2009 Asset Allocation Return and Risk Assumptions
Steven J. Foresti, Managing Director Michael E. Rush, CFA, Vice President Alexander C. Browning, Senior Associate Email:
[email protected]
January 26, 2009
January 26, 2009
Table of Contents Introduction......................................................................................................................... 1 Expected Future Returns................................................................................................. 1 Historical Returns........................................................................................................... 4 Inflation............................................................................................................................... 4 Equity.................................................................................................................................. 7 U.S. Stocks ...................................................................................................................... 7 Developed ex-U.S. Market Stocks................................................................................. 10 Emerging Market Stocks ............................................................................................... 11 Global and Global ex-U.S. Market Stocks.................................................................... 12 Fixed Income .................................................................................................................... 13 U.S. Treasury Bonds: Market and Long Term.............................................................. 13 U.S. Bonds..................................................................................................................... 14 Cash Equivalents .......................................................................................................... 16 Non-U.S. Bonds............................................................................................................. 17 Treasury Inflation Protected Securities (TIPS) ............................................................ 17 Long-Term Bond ........................................................................................................... 18 High Yield Bonds .......................................................................................................... 18 Emerging Market Debt ................................................................................................. 19 Private Market Investments .............................................................................................. 20 Buyouts.......................................................................................................................... 21 Venture Capital............................................................................................................. 21 Non-U.S. Buyouts.......................................................................................................... 22 Distressed Debt............................................................................................................. 22 Mezzanine Debt............................................................................................................. 22 Private Markets Portfolio ............................................................................................. 23
Real Assets........................................................................................................................ 23 U.S. Real Estate Securities............................................................................................ 23 Non-U.S. Real Estate Securities.................................................................................... 24 Private Real Estate (Direct Property) .......................................................................... 24 Timberland.................................................................................................................... 25 Commodity Futures....................................................................................................... 25 Oil and Gas Partnerships ............................................................................................. 27 Real Asset Basket .......................................................................................................... 28 Wilshire’s Historical Forecasts ......................................................................................... 28 Risk and Correlation ......................................................................................................... 29 Appendix A: Appendix B: Appendix C: Appendix D: Appendix E: Appendix F:
Wilshire 2009 Correlation Matrix.............................................................. 30 Wilshire 2009 Private Markets Correlation Matrix.................................... 31 Wilshire 2009 Private Real Estate Correlation Matrix............................... 32 Wilshire 2009 Real Asset Basket Correlation Matrix................................ 33 Historical 1, 5 & 10-Year Rolling Returns: 1926 to 2008......................... 34 Histogram of 1, 5 & 10-Year S&P 500 Index Returns............................... 37
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[email protected]
Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Introduction This report is Wilshire Consulting’s annual study on asset allocation for institutional portfolios. The return and risk assumptions contained within the report should be used for asset-liability and asset allocation studies conducted in 2009. Unless otherwise noted, all return assumptions represent median geometric returns based on a log-normal distribution. The asset allocation process is comprised of four steps. The initial step requires forecasting return, risk and correlation for all asset classes. The second step is client specific and involves a review of a fund’s unique financial commitments. Next, using inputs from the first two steps, an efficient frontier of diversified portfolios is constructed. The portfolios residing on this frontier are specific to each client’s commitments, or spending objectives, and represent varying tradeoffs between expected risk and funding cost or expected risk and real return. The final step is to select an asset mix from the efficient frontier that matches the institution’s attitude toward risk. The research presented here aids in completing the first step of the asset allocation process. Wilshire Consulting works with funds individually to complete the remaining steps and to select the optimal portfolio that best reflects the risk tolerance and environment for that institution. Expected Future Returns At the beginning of each year, Wilshire reviews its long-term return and risk assumptions for the major asset classes. We define “long-term” as forecasts that span at least the next ten years. This extended time horizon is consistent with the benefit/spending obligations of institutional investors, which generally average at least ten years. Wilshire’s forecasting methodology, which will be illustrated in exhibits throughout the paper, has a strong degree of accuracy over intervals of ten or more years and is superior to short-term estimates that are notoriously error prone. As a result of this long-term forecasting horizon, Wilshire’s assumptions typically change very little from year-to-year. However, following periods such as that experienced in 2008, which can be characterized by volatile directional swings in asset markets or relative valuations, one can expect more significant forecasting adjustments. The past twelve to eighteen months have presented some of the greatest economic challenges the U.S. and world economies have faced in decades. As we have discussed in various research notes throughout 2008, what started as a collapse from loose lending practices in the sub-prime area of the mortgage market has triggered a general contagion into the broader credit market. The result to date has been a flight to quality, reflected in historically low yields priced into Treasury securities, and severe sell-offs in risk-based assets. Investment grade and high yield corporate spreads have widened dramatically, while global equity and real estate securities have sold off violently. As we discuss throughout the body of the report, in addition to destroying value in Copyright © 2009, Wilshire Associates Incorporated
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
investment portfolios, the market environment described above presents challenges to the formulation of long-term asset class assumptions. Even models that have proven track records of success must be further scrutinized during times of market stress to ensure their assumptions regarding market “normality” are robust in today’s somewhat dislocated markets. As such, in this year’s report we overlay an increased level of judgment, or “art,” to enhance the pure quantitative signals, or “science,” produced by our models. Wilshire always has recognized the importance of transparency in the forecasting process, particularly as it relates to model inputs, and we remain committed to maintaining that spirit of disclosure by qualitatively detailing our thinking in areas of departure from our traditional models. Several notable areas of change from our 2008 assumptions are inflation, stocks and high yield bonds. Our current inflation forecast is 1.50%, which is 75 basis points lower than our 2.25% forecast last year. As we discuss in the inflation section on page 4, our inflation forecast is more than a percent above what would be suggested by the TIPS breakeven-inflation rate. Our 2009 forecast for U.S. stocks introduces an alternate valuation model to serve as an additional signal to enhance the information from our three-stage dividend-discount model (DDM), which has experienced some forecasting variance in the most recently ended ten-year periods. Both models indicate a 0.25% increase in our public market stock assumptions, which brings our U.S. Stock forecast to 8.50% from 8.25% last year. Finally, despite an embedded input assumption of a record level of defaults in high yield bonds, the dramatic spreads priced into non-investment grade bonds results in Wilshire’s 2009 High Yield forecast of 8.50%, up 1.50% from our 2008 projection. These and all of Wilshire’s other asset class forecasts will be discussed in greater detail in the relevant sections of this report. Long-term return forecasts play an important role in the institutional investment process. Actuarial interest rate assumptions, which are essentially portfolio return forecasts, are intensively scrutinized because of their potential impact on plan contributions. Wilshire has been forecasting asset class returns using forward looking assumptions since 1981 with a strong record of success for ten-year periods. We believe the methods used in this report are intuitive, robust and provide sufficient flexibility to adapt to a rapidly changing landscape. Exhibit 1 presents Wilshire’s 2009 return forecasts and contrasts them with our 2008 assumptions; while Exhibit 2 displays our 2009 projections in graphical form.
Copyright © 2009, Wilshire Associates Incorporated
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Exhibit 1 Wilshire’s Expected Return and Risk Assumptions Total Return 2009
2008 Investment Categories: US Stocks Dev ex-US Stocks Emerging Mkt Stocks Cash Equivalents U.S. Bonds High Yield Bonds TIPS Non-U.S. Bonds US RE Securities Private Real Estate Non-US RE Securities Private Markets Real Assets Commodities
8.25 % 8.25 8.25 3.00 5.00 7.00 4.00 4.75 5.75 6.50 5.75 11.25 n.a. 4.25
Risk
8.50 % 8.50 8.50 2.00 4.00 8.50 3.50 3.75 7.00 7.65 7.00 11.55 6.70 3.50
Change
2008
2009
0.25 % 0.25 0.25 -1.00 -1.00 1.50 -0.50 -1.00 1.25 1.15 1.25 0.30 n.a. -0.75
16.00 % 17.00 24.00 1.00 5.00 10.00 6.00 10.00 15.00 12.25 13.00 26.00 n.a. 13.00
16.00 % 17.00 24.00 1.25 5.00 10.00 6.00 10.00 15.00 12.25 13.00 26.00 8.50 13.00
Inflation:
2.25
1.50
-0.75
Total Returns minus Inflation: U.S. Stocks U.S. Bonds Cash Equivalents
6.00 2.75 0.75
7.00 2.50 0.50
1.00 -0.25 -0.25
Stocks minus Bonds:
3.25
4.50
1.25
Bonds minus Cash:
2.00
2.00
0.00
1.00
1.75
Change 0.00 % 0.00 0.00 0.25 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 n.a. 0.00 0.75
Exhibit 2 2009 Return and Risk Assumptions 18.00
30.00
16.00 25.00
12.00
Risk (%)
10.00 15.00
8.00 6.00
10.00
Return (%)
14.00
20.00
4.00 5.00
2.00
Risk
Geometric Return
Copyright © 2009, Wilshire Associates Incorporated
rit ie s Se cu rit ies U S D S ev to ck ex s Em -U S er S gi to ng ck M s kt St Pr o iv ck at s eM ar ke ts
iti es
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Arithmetic Return
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
These return forecasts are more fully explained in subsequent sections dedicated to each asset class. Historical Returns A key check on the reasonableness of Wilshire’s assumptions is their relationship to historical returns. Exhibit 3 contrasts Wilshire’s return assumptions with historical returns over various periods of time and market scenarios. Exhibit 3 Historical Returns1 vs. Wilshire Forward-Looking Assumptions 1802-2008 *
Historical Returns High Inflation 1926-2008 1970-1979
Bull Market 1980-1999
Wilshire Forecast
Total Returns: Stocks Bonds T-bills
8.0 % 4.9 4.2
9.6 % 5.7 3.8
5.9 % 7.2 6.4
Inflation:
1.4
3.0
7.4
4.0
1.5
Total Returns minus Inflation: Stocks Bonds T-bills
6.5 3.5 2.8
6.6 2.6 0.8
-1.5 -0.2 -1.0
13.8 6.0 3.1
7.0 2.5 0.5
Stocks minus Bonds:
3.0
4.0
-1.3
7.8
4.5
17.8 % 10.0 7.2
8.5 % 4.0 2.0
* Jeremy Siegel return history from 1802-2001 ("Stocks for the Long Run" McGraw-Hill 2002) updated with the S&P 500 Index and Barclays Capitaal Aggregate Bond Index.
There are several notable relationships. Wilshire’s stock and bond return forecasts, 8.5% and 4.0%, respectively, are reasonably close to the actual returns achieved over the 207year period ending 2008. However, since they are off in opposite directions – stocks slightly higher than historical and bonds lower – the 4.5% relative return forecast for stocks versus bonds is significantly higher than the 3.0% historical spread. Our relative return forecast for stocks versus inflation of 7.0% is 0.50% greater than the long-run historical average of 6.5%. The remainder of the report explains the methodologies behind Wilshire’s return forecasts.
