of the financial crisis abated, most institutional
investors reexamined their asset allocation and definition of risk. The
process of reviewing the strategic asset allocation every 2-3 years
seemed no longer enough and the search for a silver bullet reducing
the total risk of the portfolio while maintaining returns to meet
spending needs was on. Risk-parity strategies gained popularity and
were implemented across the board from smaller funds to big
institutional investors. No wonder, after the financial crisis, reducing
your equity allocation in favor of more fixed income made perfect
sense to investors, especially since fixed income performed well in
2008 and subsequent years. Salient’s Risk Parity Index
returned -12% in 2015, the first negative return since 2008.
1
Risk
parity strategies remained attractive for investors looking to reduce
their exposure to equity risks and building a more diversified portfolio
from a risk perspective. The important question, however, is whether
risk parity strategies will perform well on a risk-adjusted basis going
forward. Compared to a traditional balanced portfolio, the relatively
fixed income heavy risk parity strategy is facing headwinds in a rising
interest rate environment due to potentially lower fixed income returns
and more expensive leverage. “Leverage adhered to over time can
add to returns. And when does risk parity work well? When levered
10-year Treasuries make you money – so since 1981, you’d have
been in seventh heaven.”
2
Risk parity strategies do reduce the equity
risk in an intuitional portfolio but risk is measured by standard
deviation, failing to address other risks such as shortfall risk or
illiquidity risk.
Investment Opportunities Revisited
Long-term return assumptions have changed marginally from last
year and continue to favor investments outside the United States.
3
The performance of the U.S. stock market over the last 7 years has
been impressive, handily outperforming its foreign peers. Over the
last 7 years, the MSCI AC Index returned 12.55% per annum as of
March 31, 2016 compared to the MSCI AC ex. USA Index at 9.18%
for the same period. With an expected return of approximately 6%
for a balanced portfolio, investors often need to invest in riskier assets
to meet their investment objectives. Investments often shunned in
the last few years are looking more and more attractive. Christopher
Brightman, CIO of Research Affiliates, Inc., recently called emerging
markets “possibly the trade of the decade.”
4
Shipping investments
have made an appearance on investors’ radars every now and then
in recent years. The surplus of vessels on the global market would
theoretically be a good buying opportunity with attractive total returns
to be realized when shipping rates increase due to increased
demands. This scenario, however, does require sustained global
growth, especially a better handle on China’s appetite for
commodities. While dry bulk rates have fallen significantly since the
peak in 2008 and in many cases not even cover break even costs
today, oil tanker rates have increased significantly, mainly due to the
recent fall in oil prices. Timber investments have gained more traction
in recent years as institutional investors are looking to further diversify
their portfolios. While most timber investments are made in the
United States, investors are more and more willing to look at
investments outside the United States where competition for new
timber investments is lower and valuations are more attractive.
Roger Beutler, CAIA worked in banking and finance since starting his career in the early 90s in Switzerland. He was a Director of Investments for a $2 billion
foundation, where he was responsible for the foundation’s private market investments comprising of over $500M in private equity and real estate commitments.
Prior, Beutler led the sub-adviser selection for a family of mutual funds and held positions in the investment consulting industry. Beutler graduated from the Bern
University of Applied Sciences in Berne, Switzerland, majoring in Banking and Finance.
This article is for informational purposes only and does not constitute an offering of investment services. This article in no way constitutes the provision of investment advice. Information
in the article is not an offer to buy or sell, or a solicitation of any offer(s) to buy or sell the securities mentioned herein. For further information, please contact me at 858-205-4244.
1
Pension & Investments: Risk-parity backers not fazed by poor 2015 performance,
February 22, 2016.
2
The Risk of Risk Parity, Brandes Institute, April 2014
3
J.P. Morgan Asset Management, 2016 Long-Term Capital Market Assumptions
4
Bloomberg.com, February 24, 2016.