As a macro-based firm, RBA believes that the macroeconomy drives asset performance. Although some stock and bond pickers claim to ignore macroeconomic events and only look at company fundamentals, we think they do so at their own peril. Nearly 25 years ago, our work clearly showed that the macro-environment greatly affects the performance of asset classes, size, style, risk and quality.

The macroeconomic environment also seems to have been the main factor driving the success of the Endowment Model. Our caution today toward the Endowment Model approach is based on our view that the global economy is going through a significant metamorphosis (namely the deflation of the global credit bubble) that challenges some of the major tenets within Endowment Model strategies.

Chart 1 shows the relative performance of credit-related asset classes versus the S&P 500 from 1998 to 2008, which was the period during which the global credit bubble inflated. Credit-related asset classes uniformly outperformed stocks during this period. Credit-related asset classes are those asset classes that have the greatest sensitivity to credit creation, and that sensitivity proved to be a huge fillip to asset performance during the credit bubble.

However, credit-related asset classes have underperformed equities since the credit bubble started to deflate in 2008. These asset classes’ sensitivity to credit creation, which aided performance from 1998 to 2008, is now detracting from performance as the global credit bubble deflates.


*Private Equity Performance available through 12/31/15.
Source: Richard Bernstein Advisors LLC, MSCI, Standard & Poors, BofA Merrill Lynch, Bloomberg Finance
L.P., Cambridge Associates, HFRI. For Index descriptors, see "Index Descriptions" at end of document.

The core of the Endowment Model focuses on many of these credit-related asset classes. Hedge funds, private equity, real estate, commodities, and emerging markets, for example, are all credit-related asset classes. Although each asset class has had short periods of outperformance since the deflation of the global credit bubble began, they have secularly underperformed. Thus, much of the Endowment Model’s historical success can be tied to the secular inflation of the global credit bubble. The secular deflation of the global credit bubble could lead to secular underperformance.

If it quacks like a duck and walks like a duck, then it’s correlated to a duck.

Asset Allocation 2.0 questions why investors would invest in a broad range of asset categories that ultimately are positively correlated with each other. Wouldn’t it make more sense to invest in fewer asset classes that are uncorrelated or negatively correlated?

Correlation is probably the most manipulated statistic in all of investment management. One can manipulate correlation statistics to give virtually any desired result if one changes the periodicity of the returns, the time horizon, or the historical period studied.

Because of the vagaries of correlation statistics, we use secular correlations within Asset Allocation 2.0. Our measures change through time, but are relatively stable for shorter intervals. That allows us to better gauge the potential diversification benefits of an asset class, and whether such benefits may be fleeting.

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