Inflation Wilshire’s long-term inflation forecast is 1.50%, which is down 0.75% from a year ago. In recent years it has been Wilshire’s practice to derive its inflation forecast by observing the spread between the yield on a 10-year Treasury and the real yield on a similar maturity Treasury Inflation Protected Security (TIPS). This year however, the current market environment makes using this breakeven-inflation forecasting technique 1
Source of historical returns throughout report is Wilshire Compass unless otherwise noted.
Copyright © 2009, Wilshire Associates Incorporated
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
problematic. The current credit strained environment has investors paying unusually large premiums for quality and liquidity, which contribute significantly to Treasury and TIPS pricing, thus distorting the usually reliable inflation signal implied in the relative yield spread. Although TIPS are issued by the U.S. Treasury, they do not provide the exact same level of liquidity as nominal Treasuries. The severe flight to quality and related demand for liquidity have impacted TIPS pricing relative to nominal Treasuries as investors are demanding a higher yield (lower price) on TIPS than they would under more “normal” circumstances. Another issue with current TIPS is that investor uncertainty concerning future inflation is altering the historical spread relationship between TIPS and nominal bonds. For example in Exhibit 4, the 2-year inflation swap suggests that investors were expecting short-term inflation in excess of 3% at the end of the second quarter. By the end of the third quarter, however, that expectation had dropped to 1% as investors began to consider the possibility of future deflation. Viewing the 10-year breakeven inflation series in this context, it is possible that this short-term uncertainty also is pushing the real yield on longer maturity TIPS higher as the inflation signal on even the longest term bonds (20+ years) would suggest a historically low inflation expectation. As a result, TIPS pricing in the short and long-term seems to suggest that investors are treating longer maturity TIPS as nominal bonds until the inflation picture begins to clear. Exhibit 4 2008 Inflation Expectation Activity through September 4.00
Q2 2008
3.50 3.00
First two weeks of September
(%)
2.50 2.00 1.50 1.00 0.50
10-Yr Breakeven Inflation
28
29
14
30
15
30
13
9/
9/
8/
8/
7/
7/
15
31
2-Yr Inflation Swap
6/
6/
5/
1
16
5/
5/
1
16
4/
4/
2
17
3/
3/
1
16
2/
2/
2 1/
1/
17
0.00
13-Week T-Bill Yield
As can be seen in Exhibit 4, there was a relatively short period of time where investors’ expectations on both liquidity and inflation seemed to change dramatically. The shortterm, 2-year inflation swap begins to fall quickly at the beginning of September. During the first two weeks, the rate fell by more than 100 bps. In approximately the middle of Copyright © 2009, Wilshire Associates Incorporated
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
that same month, Treasury bills fell 140 bps in three days. This volatile market action strongly suggests that the issues described above regarding liquidity began materially distorting market pricing in September. Therefore, rather than somewhat arbitrarily accepting the end-of-year breakeven inflation signal, Wilshire is looking to the period just after these changes appeared to happen – when liquidity and deflation concerns were rapidly re-priced into the market – for the basis of an inflation expectation. The breakeven inflation on a 10-year TIPS bond was 1.61% when short-term Treasury bills fell to nearly zero. By year-end however, TIPS on the open market appeared to be providing a severely distorted view of true inflation expectations. Our 2009 assumption of 1.50% reflects an inflationary environment not seen since the mid-1960’s but nonetheless represents a prudent estimate that recognizes the market’s expectation for some deflation, reflected by a 2-year swap rate of –2.40% at year-end. A number of issues point to deflation being a real possibility, at least in the short-term. Although the monetary base within the U.S. is rising rapidly, banks have yet to loosen their lending restrictions and the consumer has yet to begin spending. A continuing rise in unemployment and drop in GDP also provides uncertainty to the inflation picture. Finally, from a technical perspective, any deflation that does occur would have to then be re-inflated before prices return to current levels. Exhibit 5 provides a summary of Wilshire’s historical inflation forecast and the actual following ten-year result.2 Exhibit 5 Wilshire’s Inflation Forecast and Historical CPI 1982-2008 Wilshire Historic Inflation Estimates
7.5
Annualized Return (%)
6.8
Wilshire Forecast
6.0 5.3
Historical Return
4.5 3.8 3.0 2.3 1.5
Next 10 Yrs
0.8 2006 2007 2008
2003 2004 2005
2000 2001 2002
1997 1998 1999
1994 1995 1996
1991 1992 1993
1988 1989 1990
1985 1986 1987
1982 1983 1984
0.0
2
It is worth noting that TIPS are relatively new and are just now producing a ten-year track record. Therefore, their accuracy in forecasting future inflation can now be measured. Copyright © 2009, Wilshire Associates Incorporated
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Equity U.S. Stocks The equity environment since the fourth quarter of 2007 has been one of the most treacherous periods in history. The U.S. stock market suffered its worst calendar-year loss in seven decades in 2008 as the Dow Jones Wilshire 5000 Composite Index SM was off -37.2%. As can be seen in the histogram of single-year returns in Appendix F, the S&P 500 Index’s -37.0% return in 2008 was the second worst among its 83 annual returns since 1926, surpassing only 1931’s return of -43.4%. From its October 9, 2007 peak to its November 20, 2008 low, the DJ Wilshire 5000 was down -51.6%, but ended the year with a 22.0% rally off of those lows. It is Wilshire’s practice to employ a dividend-discount model (“DDM”) to forecast longterm U.S. stock returns. With the notable exception of periods beginning in the late 1980s and early 1990s, Wilshire’s DDM forecast has been a very good predictor of the market’s return during the following ten-year period. Actual ten-year returns that began in those years include the technology bubble of the late 1990s, something we would not expect our methodology to predict. Exhibit 6 below charts the performance of the DDM forecast (blue line) against the actual market return for the ten-years following (thick black line) over the past 30 years. As the chart reveals, Wilshire’s DDM forecasts prior to the bubble and from 1992 through 1996, which span both the inflating and deflating of the bubble, were consistent with actual S&P 500 returns for the subsequent ten years. For the past two rolling ten-year periods, however, while the DDM forecast was signaling lower returns, it was unable to fully anticipate the negative equity environment. Exhibit 6 Equity Model Forecasting Accuracy 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% ‐5.00%
19 3 19 6 39 19 4 19 2 45 19 4 19 8 51 19 5 19 4 5 19 7 60 19 6 19 3 66 19 6 19 9 72 19 7 19 5 78 19 8 19 1 84 19 8 19 7 9 19 0 9 19 3 9 19 6 99 20 0 20 2 0 20 5 08
‐10.00%
Nex t 10‐Y r
Copyright © 2009, Wilshire Associates Incorporated
I+ G + V
DDM
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Correctly projecting an outlier long-term stock return such as the -1.4% annualized performance experienced over the past ten years is challenging. For perspective, the ten years through 2008 have delivered one of only three such periods with negative stock returns out of 74 ten-year observations since the early 1930s (see the ten-year return histogram in Appendix F). Challenges aside, Wilshire Consulting continuously evaluates additional methods that may prove valuable in enhancing the quality of our long-term stock forecasts. For example, the green line in Exhibit 6 from above plots the historical forecast of an Income plus Growth plus Valuation Change model (IGV) that we believe provides a valuable forecasting signal. The IGV model utilizes the market’s current dividend yield for Income, the historical dividend growth rate for Growth and assumes a market price in ten years that leads to the historical average dividend yield. The model is attractive for a variety of reasons: it avoids the necessity of making any heroic assumptions as it relies solely on past relationships, its dependence on limited and readily available data facilitates long historical evaluation periods and, most importantly, its forecasting signal seems accurate over many market environments and cycles. Of course some of its strengths, such as only using historical data, can be viewed as a weakness in not being able to foresee systemic shifts in market fundamentals. While the inputs could be questioned for their historical bias, they are complimentary when combined with our DDM approach which uses forward-looking estimates of earnings and dividends. Using the two models together with their complimentary inputs gives us greater confidence in our forecasts, especially when the two signals correspond. As such, we use the IGV model and other valuation tools as additional signals to help validate or question the DDM forecast and point to the IGV model’s pessimistic view of equity returns leading in to the latest ten-year periods as solid evidence of its potential value in this role. In light of the current market volatility and uncertainty, we gain some greater confidence in seeing that both the DDM and IGV models are producing similar return signals for the coming years; suggesting a long-term U.S. stock forecast of 8.50%. Wilshire’s current expected return for stocks incorporates the following DDM assumptions: ¾ A year-end 2008 S&P 500 Index price of 903, down sharply from 1,468 a year earlier; ¾ A base earnings level of $62.4 per share, down significantly from $82.5 per share a year earlier; ¾ Earnings-per-share growth of 7.25% during the next five years, dropping incrementally to 4.0% from years six through 15; ¾ A 40% dividend payout ratio over the next five years, increasing incrementally from years six through 15 to 45% - its historical average over the past quartercentury. Wilshire’s assumption of 7.25% earnings growth over the next five years is based on the historical relationship between the I/B/E/S “bottom-up” security level median five-year Copyright © 2009, Wilshire Associates Incorporated
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
long-term earnings growth rate and the actual five-year earnings growth rate following the forecast. The historical relationship between these two suggests the “bottom-up” estimate is consistently overly optimistic and prone to significant “over shoot” error. Therefore, in light of a year-end bottom-up long-term growth rate estimate of 10.5%, we expect the earnings growth rate over the next five years to be 7.25%. We expect dividend payout ratios to move towards their historical average of 45% during the next 15 years. Exhibit 7 details the history of Wilshire’s stock return forecasts together with the dividend-discount and IGV models return forecasts, historical returns, and the rolling returns for the ten-year period following each estimate.
