Strategic Briefing | 8.22.12 | Analyzing Asset Classes

Arnott: Emerging Markets Are Today’s Low-Hanging Fruit | August 9
The Research Affiliates chairman discusses why he see value in developing-markets bonds as well as the urgency for investors to build a ‘third pillar’ in their portfolios.

The Untold Story of Municipal Bond Defaults
Liberty Street Economics (NY Fed) | Aug 15
In our recent post on the state and local sector, we argued that structural problems in state and local budgets were exacerbated by the recession and would likely restrain the sector’s growth for years to come. The last couple of years have witnessed threatened or actual defaults in a diversity of places, ranging from Jefferson County, Alabama, to Harrisburg, Pennsylvania, to Stockton, California. But do these events point to a wave of future defaults by municipal borrowers? History—at least the history that most of us know—would seem to say no. But the municipal bond market is complex and defaults happen much more frequently than most casual observers are aware. This post describes the market and its risks.
[REIT] Valuations Expected to Climb in Second Half | August 9
Look for continued growth in valuations and operating income in the commercial real estate industry during the second half of 2012, according to Paul Whyte, managing director with Credit Suisse. Whyte heads Credit Suisse’s real estate investment banking division. In a video interview with in New York at REITWorld 2012: NAREIT’s Investor Forum, Whyte offered his near-term outlook for REIT investment in the United States. He also discussed some of the potential pitfalls in both the real estate market and financial system that could give REIT investors problems.
Revisiting Stocks For The Long Run
James Biano (The Big Picture) | August 20
Dr. Siegel posited stocks are less risky than bonds as holding periods lengthen. The following table displays the relative frequency of stocks outperforming either bonds or Treasury bills as a function of holding period. Specifically, stocks outperformed bonds over a thirty-year holding period 100% of the time from 1871 to 1993. From 1802 to 1993 stocks outperformed 97.2% of the time. The only time other than the present when stocks underperformed bonds over 30 years was the 1840s. However, as the set of tables on the next page show, this trend has drastically changed in the wake of the financial crisis. The first table shows returns through September 30, 2011. Bonds have completely dominated stocks over every tenor from one month to 30 years. Critics would say that September 30 is a favorable period for bonds as the all-time high in yields (low price) was September 30, 1981. This is true, but since the 1840s there have been numerous peaks in yields and none of those produced a bond outperformance over stocks as was seen since 1981.
Fama: Why Small and Value Stocks Outperform
Fama/French Forum (Dimensional Funds) | June 7
I talked with Client Insights host Dan Richards about the problems with the Capital Asset Pricing Model (CAPM) and the development of the Fama/French three-factor model as a more accurate way of determining how average returns differ from one another. I also explain why higher expected returns for small and value stocks should persist.
Reaching for Yield in the Bond Market
Bo Becker and Victoria Ivashina (Harvard) | May 16
Reaching-for-yield — the propensity to buy riskier assets in order to achieve higher yields — is believed to be an important factor contributing to the credit cycle. This paper analyses this phenomenon in the corporate bond market. Specifically, we show evidence for reaching for yield among insurance companies, the largest institutional holders of corporate bonds. Insurance companies have capital requirements tied to the credit ratings of their investments. Conditional on ratings, insurance portfolios are systematically biased toward higher yield, higher CDS bonds. This behavior appears to be related to the business cycle, being most pronounced during economic expansions. It is also more pronounced for the insurance firms for which regulatory capital requirements are more binding. The results hold both at issuance and for trading in the secondary market and are robust to a series of bond and issuer controls, including issuer fixed effects as well as liquidity and duration. Comparison of the ex-post performance of bonds acquired by insurance companies does not show outperformance, but higher volatility of realized returns.