Year End 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Historical Return
Next 10 Yrs DDM
S&P 500 1926 to 10.30 10.08 10.37 10.32 10.32 10.18 10.53 10.70 10.99 11.21 11.34 11.04 10.70 10.20 10.42 10.42 10.35 10.42 10.35 9.61
DDM at 12/31 11.23 11.33 10.42 9.93 9.91 10.80 9.99 9.53 9.14 8.66 9.17 9.72 8.66 7.88 7.65 7.90 8.31 8.29 8.30 8.52
Copyright © 2009, Wilshire Associates Incorporated
IGV at 12/31 9.86 12.72 8.25 7.62 6.98 7.45 4.17 3.12 0.13 -3.21 -5.58 -5.53 -4.61 -1.32 -2.59 -1.57 0.52 0.70 2.28 9.06
Wilshire Forecast 11.50 11.50 10.50 10.00 10.00 10.50 9.50 9.50 9.00 8.75 9.25 9.50 8.75 8.00 7.75 8.00 8.25 8.25 8.25 8.50
2008
2006
2004
2002
1998
1996
1994
1992
1990
1988
IGV
1986
1984
Wilshire Forecast
2000
20.0 18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 1982
Annualized Return (%)
Exhibit 7 Wilshire Stock Return Forecast vs. DDM Return, IGV Return, Historical Return & Actual 10-Year Return Following Forecast
S&P 500 Next 10 Yrs 18.21 17.46 12.94 9.34 11.06 12.07 9.08 8.42 5.92 -1.39
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Developed ex-U.S. Market Stocks Wilshire uses the same 8.5% expected return for non-U.S. stocks of developed markets as it does for U.S. stocks. While this view has gained wider acceptance in recent years, some institutional investors and their money managers assume that the non-U.S. developed stock market will generate somewhat higher returns than U.S. stocks. As demonstrated in Exhibit 8, the historical record does not support a non-U.S. return premium. Exhibit 8 Historical Returns: 1970 – 2008
S&P 500 Index MSCI EAFE Index Europe Pacific
U.S. Dollar Return Risk 9.5 % 15.4 % 9.0 16.9 9.3 17.0 9.1 20.6
Local Currency Return Risk 9.5 % 15.4 % 7.2 14.6 8.8 15.4 6.3 17.3
Reliable returns for non-U.S. stocks are available beginning in 1970. Since that time U.S. stocks, as represented by the S&P 500 Index, have returned 9.5% per year, versus 9.0% for developed market non-U.S. stocks as measured by Morgan Stanley Capital International’s (“MSCI”) EAFE Index in U.S. dollars. Given this long-term performance record, similar risk levels, and common financial attitudes toward risk-taking, it would seem reasonable to forecast similar long-term returns for the U.S. and non-U.S. developed stock markets. In fact, evidence might suggest slightly lower expected returns on international stocks due to higher costs (transaction costs, taxes and dividend withholding) of investing outside U.S. markets. Exhibit 9 includes the period from mid-1985 through most of 1995 during which the MSCI EAFE Index outperformed the S&P 500 Index due to the then robust Japanese market. However, the subsequent 11-plus years of out-performance by U.S. stocks versus non-U.S. stocks supports our assumption that the economic theories of Purchasing Power Parity (“PPP”) and Interest Rate Parity (“IRP”) prevail over long time periods and justify the selection of a single return assumption for both asset classes.
Copyright © 2009, Wilshire Associates Incorporated
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
25%
20% 15% 10% 5% 0%
-0 7
-0 5
D ec
-0 3 D ec
D ec
-9 9
-0 1
MSCI - Pacific Index ($Net)
20% 15% 10% 5%
MSCI - EAFE Index ($Net) MSCI - Pacific Index ($Net)
S&P - 500 Index MSCI - Europe Index ($Net)
5
3
1
9
7 D ec -0
D ec -0
D ec -0
D ec -0
D ec -9
5
3
7 D ec -9
D ec -9
D ec -9
1 D ec -9
9 D ec -8
5
3
1
9
7 D ec -8
De c8
D ec -8
D ec -8
5
7 D ec -0
De c0
3 D ec -0
1 D ec -0
7
9 D ec -9
5 D ec -9
S&P - 500 Index MSCI - Europe Index ($Net)
De c9
1
9
3 D ec -9
D ec -9
7 D ec -8
D ec -8
3
5 D ec -8
D ec -8
1
0% D ec -8
9
-5%
D ec
-9 7
30%
25%
Rolling 10-Year Risk
30%
D ec -7
D ec
-9 5
D ec
D ec
-9 1
-8 9
-9 3 D ec
D ec
-8 7
MSCI - Europe Index ($Net)
D ec -7
Rolling 10-Year Returns
MSCI - EAFE Index ($Net)
D ec
D ec
-8 3
D ec
-8 1
D ec
D ec
D ec
-8 5
25% 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% -7 9
Rolling 10-Year Returns Relative to S&P 500
Exhibit 9 Rolling 10-Year Return & Risk Comparisons
MSCI - EAFE Index ($Net) MSCI - Pacific Index ($Net)
With the deficiency of concrete evidence that supports a non-U.S. equity return premium, Wilshire forecasts an 8.5% return for non-U.S. stocks of developed nations, the same as for U.S. stocks. Emerging Market Stocks Money managers have long supported the view that emerging markets should produce returns above the developed EAFE markets. Poor returns in the late 1990s combined with emerging markets’ high volatility have, however, caused some managers to reevaluate their position. In fact, it is important to understand that the historical record on emerging market performance is short and shows mixed results. This gives us little confidence in predicting a return premium to emerging markets above our return forecast for the developed stock markets. For example, prior to 2004, the historical return of the MSCI Emerging Markets Index was 12.4%, almost directly in line with the 12.5% return on the S&P 500 Index during the same period. The last five years, however, have seen emerging markets outperform developed equity markets by a wide margin. This has caused the relative returns for emerging markets to again be superior to those of the developed markets, as measured from the start of the MSCI Emerging Markets Index, in a similar fashion to that seen in the early 1990’s. As shown by the rolling 5-year relative return line in Exhibit 10, this appears to be a cyclical phenomenon and as such is insufficient justification to support a long-term return premium. The rolling 10-year relative return line demonstrates the questionability of anticipating a sustainable return premium for emerging stocks.
Copyright © 2009, Wilshire Associates Incorporated
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Exhibit 10 Emerging Market Returns: 1988 – 2008
Risk 14.3 % 24.0
30% 20% 10% 0% -10% -20% -30% -40% D ec -9 D 2 ec -9 D 3 ec -9 D 4 ec -9 D 5 ec -9 D 6 ec -9 D 7 ec -9 De 8 c9 D 9 ec -0 D 0 ec -0 D 1 ec -0 D 2 ec -0 D 3 ec -0 D 4 ec -0 D 5 ec -0 De 6 c0 D 7 ec -0 8
MSCI Emerging Mkts Rolling 5 Yr. & 10 Yr. Returns Relative to S&P 500
S&P 500 Index MSCI Emerging Markets
U.S. Dollar Return 8.8 % 11.2
Rolling Excess 5-Yr Return
Rolling Excess 10-Yr Return
Wilshire recommends an emerging market expected return equal to the return for developed markets, rather than assuming a small return premium to emerging markets. Our research shows that efficient portfolios include a small allocation to emerging markets, consistent with a market-weighting, even with a level of return equal to that of the developed equity markets. For example, an efficient frontier constructed from Wilshire’s underlying assumptions for U.S., non-U.S. developed market and emerging market stocks suggests an allocation of approximately 13.5% to emerging markets at a 16% risk level, which is the expected risk level of global stocks. This allocation is above the emerging markets’ 9.5% weight within the global opportunity set, reflecting a relative attraction to emerging market stocks despite their elevated risk level. Global and Global ex-U.S. Market Stocks Despite creating separate forecasts for the developed and emerging markets as discussed above, Wilshire’s asset allocation work – unless otherwise directed by client circumstances – will implicitly assume a market weighted combination of our non-U.S. developed and emerging market components in a single non-U.S. equity asset class. The emerging markets component will be market-weighted, which, as of 2008 end of year market values, represents approximately 17% of total non-U.S. equity. This approach is consistent with Wilshire’s treatment of the U.S. stock market where large stocks are not separated from small stocks and value stocks are not separated from growth stocks in the asset allocation process. Wilshire believes that emerging markets have become sufficiently integrated into the fabric of institutional money management that market capitalization weighting will give most investors a near optimal return/risk tradeoff. Copyright © 2009, Wilshire Associates Incorporated
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
In this framework, emerging stock markets become a risk management or diversification vehicle rather than an asset class that is expected to generate higher long-term returns. Some clients, including most non-U.S. fund sponsors, may prefer to treat emerging markets as a separate asset class. Such an approach is easily accommodated and is well supported by our practice of deriving separate assumptions for the developed and emerging markets. A market-weighted blend of our developed ex-U.S. and emerging market stock forecasts leads to a combined global ex-U.S. equity return of 8.7%, or a 20 basis-point premium to each of the underlying components, which is due to the complementary nature of combining diversifying sub-asset classes. Wilshire can build the process up one step further for clients that view the entire global equity market as a single asset class; thus completely eliminating any home-country equity bias within their portfolios. Within this context, we construct the global marketweighted portfolio with allocations of 45% to U.S. stocks and 55% to the Global ex-U.S. market, resulting in an 8.7% return forecast at 16% estimated risk.
Fixed Income U.S. Treasury Bonds: Market and Long Term Wilshire’s return assumption for Treasuries has historically been derived from the yieldto-maturity on the Barclays Capital (formerly Lehman Brothers) Treasury indexes with no assumed permanent change in interest rates. However, this year’s deviation in forecasting inflation naturally leads us to re-model our Treasury assumptions – and those for the entire fixed income market segment. As the economy’s inflationary environment typically affects the Federal Reserve’s rate decisions, our inflation assumption of 1.50% provides the basis for our Treasury bond assumptions. The methodology used looks at the historical difference between Treasury yields and inflation, which has averaged 2.50% since 1973. Wilshire is assuming that the market will “normalize” at some point during the next ten years and that the yield on the Treasury Index will reach that historical spread above inflation, or 4.00% based on our inflation assumption. Rising rates will affect a current investment in Treasuries in two ways: 1) the principal value will decline as rates rise and 2) the reinvestment rate will increase at the same time. Based on the December 31, 2008 yield-to-maturity of 1.55% of the Barclays Treasury Index and its duration, Wilshire’s model indicates that the improving reinvestment rate during the next ten years will provide a boost to the Treasury Index. A simulated investment in Treasuries under this environment would yield a return of 2.00%, which is our 2009 return forecast. The same model applied to the Long Term Treasury Index reveals that a rising rate environment would be a detriment to long term bonds as the decreasing principal value is too great for the higher reinvestment rate to compensate. Based on the Barclay’s Long Term Treasury Index year end yield-to-maturity of 2.97% and its duration, a simulated investment would return 2.50%, which is our 2009 assumption.
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
U.S. Bonds The core bond market as represented by the Barclays Aggregate Bond Index is comprised of four major segments: Treasuries, Government-related, Corporate and Securitized. Again due to our inflation and Treasury assumptions, Wilshire modeled the remaining three segments based on an environment of not just rising Treasury rates but also decreasing spreads to a historically-based average. Simulated investments showed that, besides the improving Treasury bond environment, Government-related investments would also receive a boost in return while Corporate bonds would suffer from a decreasing spread, and therefore decreasing reinvestment rate. Our model suggests that the net effect is a wash for an investment in the core market with an expected return of 4.00% versus the Index’s yield-to-maturity of 3.99% on December 31, 2008. The U.S. yield curve dropped dramatically during 2008 and also steepened on the short to intermediate portion of the curve. Exhibit 11 illustrates the yield curve shift and compares the current curve to the historical 10 and 20-year averages. Current yields are lower than recent history across the term structure. The current spread between the tenand two-year yield is 1.49 versus 1.04 for the ten-year average and 0.92 for 20-years. The spread between the 30 and ten-year yield is 0.44 versus 0.42 and 0.38 for the ten- and 20-year averages, respectively. As will be explained in the discussion of U.S. TIPS, the Barclays 7-10 Year Treasury Index provides the supporting data for our TIPS forecast. Exhibit 11 Historical Treasury Yield Curves 7.00 6.00
Yield (%)
5.00 4.00 LB 10-20 Yr
3.00
LB LT Treasury LB 7-10 Yr
2.00 LB Treasury LB 3-5 Yr
1.00 0.00 0
5
10
15
20
25
30
Maturity Dec-08
10-year avg
20-year avg
Dec-07
Source: Barclays Capital, U.S. Department of Treasury
Exhibit 12 below compares Wilshire’s past bond return assumptions with historical returns, yields and the rolling returns for the ten year period following each forecast. The accuracy of Wilshire’s forecast methodology of future long-term returns is confirmed by
Copyright © 2009, Wilshire Associates Incorporated
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
the tight relationship between the forecast line and the rolling ten-year historical return line depicted below. Exhibit 12 Wilshire Bond Return Forecast vs. Current Yield, Historical Return, & Actual 10-Year Return Following Forecast 14.0
Barclays Agg Yield
Annualized Return (%)
12.0 10.0
Next 10 Yrs 8.0 6.0
Wilshire Forecast
4.0
Historical Return 2.0
Year End 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Barclays Agg 1926 to 5.24 5.30 5.45 5.48 5.54 5.42 5.59 5.56 5.62 5.66 5.57 5.65 5.69 5.74 5.72 5.71 5.66 5.65 5.66 5.66
Barclays Agg Yield at 12/31 8.66 8.52 6.70 6.64 5.82 8.21 6.01 6.69 6.24 5.65 7.16 6.43 5.60 4.06 4.15 4.38 5.08 5.34 4.90 3.99
Copyright © 2009, Wilshire Associates Incorporated
Wilshire Forecast 8.50 8.50 7.00 6.50 6.50 7.00 6.00 6.50 6.00 5.75 6.75 6.25 5.50 4.75 4.50 4.75 5.00 5.25 5.00 4.00
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
0.0
Lehman Agg Next 10 Yrs 7.69 7.96 7.23 7.51 6.95 7.72 6.16 6.24 5.97 5.63
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Cash Equivalents Wilshire blends two methodologies in forecasting returns for cash equivalents: a “Yield Curve Approach” and an “Inflation-plus Approach.” The yield curve approach starts with the yield-to-maturity on Treasury bonds and subtracts the average yield premium between short and long bond yields. For 2009, we will be using our 2.00% Treasury assumption instead of the market yield. A 20-year average is used and allows for changes in market conditions while avoiding undesirable swings in the assumed premium. As of December 31, 2008, the 20-year yield curve premium averaged 1.30%, resulting in a 0.70% cash return forecast. Alternatively, the inflation-plus approach adds a short-term real return component to our inflation rate forecast. During the past half-century, real returns for Treasury bills have averaged 1.66% that, when added to our 1.50% inflation rate assumption, equals a 3.16% cash return forecast. An equal blend of the two approaches, rounded to the nearest 0.25%, leads to a 2.00% cash return forecast. Exhibit 13 compares Wilshire’s yield curve approach, inflation-plus approach and a 50/50 blend of the two approaches with the Treasury bill return for the rolling ten-year period following each estimate. Focusing on the red line depicting a 50/50 blend of the two approaches and the black line depicting the Treasury bill rolling ten-year return, it appears that the 50/50 blend serves as a relatively accurate predictor of cash equivalents for the forward ten-year period. Exhibit 13 Wilshire’s Cash Equivalents Forecast vs. Actual 10-Year Return 10.00
Annualized Return (%)
9.00 8.00 7.00 6.00 5.00 4.00 3.00 2.00 1.00
Yield Curve Approach
Inflation plus Approach
BLEND
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
0.00
Actual
Source: Wilshire Compass, U.S. Department of Treasury
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Non-U.S. Bonds Investment theory suggests that non-U.S. bond yields will be equivalent to core U.S. bond yields when currency adjustments are taken into account. This would imply using the same 4.00% core U.S. bond return forecast for non-U.S. bonds. Our experience, however, shows that custodial costs, taxes, transaction fees and a higher credit quality versus the U.S. bond market, due to the large proportion of government debt in non-U.S. bond indexes, reduce the non-U.S bonds return by 25 basis points. Thus, our methodology results in a 3.75% expected return for non-U.S. bonds. Exhibit 14 compares historical core U.S. bond return and risk values3 with hedged and unhedged values of the Citigroup Non-U.S. Government Bond Index. Exhibit 14 U.S. vs. Non-U.S. Bond Returns (1985 through 2008)
Core U.S. Bonds Citigroup Non-U.S. Govt.
U.S. Dollar Local Currency Return Risk Return Risk 8.1% 4.8% 8.1% 4.8% 10.0% 11.6% 7.5% 4.1%
Unhedged non-U.S. bonds offered better returns over the 24-year period due to a net fall in the dollar, in aggregate, for the entire time period. Hedged non-U.S. bond returns take out expected and unexpected currency movements and exhibit returns 60 basis points below core U.S. bonds at less risk. A long-term forecast for non-U.S. bonds should not include a currency return, positive or negative, and should rely upon historical hedged returns. Risk forecasts, however, should come from the experience of the unhedged indexes unless a hedged strategy is employed. In summary, Wilshire is using a 3.75% expected return for unhedged non-U.S. bonds and a 3.65% expected return for hedged non-U.S. bonds, with a ten basis point deduction in return due to expected additional hedging costs. Treasury Inflation Protected Securities (TIPS) Wilshire typically recommends using an expected return for Treasury Inflation Protected Securities (TIPS) equal to the expected return for nominal Treasury bonds of similar maturity. This year however, because Wilshire is forecasting future inflation that differs from what is currently priced into the TIPS market, our return forecast methodology for TIPS must reflect this change. As a result, if our inflation forecast proves accurate, TIPS investors will benefit above nominal Treasury bond returns as breakeven inflation adjusts. Therefore, we are adding an “inflation surprise” to our traditional TIPS forecast. This inflation surprise is equal to the difference between our inflation assumption (1.50%) and the breakeven inflation currently priced into a 10-year TIPS (0.25%), or 3
Wilshire uses the Barclays Aggregate U.S. Bond Index as the principal benchmark for U.S. Core Bonds.
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
1.25%. Thus, Wilshire’s 2009 return forecast for TIPS is 3.50%; equal to the 2.25% yield-to-maturity of similar maturity Treasury bonds plus an inflation surprise of 1.25%. Long-Term Bond Beginning in 2009, Wilshire’s return assumption for long-term bonds will be derived from the yield-to-maturity on the Barclays Long Term Government/Credit Index. Previously, we had utilized the Citigroup Large Pension Fund (LPF) Index. Both indexes are comprised of government and credit securities with relatively long term maturities. The Barclays index consists of Treasuries, government-related and corporate securities with a minimum maturity of ten years. Like with the core bond market, we modeled the various sectors within the index due to our custom return forecast for long-term Treasuries. Also like with the core market, our assumptions of rising interest rates and shrinking credit spreads are projected to result in no net return difference from what the current yield-to-maturity would suggest. Our return forecast for long-term bonds is 5.00% versus the yield-to-maturity of 5.03% on the Barclays index as of December 31, 2008. While the assumption is greater than our long-term Treasury assumption of 2.50%, the difference is due to the inclusion of spread products in the long core index. High Yield Bonds Wilshire’s return forecast for high yield bonds is 8.50%. This return forecast is based upon our high yield bond model that accounts for the dynamic nature of credit yield spreads, defaults and recoveries. Wilshire’s 8.50% high yield expected return incorporates the following assumptions: ¾ An initial yield spread of 17.75%, up from 6.04% one year prior; ¾ An initial default rate of 15.00%, decreasing incrementally over a three-year explicit period to a historical 4.50% long-run average; ¾ A ten-year cumulative annual default rate of 60.75%; ¾ An initial recovery rate of 25.00%, increasing incrementally over a three-year explicit period to a historical 40.00% long-run average; ¾ A ten-year cumulative annual loss rate – defaults minus recoveries – equal to 39.40% versus 20.70% last year. Wilshire’s high yield bond model incorporates the ability to input variable default rates. In Exhibit 15 we graph Wilshire’s expected future default rates against all historical cumulative default rates from 1970 through 2007. Each line represents the historical cumulative default rates for high yield bonds issued in a single vintage year. The dark solid line is Wilshire’s forward-looking default rate that is used in our expected return model for high yield bonds. Wilshire’s default forecast line represents default expectations for a market portfolio holding bonds issued across various years. While it differs in nature from the vintage year default lines, which represent cumulative default
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
rates specific to each single year of issue, the chart is useful in comparing our projection to historical default rate paths. Exhibit 15 Historical Cumulative Default Paths - 1970 to 2007
Cumulative Default Rate (%)
70 60 50
Wilshire Projection: 2009 to 2019
40 30 20 10 0 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
No. of Years from Issuance Source: Moody’s Investor Service
Our previous research on high yield bonds4 explains the rationale behind Wilshire’s longterm return forecasting methodology in greater detail. Emerging Market Debt In the context of a portfolio, emerging market debt can be viewed as a spread product among other high yield fixed income components providing access to unique country specific risk5. As such, returns to emerging market debt can be forecasted using modeling techniques similar to other credit instruments. Wilshire’s 8.25% emerging market debt expected return incorporates the following assumptions: ¾ An initial yield spread of 8.60%; ¾ An initial default rate of 4.00%, decreasing incrementally over a three-year explicit period to a historical 1.34% long-run average; ¾ A ten-year cumulative annual default rate of 17.39%; ¾ A constant 38.00% recovery rate, equal to the historical average recovery rate; ¾ A ten-year cumulative annual loss rate – defaults minus recoveries – equal to 10.78%. 4
Wilshire Associates Incorporated (2005). High Yield Market Update: Yang. Details on Wilshire’s forecasting methodology; Working Paper: Emerging Markets Debt: Bonafede, Foresti, and Browning.
5
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Private Market Investments The slowdown in mergers and acquisition activity that began in late 2007 intensified in 2008 as the tightening credit environment severely strained deal financing. Global M&A activity dropped from $4.2 trillion in 2007 to $2.9 trillion in 2008. The 31% decrease brought M&A volume back to near 2005 levels as depicted in Exhibit 16 below. Exhibit 16 Global M&A Volume ($ trillions) – 2004 to 2008 $4.5 $4.0 $3.5 $3.0 $2.5 $2.0 $1.5 $1.0 $0.5 $0.0 2004
2005
2006
2007
2008
Source: Citi, Thomson Reuters
A large contributor to the drop in takeover activity was the result of a spike in the level of announced transactions that were terminated prior to completion. An estimated $740 billion of transactions were terminated in 2008, representing a dramatic 85% jump from 2007, charted below in Exhibit 17. Exhibit 17 Terminated Deals ($ billions) – 2000 to 2008 $800 $600 $400 $200
08 20
07 20
06 20
05 20
20
04
03 20
02 20
01 20
20
00
$0
Source: Citi, Thomson Reuters
Wilshire’s assumptions for individual private market asset classes are contained in Appendix B together with risk and return comparisons to some of the major public asset Copyright © 2009, Wilshire Associates Incorporated
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classes. Our private market return expectations are based upon drawing parallels to the public markets where appropriate. Further detail on Wilshire’s methodology is available in part two of our three part series on private equity investing.6 Return forecasts are shown in the first row of Appendix B. Wilshire’s risk forecasts, which are expressed as standard deviations of annual returns, are reported in row two of Appendix B. Risk estimates for the Private Market asset class pose a unique challenge because infrequent private market investment valuations preclude the calculation of short-term periodic returns. As a result, projections of risk based on accounting data consistently understate risk. Wilshire’s approach has thus been to estimate risk by drawing parallels to the public markets and adjusting for any added risk contributed by financial leverage, the absence of liquidity, or greater business risk. The remaining rows in Appendix B contain correlation forecasts. Again, these estimates come from parallels to the public markets and are useful in assessing the diversification benefits of private markets. In general, Wilshire views the use of private equity as a type of super-charged equity return rather than a diversification tool. The linkage between these markets is quite intuitive, as private equity returns are subject to the receptiveness of the capital markets to generate potential outsized returns. Buyouts Our expected return for U.S. buyouts is 10.00%. The assumption is that buyouts will exhibit similar business risks as publicly traded companies but will have greater financial risk. Therefore, it is appropriate to model buyout returns using public market proxies for equity returns and financing costs. Wilshire’s Buyout return forecast is unchanged from last year, as the 0.25% increase in our underlying public equity forecast is offset by increased financing costs. All expected returns in Appendix B are intended to be net returns. For example, the 10.00% expected return for buyouts should be viewed as net of all fees, including carried interest. Wilshire’s risk forecast for U.S. buyouts is 28.0%. This forecast is considerably higher than the 16.0% risk level we assume for public stocks and is attributable to greater financial risk due to a more leveraged capital structure in buyout companies. Our leverage assumption is based on a capital structure with 40% short-term debt, 20% high yield debt, and 40% equity for buyouts, which is consistent with historical measurements. Venture Capital Wilshire’s return assumption for venture capital is 12.50%, up 50 basis points from last year and consistent with our view on the public markets. The valuation of venture capital investments can vary by manager. This mix of current and stale valuations becomes an issue when aggregating venture performance for use in asset allocation. Therefore the 6
Wilshire Associates Incorporated (2002). Private Equity Investing Part 2 – Generating Asset Class Assumptions.: Foresti and Toth.
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presence of stale valuations suggests that to the extent venture capital performance is related to public market performance it will have some sensitivity to both recent and past returns. By including lagged data from the public markets, a more correct beta can be derived versus one naively found with a regression on contemporaneous data. Our analysis indicates that venture capital exhibits a beta of 1.7 to the public market. Using the familiar CAPM formula E ( r ) = β ( Rm − R f ) + R f , we can derive an expected return for venture capital. This return estimate makes intuitive sense as investors should demand a return premium for making venture investments considering the uncertainty inherent in investing in new ventures. Non-U.S. Buyouts Wilshire’s return and risk forecasts for non-U.S. buyouts follow the same methodology used for U.S. buyouts with two changes: non-U.S. developed market equity is used as a public market proxy instead of U.S. equity and Wilshire’s non-U.S. bond assumption is used as the corporate debt proxy. The result is a 10.00% expected return and 30.00% risk. Distressed Debt The Citigroup Global Markets Bankrupt/Defaulted Debt Index was selected as a public market proxy for distressed debt investments. The index contains virtually all issues in default. The 19.00% risk forecast and correlations reported in Appendix B for distressed debt are based upon historical measurements for the Citigroup Index. The 10.00% expected return for distressed debt comes from our view that successful distressed investors take equity-like control positions in distressed companies with significant upside potential but less risk than other buyouts because companies have already encountered financial distress. Our analysis suggests that one of the benefits of including distressed debt in a private markets portfolio is its low correlation with public asset classes, particularly stocks, when compared with other private market asset classes. Mezzanine Debt Wilshire views mezzanine debt like a convertible bond. However, unlike publicly traded convertibles with characteristics combining stocks and bonds, mezzanine debt possesses characteristics combining buyouts and high yield bonds. Consequently, we expect their return and risk measures to lie somewhere between buyouts and high yield bonds. Therefore, the 9.75% return and 19.00% risk forecast for mezzanine debt in Appendix B is based upon a blend of our buyout and high yield assumptions.
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Private Markets Portfolio The return and risk forecast for a diversified private markets portfolio is provided in Appendix B. The makeup of the private markets portfolio is: U.S. Buyouts Venture Capital Non-U.S. Buyouts Mezzanine Debt Distressed Debt
50% 20% 20% 5% 5% 100%
When the components are geometrically calculated with a lognormal assumption, the forecast return for a diversified private markets portfolio is 11.55%, or approximately three percent above the 8.50% expected return for U.S. stocks. The expected risk for the diversified private markets portfolio is 26%, which is consistent with last year’s forecast at slightly more than 1.5x the forecasted risk of U.S. stocks.
Real Assets Asset correlation, or the degree to which asset prices move in tandem, results from a common sensitivity to underlying economic forces (i.e. growth, employment, inflation). Real assets, in particular, share a positive correlation to inflation and consequently, can partially hedge real asset investment values against inflationary environments. This connection with inflation generates a relatively low correlation with other traditional assets; therefore Wilshire groups the discussion of Real Estate, Timberland, Commodity Futures, and Oil and Gas Partnerships into a Real Assets7 section. While we consider TIPS a member of the real asset class, they are absent from this section as a discussion of our TIPS methodology was included in the Fixed Income section above. U.S. Real Estate Securities Wilshire is forecasting an expected return of 7.00% for U.S. real estate securities, up from last year’s forecast of 5.75%. This assumption is derived from combining the oneyear average Equity REIT dividend yield for 2008 of 5.80% with an expected dividend growth rate of 1.13%. Examining REIT dividend growth historically, Wilshire found that REITS were able to pass through about three-quarters of long-run inflation through rent and dividend increases. The 1.13% expected dividend growth equals three-quarters of Wilshire’s 1.50% inflation forecast. The REIT sector followed up a -17.6% decline in 2007 with a -39.2% loss in 2008. Exhibit 18 shows that while the REIT dividend yield increased steadily throughout the year and jumped quite sharply in November; this increase is the direct result of falling 7
Wilshire Associates Incorporated (2007). Real Asset Investments. Browning. 08/06/2007.
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index values and is a key reason for the increase in the expected return forecast for U.S. Real Estate Securities. Exhibit 18 REIT Dividend Yield 10.00 9.00
(%)
8.00 7.00 6.00 5.00 4.00 3.00 Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dividend Yield NAREIT
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
12 per. M ov. Avg. (Dividend Yield NAREIT)
Source: FTSE Group and the National Association of Real Estate Investments Trust
Non-U.S. Real Estate Securities Wilshire’s usual practice is to assume comparable non-U.S. and U.S. returns within a global asset class containing regional components. Within this context we often employ a market or model based approach to forecasting the U.S. component return, which we then build into a non-U.S. component assumption. Similar to our equity assumptions, we forecast a long-term return for U.S. real estate securities and then expand that result to serve as our non-U.S. real estate securities return forecast. While the historical record for global real estate securities is short, it does not support a non-U.S. return premium and until strong evidence supports otherwise, we are comfortable assuming a similar return globally. This approach leads to our 7.00% long-term return forecast for non-U.S. real estate securities. Private Real Estate (Direct Property) Private real estate investments with the exception of infrastructure8 can be divided into three primary subsets: core, value-added, and opportunistic. Wilshire’s return assumption for private real estate is 7.65% and is based on a private real estate portfolio consisting of 70% core, 15% value-added, and 15% opportunistic property investments. The 115 basis point increase in our private real estate return mainly reflects an increase in the capitalization rates of the individual components in our private real estate portfolio. These private real estate asset weightings are flexible and dependent on a client’s investment objectives. Wilshire’s assumptions for individual private real estate asset classes are contained in Appendix C together with comparisons to some of the major 8
Wilshire Associates Incorporated (2007). Infrastructure Investing.: Dudkowski and Toth.
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public asset classes. As mentioned above, the private real estate portfolio can be broken up into three categories: core, value-added, and opportunistic. Core real estate investments are characterized by larger properties with more stable cash flows, less utilization of financial leverage and a lower level of risk than the other real estate investment strategies. Valueadded investments in the real estate market are characterized by improvements in a number of attributes. Value-added real estate investors are able to create wealth by developing new properties as well as redeveloping underperforming properties through physical, financial and operational upgrades. Investing in opportunistic real estate occurs after the cyclical nature of assets in different geographies and property types cause market values to fall. The opportunistic investor attempts to successfully exploit inefficient market pricing through property selection and market-timing while at the same time managing risk appropriately. For a more detailed discussion on Private Real Estate Investing, please refer to Wilshire’s 2006 research paper “Private Real Estate Investing.” Timberland Timberland Investment returns are driven by four primary components: biological growth, the market price for timber, the market price for land, and the skill of active management. Wilshire’s return assumption for the timber asset class is 6.50% and is based on a return attribution of 5.00% annual biological growth and a 1.50% increase in timber market prices. The timber market price component is consistent with our inflation forecast and reflects the ability of timberland products to capitalize expected and unexpected inflation over long time periods. The holding period return to land is assumed to be negligible, and thus estimated to have no addition to return unless successful management is employed. Active timber management is thus viewed as a source of excess return, which in our forecast is assumed to contribute 0% net-of-fees across the universe of timber managers. Wilshire forecasts the risk for the timberland asset class to be 15.00%. For a more detailed discussion on our forecast methodology, please refer to Wilshire’s 2007 research paper “Timberland Investments – Does the Return Fall Far From the Tree?” Commodity Futures Commodity futures index investments staged a particularly acute performance reversal mid-way through 2008 in response to global economic forecasts dominated by the affects of global de-leveraging. Increasing signals of deflationary pressure on the horizon also dampened investor interest significantly. However, while commodity futures investment demand may continue to moderate in the short-term, their unique sensitivity to physical supply and demand supports their diversification benefits in an investment portfolio. Institutional investors can gain exposure to commodities through either the futures market or via a swap contract.
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
The returns for commodities differ from other asset classes because commodities do not represent compensation for the risk associated with future cash flow uncertainty. Instead, investors in commodity futures are compensated for bearing the risk of short-term commodity price fluctuations. In other words, a majority of a commodity future investor’s exposure is to short-term economic conditions. Wilshire’s 2005 paper “Commodity Futures Investing: Is All That Glitters Gold?” provides a more in depth examination of the history of commodities and their use in an institutional portfolio. Exhibit 19 lays out a return history for the Dow Jones-AIG Commodity Index SM, an equal weight index, CPI-U, and CPI-U + 2% premium over time. From this historical record, we estimate that the future expected return for commodities will be inflation plus a two percent risk premium, or 3.50%. Exhibit 19 Historical Commodity Returns 18%
10 Year Rolling Commodity Return vs. CPI-U
16% 14% 12% 10% 8% 6% 4% 2%
Dow Jones-AIG Index
CPI-U
Equal Weight Index
D ec -0 8
D ec -0 6
D ec -0 4
D ec -0 2
D ec -0 0
D ec -9 8
D ec -9 6
D ec -9 4
D ec -9 2
D ec -9 0
D ec -8 8
D ec -8 6
D ec -8 4
D ec -8 2
0%
CPI-U + 2% Risk Premium
Source: Gary Gorton and K. Geert Rouwenhorst “Facts and Fantasies about Commodity Futures,” Wilshire Compass
Wilshire’s forecasted risk for commodity futures is 13% based on the historical record of the Dow Jones-AIG Commodity Index. It is important to note that other indexes differ in composition from the Dow Jones-AIG index and therefore may be substantially more or less risky. The low measured correlation of commodity returns with more traditional assets, such as stocks and bonds, stems from their price sensitivity to current economic supply and demand forces. In contrast, stock and bond valuations are more heavily driven by forward-looking expectations. Historically, these factors have caused traditional assets and commodities to have lower correlations. A complete list of correlations for commodities versus other asset classes can be found in Appendix A.
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Oil and Gas Partnerships Private Oil and Gas Partnerships generally represent geological and operational business improvement plays on oil and gas extraction. An investor’s exposure to commodity price fluctuation can vary depending on the general partner’s ability to increase the efficiency of output and distribution from the wellhead. Given the unique nature of each partnership, the underlying mineral rights of each property, and the general level of extraction technology available to producers across a spectrum of economies of scale, the expected return distribution is quite broad. Wilshire’s forecast is intended to represent a median expected return absent the assumption of alpha from active management (i.e. a broad investment to the Oil & Gas Partnership opportunity set). To model Private Oil and Gas Partnership returns and risk, Wilshire employs the following three distinct approaches with the intention of capturing market value, dividend growth, and commodity price volatility: ¾ An analysis of Master Limited Partnership (MLP) returns and Oil & Gas spot market volatility; ¾ A Dividend-Discount Model (DDM) forecast of Oil and Gas Partnerships; ¾ A yield plus inflation approach. Publicly traded upstream MLPs and the older and larger universe of Oil & Gas MLPs, as defined by the Alerian Capital MLP Select Index, represent a related public market from which to extrapolate private market returns and risk. Rolling volatility analysis over three-, five-, and ten-year periods reveals annual volatility of 14.00% for the Oil and Gas MLP universe. Relative to the MLP Select index, the upstream MLP constituents display an approximate 17.00% annual volatility with a correlation of 94% to the index. In an attempt to proxy the returns to a private Oil & Gas partnership, a portfolio is constructed with a levered MLP index, to match the risk of upstream MLPs, a commodity allocation, and a negative cash component to remove the insurance premium embedded in the commodity return. This approach yields a return expectation of 8.25% and risk of 20.00%. Under a DDM approach Wilshire’s current expected return for private Oil and Gas Partnerships incorporates the following assumptions: ¾ A year-end 2008 MLP Select Index price of $514.08, down from $813.45 a year earlier; ¾ A base earnings level of $7.50 per share, up from $6.50 per share a year earlier; ¾ Earnings-per-share growth of 1.25%, derived from our inflation estimate of 1.50%, as the MLP structure is based on distribution of income and additional capital is raised via additional unit sales; ¾ A 100% dividend payout ratio, suggesting that dividend growth will be commensurate with growth in the earnings base. Based on these inputs, the DDM approach generates an expected return of 8.75%.
Copyright © 2009, Wilshire Associates Incorporated
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
A yield plus inflation approach with a 7.50% projected dividend and an expectation that Oil & Gas Partnerships have the ability to pass through three-quarters of inflation results in a return forecast of 8.75%. By observing the estimation signals derived from the approaches described above and accounting for each method’s strengths and weaknesses, Wilshire forecasts Private Oil & Gas Partnerships to generate a long-run return of 8.50% with annual volatility of 20.00%. Real Asset Basket In an effort to help develop the discussion towards a more diversified approach to inflation linked investments, Wilshire has created a Real Asset Basket. The Real Asset Basket is an equally weighted macro-asset class with two major sub-asset components; a public real asset basket and a private real asset basket. •
Public Real Asset Basket – Equal Weight o TIPS o Commodity Futures o Global REITS
•
Private Real Asset Basket – Equal Weight o Private Real Estate (including infrastructure) o Timberland o Oil & Gas Partnerships
The aggregate Real Asset Basket has been added to the standard annual asset class matrix. Furthermore, the Real Estate sub-matrix has been expanded to include individual Real Asset components and is further detailed in Appendix D.
Wilshire’s Historical Forecasts Exhibit 20 shows how Wilshire’s return forecasts have changed during the past 26 years. Notice the relative relationship between asset classes and how, when the assumptions change, they generally move together. This co-movement in assumptions is the result of common economic drivers, such as the level of inflation and interest rates, which contribute to all asset class valuations, thereby linking various investments to each other in, at minimum, an indirect way. Such a natural linkage accommodates Wilshire’s practice of generating asset class assumptions on an annual basis and protects the usefulness of forecasts based on somewhat lagged valuations and market conditions.
Copyright © 2009, Wilshire Associates Incorporated
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Exhibit 20 Wilshire’s Past Forecasts for Asset Class Returns 14.0
Return Forecasts (%)
12.0 10.0 U.S. Stocks 8.0 Real Estate 6.0 4.0
U.S. Bonds
2.0
Cash Inflation 2 00 8
2 00 6
2 00 4
2 00 2
2 00 0
1 99 8
1 99 6
1 99 4
1 99 2
1 99 0
1 98 8
1 98 6
1 98 4
1 98 2
0.0
Risk and Correlation Wilshire’s approach to forecasting long-term risk and correlation is largely based on observed historical asset class behavior. Generally, past relationships serve as very good predictors of future risk and correlation. In practice, Wilshire applies sound financial theory and judgment to the interpretation and analysis of historical results. The role of judgment (“art”) versus measured statistics (“science”) is more pronounced for investment categories with less historical data or that have experienced material structural changes. In practice, Wilshire places much more confidence in the predictive accuracy of past relationships for asset classes with longer and more robust historical data. In this report we rely upon historical measurements of risk and correlation through 2008 to estimate future risk and correlation. To maximize the quality of our estimates, we observe this historical behavior over various time horizons (i.e. five years, ten years, full history, etc.). Wilshire does not use a preset or static rolling time period to derive these forecasts; as such an approach could result in forward numbers reacting too quickly to what may prove to be short-term relationships or event driven anomalies between markets. A full listing of Wilshire’s risk and diversification assumptions for all asset classes is found in Appendix A.
Copyright © 2009, Wilshire Associates Incorporated
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Appendix A: Wilshire 2009 Correlation Matrix
Expected Return (%) Expected Risk (%) Cash Yield (%)
US Stock 8.50 16.00 3.00
Equity Dev ex-US Stock (USD) (Hdg) 8.50 8.40 17.00 16.00 3.75 3.75
Fixed Income Emg Stock 8.50 24.00 3.75
Glbl ex-US Stock 8.70 17.25 3.75
Cash 2.00 1.25 2.00
Core Bond 4.00 5.00 4.00
LT Core Bond 5.00 10.00 5.00
LT Treas 2.50 11.00 2.50
Correlations: US Stock 1.00 Dev ex-US Stock (USD) 0.80 1.00 Dev ex-US Stock (Hdg) 0.85 0.85 1.00 Emerging Mkt Stock 0.70 0.68 0.63 1.00 Global ex-US Stock 0.83 0.98 0.85 0.80 1.00 Cash Equivalents 0.00 -0.09 -0.01 -0.05 -0.09 1.00 Core Bond 0.29 0.05 0.04 0.00 0.04 0.20 1.00 LT Core Bond 0.30 0.09 0.05 0.01 0.08 0.10 0.95 1.00 LT Treasury 0.19 0.10 0.03 -0.05 0.07 0.10 0.85 0.87 1.00 TIPS -0.05 0.05 -0.05 0.00 0.04 0.15 0.20 0.15 0.20 High Yield Bond 0.48 0.35 0.40 0.35 0.37 0.00 0.28 0.30 0.21 Non-US Bond (USD) -0.01 0.32 -0.07 -0.04 0.25 -0.10 0.40 0.39 0.44 Non-US Bond (Hdg) 0.16 0.26 0.25 -0.01 0.21 0.10 0.68 0.65 0.67 US RE Securities 0.35 0.25 0.25 0.30 0.28 0.00 0.15 0.15 0.10 Private Real Estate 0.34 0.24 0.24 0.29 0.27 0.02 0.24 0.24 0.19 Non-US RE Securities 0.50 0.65 0.50 0.60 0.68 0.00 0.10 0.10 0.05 Private Markets 0.75 0.65 0.68 0.63 0.68 0.00 0.32 0.32 0.24 Real Assets 0.31 0.41 0.31 0.46 0.45 -0.02 0.18 0.17 0.13 Commodities 0.00 0.20 0.15 0.24 0.22 -0.05 0.00 0.00 0.00 Inflation (CPI) -0.10 -0.15 -0.05 -0.13 -0.15 0.10 -0.12 -0.12 -0.12 * Inflation correlations are provided for informational purposes and do not represent forward-looking assumptions.
Copyright © 2009, Wilshire Associates Incorporated
TIPS 3.50 6.00 3.50
High Yield 8.50 10.00 8.50
Non-US Bond (USD) (Hdg) 3.75 3.65 10.00 4.00 3.75 3.65
1.00 0.01 0.05 0.25 0.15 0.16 0.15 0.01 0.36 0.20 0.10
1.00 0.01 0.27 0.30 0.37 0.40 0.34 0.37 0.08 -0.08
1.00 0.45 0.05 0.14 0.30 0.07 0.20 0.15 -0.05
1.00 0.00 0.08 0.10 0.27 0.09 0.00 -0.08
Page 30
Alternative Real Estate US Prvt xUS Prvt RES RE RES Mkts 7.00 7.65 7.00 11.55 15.00 12.25 13.00 26.00 5.75 4.45 5.75 0.00
1.00 0.82 0.50 0.35 0.65 0.20 -0.10
1.00 0.44 0.33 0.66 0.21 -0.07
1.00 0.58 0.58 0.25 0.00
1.00 0.36 0.05 -0.10
Real Assets Cmdty 6.70 3.50 8.50 13.00 3.85 2.25
1.00 0.59 0.12
1.00 0.20
US CPI 1.50 1.75
1.00
Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Appendix B: Wilshire 2009 Private Markets Correlation Matrix
Expected Return (%) Expected Risk (%) Correlations: Buyouts Venture Capital Distressed Debt Mezzanine Debt Non-US Buyouts Pvt Mkts Portfolio
Buyouts 10.00 28.00
Venture Capital 12.50 42.00
1.00 0.65 0.15 0.65 0.78 0.96
1.00 0.10 0.35 0.50 0.81
Distressed Debt 10.00 19.00
Mezz Debt 9.75 19.00
1.00 0.65 0.15 0.21
Copyright © 2009, Wilshire Associates Incorporated
1.00 0.40 0.62
Non-US Buyouts 10.00 30.00
1.00 0.83
Pvt Mkts Portfolio 11.55 26.00
US Stocks 8.50 16.00
Dev ex-US Stock 8.50 17.00
Emg Stock 8.50 24.00
Global ex-US Stock 8.70 17.25
1.00
0.70 0.60 0.30 0.70 0.60 0.75
0.55 0.50 0.25 0.55 0.70 0.65
0.55 0.50 0.25 0.58 0.60 0.63
0.58 0.53 0.27 0.59 0.72 0.68
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Cash 2.00 1.25
Core Bond 4.00 5.00
High Yield Bond 8.50 10.00
US RES 7.00 15.00
0.00 0.00 0.00 0.05 0.00 0.00
0.40 0.10 0.05 0.35 0.25 0.32
0.30 0.25 0.55 0.65 0.25 0.34
0.35 0.30 0.10 0.40 0.20 0.35
Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Appendix C: Wilshire 2009 Private Real Estate Correlation Matrix
Expected Return (%) Expected Risk (%)
US RES 7.00 15.00
Non-US RES 7.00 13.00
Correlations: US RE Securities Non-US RES Core RE Value-Added RE Opportunistic RE Private RE Basket
1.00 0.50 0.90 0.70 0.55 0.82
1.00 0.45 0.40 0.35 0.44
----------- Private RE ----------Value Prvt RE Core Added Opport Basket 6.25 9.25 11.50 7.65 10.50 15.50 23.00 12.25
1.00 0.85 0.70 0.96
Copyright © 2009, Wilshire Associates Incorporated
1.00 0.95 0.96
1.00 0.88
1.00
US Stocks 8.50 16.00
Dev ex-US Stock 8.50 17.00
Emg Stock 8.50 24.00
Global ex-US Stock 8.70 17.25
0.35 0.50 0.30 0.35 0.35 0.34
0.25 0.65 0.20 0.25 0.25 0.24
0.30 0.60 0.25 0.30 0.30 0.29
0.28 0.68 0.22 0.28 0.28 0.27
Page 32
Cash 2.00 1.25
Core Bond 4.00 5.00
High Yield Bond 8.50 10.00
0.00 0.00 0.00 0.05 0.05 0.02
0.15 0.10 0.15 0.30 0.35 0.24
0.30 0.40 0.30 0.40 0.40 0.37
Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Appendix D: Wilshire 2009 Real Asset Basket Correlation Matrix Public Real Assets
Expected Return (%) Expected Risk (%) Correlations: Global REITS TIPS Commodities Public R.A. Basket Private RE Basket Timber Oil & Gas Prtnshp Priv R.A. Basket Real Asset Basket US Stocks Dev X-U.S. Stocks Emg Stock Global X-U.S. Stock Cash Core Bond High Yield Bond
Global REITS 7.25 12.50
TIPS 3.50 6.00
Cmdty 3.50 13.00
Public RA Basket 5.05 7.50
Prvt RE 7.65 12.25
1.00 0.17 0.25 0.74 0.77 0.19 0.34 0.57 0.71 0.47 0.47 0.48 0.50 0.00 0.15 0.39
1.00 0.20 0.48 0.16 0.15 0.15 0.21 0.36 -0.05 0.05 0.00 0.04 0.15 0.20 0.01
1.00 0.78 0.21 0.30 0.25 0.36 0.59 0.00 0.20 0.24 0.22 -0.05 0.00 0.08
1.00 0.57 0.33 0.38 0.58 0.84 0.25 0.41 0.42 0.43 0.01 0.13 0.27
1.00 0.16 0.30 0.61 0.66 0.34 0.24 0.29 0.27 0.02 0.24 0.37
Copyright © 2009, Wilshire Associates Incorporated
Private Real Assets Oil & Gas Timber Prtnshp 6.50 8.50 15.00 20.00
1.00 0.25 0.65 0.58 0.00 0.10 0.15 0.12 -0.05 0.00 0.05
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1.00 0.82 0.72 0.30 0.35 0.40 0.39 -0.05 0.15 0.35
Private RA Basket 8.15 11.25
Real Asset Basket 6.70 8.50
1.00 0.93 0.30 0.34 0.41 0.38 -0.04 0.18 0.37
1.00 0.31 0.41 0.46 0.45 -0.02 0.18 0.37
Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Appendix E: Historical 1, 5 & 10-Year Rolling Returns: 1926 to 2008 Appendix E: 1-Year Returns Year 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967
S&P 500 Index 11.6 37.5 43.6 -8.4 -24.9 -43.4 -8.2 54.0 -1.4 47.7 33.9 -35.0 31.1 -0.4 -9.8 -11.6 20.4 25.9 19.7 36.4 -8.1 5.7 5.5 18.8 31.7 24.0 18.4 -1.0 52.6 31.6 6.6 -10.8 43.4 12.0 0.5 26.9 -8.7 22.8 16.5 12.5 -10.1 24.0
Bond Index 7.4 7.4 2.8 3.3 8.0 -1.9 10.8 10.4 13.8 9.6 6.7 2.8 6.1 4.0 3.4 2.7 2.6 2.8 4.7 4.1 1.7 -2.3 4.1 3.3 2.1 -2.7 3.5 3.4 5.4 0.5 -6.8 8.7 -2.2 -1.0 9.1 4.8 8.0 2.2 4.8 -0.5 0.2 -5.0
T-bills 3.3 3.1 3.5 4.7 2.4 1.1 1.0 0.3 0.2 0.1 0.2 0.3 0.0 0.0 0.0 0.0 0.3 0.4 0.3 0.3 0.4 0.5 0.8 1.1 1.2 1.5 1.7 1.8 0.9 1.6 2.5 3.2 1.5 3.0 2.7 2.1 2.7 3.1 3.5 3.9 4.8 4.2
CPI -1.5 -2.1 -1.0 0.2 -6.0 -9.5 -10.3 0.5 2.0 3.0 1.2 3.1 -2.8 -0.5 1.0 9.7 9.3 3.2 2.1 2.3 18.2 9.0 2.7 -1.8 5.8 5.9 0.9 0.6 -0.5 0.4 2.9 3.0 1.8 1.5 1.5 0.7 1.2 1.7 1.2 1.9 3.4 3.0
Year 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Winning Percentage:
Copyright © 2009, Wilshire Associates Incorporated
S&P 500 Index 11.1 -8.5 4.0 14.3 19.0 -14.8 -26.4 37.2 24.1 -7.3 6.4 18.5 32.2 -4.9 21.1 22.4 6.1 32.1 18.6 5.2 16.8 31.5 -3.2 30.6 7.7 10.0 1.3 37.5 23.1 33.3 28.8 21.0 -9.1 -11.9 -22.1 28.7 10.9 4.9 15.8 5.5 -37.0
Bond Index 2.6 -8.1 18.4 11.0 7.3 2.3 0.2 12.3 15.6 3.0 1.4 1.9 2.7 6.3 32.6 8.4 15.2 22.1 15.3 2.8 7.9 14.5 9.0 16.0 7.4 9.8 -2.9 18.5 3.6 9.7 8.7 -0.8 11.6 8.4 10.3 4.1 4.3 2.4 4.3 7.0 5.2
T-bills 5.2 6.6 6.5 4.4 3.8 6.9 8.2 5.8 5.0 5.4 7.5 10.3 11.8 14.5 11.1 8.8 9.9 7.7 6.1 5.4 6.7 9.0 8.3 6.4 3.9 3.2 4.2 6.1 5.4 5.5 5.4 4.6 6.2 4.4 1.8 1.2 1.3 3.1 4.8 5.0 2.1
61%
25%
13%
CPI 4.7 6.1 5.5 3.4 3.5 8.7 12.4 7.0 4.9 6.7 9.0 13.3 12.5 8.9 3.8 3.8 4.0 3.8 1.1 4.4 4.4 4.6 6.1 3.1 2.9 2.8 2.7 2.5 3.3 1.7 1.6 2.7 3.4 1.6 2.4 1.9 3.3 3.4 2.6 4.1 2.0
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Appendix E: 5-Year Returns Year 1926-30 1927-31 1928-32 1929-33 1930-34 1931-35 1932-36 1933-37 1934-38 1935-39 1936-40 1937-41 1938-42 1939-43 1940-44 1941-45 1942-46 1943-47 1944-48 1945-49 1946-50 1947-51 1948-52 1949-53 1950-54 1951-55 1952-56 1953-57 1954-58 1955-59 1956-60 1957-61 1958-62 1959-63 1960-64 1961-65 1962-66 1963-67 1964-68 1965-69
S&P 500 Index 8.7 -5.1 -12.5 -11.2 -9.9 3.1 22.5 14.3 10.7 10.9 0.5 -7.5 4.6 3.8 7.7 17.0 17.9 14.8 10.9 10.7 9.9 16.7 19.4 17.9 23.9 23.9 20.2 13.6 22.3 15.0 8.9 12.8 13.3 9.8 10.7 13.2 5.7 12.4 10.2 5.0
Bond Index 5.8 3.9 4.5 6.0 8.1 8.4 10.3 8.6 7.8 5.8 4.6 3.8 3.8 3.1 3.3 3.4 3.2 2.2 2.4 2.2 1.8 0.9 2.0 1.9 2.3 2.0 1.1 2.1 1.0 -0.3 1.4 3.8 3.6 4.5 5.7 3.8 2.9 0.3 0.4 -2.2
T-bills 3.4 3.0 2.5 1.9 1.0 0.5 0.3 0.2 0.1 0.1 0.1 0.1 0.1 0.1 0.2 0.3 0.3 0.4 0.5 0.6 0.8 1.0 1.3 1.5 1.4 1.5 1.7 2.0 1.9 2.3 2.6 2.5 2.4 2.7 2.8 3.1 3.6 3.9 4.3 4.9
CPI -2.1 -3.7 -5.4 -5.1 -4.8 -3.0 -0.8 2.0 1.3 0.8 0.4 2.0 3.2 4.5 5.0 5.3 6.8 6.8 6.7 5.8 6.6 4.3 2.7 2.2 2.5 1.4 0.8 1.3 1.5 1.9 2.1 1.7 1.3 1.3 1.2 1.3 1.9 2.2 2.8 3.8
Year 1966-70 1967-71 1968-72 1969-73 1970-74 1971-75 1972-76 1973-77 1974-78 1975-79 1976-80 1977-81 1978-82 1979-83 1980-84 1981-85 1982-86 1983-87 1984-88 1985-89 1986-90 1987-91 1988-92 1989-93 1990-94 1991-95 1992-96 1993-97 1994-98 1995-99 1996-00 1997-01 1998-02 1999-03 2000-04 2001-05 2002-06 2003-07 2004-08
Winning Percentage:
Copyright © 2009, Wilshire Associates Incorporated
S&P 500 Index 3.4 8.4 7.5 2.0 -2.4 3.2 4.9 -0.2 4.3 14.8 13.9 8.0 13.9 17.2 14.6 14.6 19.7 16.4 15.4 20.4 13.2 15.4 15.9 14.5 8.7 16.6 15.2 20.2 24.1 28.6 18.3 10.7 -0.6 -0.6 -2.3 0.5 6.2 12.8 -2.2
Bond Index 1.2 3.3 5.8 5.8 7.6 6.5 7.4 6.5 6.3 6.7 4.8 3.1 8.4 9.8 12.6 16.5 18.4 12.5 12.4 12.3 9.8 9.9 10.9 11.3 7.7 9.5 7.0 7.5 7.3 7.7 6.5 7.4 7.5 6.6 7.7 5.9 5.1 4.4 4.6
T-bills 5.4 5.4 5.3 5.6 6.0 5.8 5.9 6.3 6.4 6.8 8.0 9.9 11.0 11.3 11.2 10.4 8.7 7.6 7.1 7.0 7.1 7.1 6.8 6.1 5.2 4.8 4.6 4.9 5.3 5.4 5.4 5.2 4.5 3.6 3.0 2.4 2.4 3.1 3.2
73%
23%
4%
CPI 4.5 4.5 4.6 5.4 6.6 6.9 7.2 7.9 8.0 8.1 9.2 10.1 9.5 8.4 6.5 4.8 3.3 3.4 3.5 3.7 4.1 4.5 4.2 3.9 3.5 2.8 2.8 2.6 2.4 2.4 2.5 2.2 2.3 2.4 2.5 2.5 2.7 3.0 3.1
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Appendix E: 10-Year Returns Year 1926-35 1927-36 1928-37 1929-38 1930-39 1931-40 1932-41 1933-42 1934-43 1935-44 1936-45 1937-46 1938-47 1939-48 1940-49 1941-50 1942-51 1943-52 1944-53 1945-54 1946-55 1947-56 1948-57 1949-58 1950-59 1951-60 1952-61 1953-62 1954-63 1955-64 1956-65 1957-66 1958-67 1959-68 1960-69 1961-70 1962-71
S&P 500 Index 5.9 7.8 0.0 -0.9 -0.1 1.8 6.4 9.4 7.2 9.3 8.4 4.4 9.6 7.3 9.2 13.4 17.3 17.1 14.3 17.1 16.7 18.4 16.4 20.1 19.4 16.2 16.4 13.4 15.9 12.8 11.1 9.2 12.9 10.0 7.8 8.2 7.1
Bond Index 7.1 7.0 6.5 6.9 6.9 6.5 7.0 6.2 5.4 4.5 4.0 3.5 3.0 2.8 2.7 2.6 2.0 2.1 2.2 2.2 1.9 1.0 2.1 1.4 1.0 1.7 2.4 2.9 2.7 2.7 2.6 3.3 1.9 2.4 1.7 2.5 3.1
T-bills 2.0 1.7 1.4 1.0 0.6 0.3 0.2 0.1 0.1 0.2 0.2 0.2 0.2 0.3 0.4 0.5 0.7 0.8 1.0 1.0 1.1 1.3 1.6 1.7 1.9 2.0 2.1 2.2 2.3 2.6 2.8 3.0 3.1 3.5 3.9 4.3 4.5
CPI -2.6 -2.3 -1.8 -2.0 -2.0 -1.3 0.6 2.6 2.9 2.9 2.8 4.4 5.0 5.6 5.4 5.9 5.5 4.7 4.4 4.2 4.0 2.5 2.0 1.9 2.2 1.8 1.3 1.3 1.4 1.6 1.7 1.8 1.8 2.1 2.5 2.9 3.2
Year 1963-72 1964-73 1965-74 1966-75 1967-76 1968-77 1969-78 1970-79 1971-80 1972-81 1973-82 1974-83 1975-84 1976-85 1977-86 1978-87 1979-88 1980-89 1981-90 1982-91 1983-92 1984-93 1985-94 1986-95 1987-96 1988-97 1989-98 1990-99 1991-00 1992-01 1993-02 1994-03 1995-04 1996-05 1997-06 1998-07 1999-08
Winning Percentage:
Copyright © 2009, Wilshire Associates Incorporated
S&P 500 Index 9.9 6.0 1.2 3.3 6.7 3.6 3.2 5.9 8.4 6.4 6.6 10.6 14.7 14.2 13.7 15.2 16.3 17.5 13.9 17.5 16.2 14.9 14.4 14.9 15.3 18.0 19.2 18.2 17.5 12.9 9.3 11.1 12.1 9.1 8.4 5.9 -1.4
Bond Index 3.0 3.0 2.6 3.8 5.3 6.2 6.1 7.2 5.6 5.2 7.4 8.1 9.6 10.5 10.5 10.4 11.1 12.4 13.1 14.1 11.7 11.9 10.0 9.6 8.5 9.2 9.3 7.7 8.0 7.2 7.5 6.9 7.7 6.2 6.2 6.0 5.6
T-bills 4.6 5.0 5.4 5.6 5.7 5.8 6.0 6.4 6.9 7.9 8.6 8.8 9.0 9.2 9.3 9.3 9.2 9.1 8.7 7.9 7.2 6.6 6.1 5.9 5.8 5.9 5.7 5.3 5.1 4.9 4.7 4.5 4.2 3.9 3.8 3.8 3.4
80%
15%
5%
CPI 3.4 4.1 5.2 5.7 5.9 6.2 6.7 7.4 8.1 8.6 8.7 8.2 7.3 7.0 6.6 6.4 5.9 5.1 4.5 3.9 3.8 3.7 3.6 3.5 3.7 3.4 3.1 2.9 2.7 2.5 2.5 2.4 2.4 2.5 2.4 2.7 2.7
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
Appendix F: Histogram of 1, 5 & 10-Year S&P 500 Index Returns 1-Year Returns Ending:
-37.0% return
1931
2008
2001 1973 1966 1957 1941
2002 1974 1930
1937
2000 1977 1969 1962 1946 1940 1932 1929
1990 1981 1953 1939 1934
2007 1992 1987 1984 1978 1956 1948 1947
2005 1994 1970 1960
1999 1996 1983 1982 1976 1967 1963 1951 1942
2003 1998 1961 1943
1997 1991 1989 1985 1980 1955 1950 1938 1936
1995 1975 1945 1927
1958 1928
1935
1954 1933
% 35
% 40
% 45
% 50
% 55
% 30
% 35
% 40
% 45
% 50
% 55
% 30
% 35
% 40
% 45
% 50
% 55
1941 1934 1931
2008 2004 2003 2002 1977 1974
2005 1978 1976 1975 1973 1970 1969 1966 1943 1942 1940 1935
2006 1994 1981 1972 1971 1969 1966 1963 1960 1950 1944 1930
2000 1996 1995 1992 1991 1988 1987 1986 1983 1959 1953 1952 1951 1946 1945
1998 1997 1989 1958 1956 1955 1954 1936
% 20
% 15
10-Year Annualized Returns Ending:
2001 1993 1990 1985 1984 1982 1980 1979 1968 1967 1965 1964 1962 1961 1957 1949 1948 1947 1939 1938 1937
% 10
5%
0%
% -5
0% -1
5% -1
0% -2
5% -2
0% -3
5% -3
% 30
1933 1932
0% -4
% 25
2007
-2.2% return
5% -4
% 25
% 25
% 20
% 15
% 10
5%
0%
%
%
%
%
%
%
%
%
% -5
0 -1
5 -1
0 -2
5 -2
0 -3
5 -3
0 -4
5 -4
5-Year Annualized Returns Ending:
2004 1993 1971 1968 1965 1959 1926
2006 1988 1986 1979 1972 1964 1952 1949 1944
1999
2007 2006 2005 2002 1982 1981 1980 1979 1976 1973 1972 1971 1970 1969 1966 1949 1948 1947 1945 1944 1943 1942 1941 1936 1935
-1.4% return
2008 1939 1938
1978 1977 1975 1974 1946 1940 1937
2000 1999 1998 1997 1996 1992 1991 1989 1988 1987 1963 1961 1960 1959 1957 1956 1955 1954 1952 1951
1958 % 20
% 15
% 10
5%
0%
% -5
0% -1
5% -1
0% -2
5% -2
0% -3
5% -3
0% -4
5% -4
Copyright © 2009, Wilshire Associates Incorporated
2004 2003 2001 1995 1994 1993 1990 1986 1985 1984 1983 1968 1967 1965 1964 1962 1953 1950
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Wilshire Consulting 2009 Asset Allocation Return and Risk Assumptions January 26, 2009
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. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that these suggestions will work under all market conditions, and each investor should evaluate their ability to invest for the longterm, especially during periods of downturn in the market.
Copyright © 2009, Wilshire Associates Incorporated
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