Noncorrelated Investments: Narwhal or Unicorn?
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Spring 2012
Noncorrelated Investments: Narwhal or Unicorn?
Kenneth B. Trippe, CFA, FRM, Director of Private Investments
Both the narwhal and the reinsurance, water rights, film rights,
unicorn are fantastical life settlements, pharmaceutical co-
creatures—one real and development and intellectual property.
one, sadly, mythical. In At Glenmede, we have invested in
the case of noncorrelated some of these strategies, but found
investments, we ask the the market for others too immature
question, “Is it possible to find that or the risk too difficult to quantify.
rare investment whose returns are
independent of the factors that move Further, noncorrelated investments
publicly traded debt, equity and real tend to be somewhat esoteric. Last
estate markets?” The answer is year, for example, we invested in
yes … and no. a sector of the reinsurance market
known as the retrocessional market.
Most publicly traded investments Our thesis was driven by the fact
depend on economic conditions that the reinsurers had been hard hit
in some way. Equity returns are by natural disasters, including the
contingent on a business’s prospects earthquake and tsunami in Japan
and profitability, and real estate and windstorms in the U.S. As
values depend on such factors as a result, we concluded that the
employment levels and the buildup reinsurers would need to reduce their
of available inventory. From time to ongoing risks so as not to deplete
time, some investments are negatively their capital bases. In the Private like fantastical creatures, they are
correlated with economic conditions. Investments Group, we like to hard to find. These investments can
In a recessionary environment, for examine situations where there be highly beneficial to portfolios
instance, an investment with a fixed is some sort of market dislocation. since they provide a great deal of
payment (e.g., Treasury bonds) may diversification for the dollar. An
increase in value as the values of Is this reinsurance transaction a academic using the risk/return profile
equity securities decline. This inverse noncorrelated investment? “Yes,” in of these investments in a portfolio
correlation, however, may not persist the sense that a crash in the financial optimization program may wish to
as market conditions change—for markets will not cause an earthquake, take an extra helping.
example, if the economy reflates. tsunami or hurricane. Yet “No,” since
a severe natural disaster could shock Problematically, the risks presented
If you flipped a coin and called heads the financial markets. More subtly, by noncorrelated investments are
or tails, the result would obviously the risk-adjusted returns embedded not always easily quantifiable. For
be unrelated to the factors that in most investments will reprice as example, in certain regions, water
drive the financial markets. With capital flows to what investors see as rights may be attractive as population
noncorrelated investments, the the most attractive opportunity— growth places increasing demands
risks for which you are compensated though this shift may take time. on the water supply. Though the
are dissimilar to those common scarcity of water may appear to
elsewhere in your portfolio. Examples There are many reasons to seek be an irreversible trend, the value
of noncorrelated investments include noncorrelated investments, even if,
continues on page 2
Glenmede Perspectives Spring 2012
Noncorrelated Investments: Narwhal or Unicorn?
continued from first page
of the rights might ultimately be It is our belief that noncorrelated generate excess returns by deploying
linked to economic cycles, since investments have earned a place in this expertise.
residential developers may bid them sophisticated investment portfolios.
up when they are building housing We will continue to avoid those that As in the cases of our fantastical
communities. The value of intellectual appear to be fads but will seek unique creatures, careful study is required
property, such as patents, may also opportunities that offer attractive to separate the real from the
be linked to economic conditions; and diversified returns. As always, we mythological.
companies tend to pay more when target investment managers who
revenue prospects are promising. have operational expertise and can
Providing Clarity Amid Complexity
Susan P. Mucciarone, Director of Wealth Advisory
Lisa M. Whitcomb, Director of Wealth Strategy
Personal The estate planning and tax strategies
financial . . . Cash Needs . . . used to achieve these goals can be
health has never mattered more
Retirement, the economy, exceedingly complex and difficult for
and has perhaps never felt more markets and unforeseen family clients to visualize. Once Glenmede
elusive. Keeping pace with global health emergencies upended has reviewed a client’s trusts, will and
and domestic events that affect Jeffrey and Susan’s world. other estate planning documents, we
household cash flow and balance Their Glenmede team helped frequently create an illustration of the
them reconsider and revise
sheets can strain even the most
their spending goals, offering
estate plan using graphics to show
engaged investor. At Glenmede, expertise that provided Jeffrey who gets what, and when. It’s often
our goal for wealth advice is to and Susan with confidence that a turning point in our clients’
make the complex clear and the they will not outlive their assets. understanding of how their wishes
possible attainable.
This is a process accomplished over some it makes sense to start by
time. Clarifying financial goals . . . As Families Grow . . .
building a complete, organized
often requires several foundational overview of the “big picture.” For Prompted by the birth of
conversations, periodic review Pamela’s first grandchild,
others, we may home in on assets to Glenmede conducted
and continual refinement—a project spending needs and determine a thorough review of her
collaboration that requires the the probability of achieving a range of trusts, family foundation and
ongoing commitment of staff and outcomes. These early conversations portfolio. Cash flow projections
clients. Conversations can target guide our recommended solutions, demonstrated there was
specific areas of interest or the full sufficient capital to forgo the
inform how we build effective plans discretionary income generated
scope of a client’s financial life. and ultimately determine how assets by the trusts she had inherited,
This is an enduring process that are deployed. allowing her to pass additional
evolves over the course of each client assets to her heirs, free of estate
relationship and often involves A Dynamic, Continuous Process and GST taxes. New tax-efficient
multiple generations. Building a comprehensive wealth trusts were created for her
plan that aligns your financial and children and grandchildren,
What Is Important to the Client? investment strategies with your and a formal gifting program
Our job is to listen closely for was established. To bolster the
lifestyle, legacy and charitable goals long-term sustainability of the
financial and nonfinancial clues, is essential to a successful outcome. family foundation, Glenmede’s
understanding that seemingly However, life is not static and neither Philanthropic Services team
innocuous information can often lead are financial goals. We chronicle and worked with the family to create
to critical insights. The starting point periodically review client objectives, a formal charitable mission and
is defined by each client’s particular providing the context and rationale grant-making plan.
objectives and circumstances. For for sound decision-making over time.
Glenmede Perspectives Spring 2012 2
will be carried out. The illustration
provides clarity and insight for
family members and serves as the
groundwork for developing priorities
for the ongoing stewardship of family
wealth. As families grow, tax laws and
regulations change, new markets and
asset strategies emerge, and personal
financial objectives shift, we revisit
client wealth plans and initiate new
conversations to be sure that the plans
continue to align with changing
circumstances and personal goals.
Going Further
Glenmede places a high value on
working in concert with clients . . . Generational Education . . .
and their team of advisors to share
Sam and Laura asked Glenmede to educate their three sons about the
ideas and implement the best
responsibilities they will face as stewards of the family’s wealth. The young
thinking. Glenmede’s role is to men are vastly different in their familiarity with—and interest in—financial
uncover and clearly communicate matters. Glenmede created an education plan and meets with the sons
the planning options, overseeing the semiannually, educating them on topics ranging from basic finance and
implementation of ideas and strategies. beneficiary duties to advanced financial instruments and the responsibilities
For some, it is the simple but often they will assume as trustees. As part of the plan, the sons are acquiring real-
world experience by taking an active part in the family limited partnership,
forgotten planning for heirs’ medical with Glenmede serving as mentor and guide.
and education costs; for others, it is
establishing goals and governance
around family philanthropy.
and satisfaction derived from having charitable goals are thoughtfully and
Any step into the process can be a a clear understanding of one’s strategically supported and aligned.
useful starting point. The end result, financial health and the confidence
in every case, is the empowerment of knowing financial, legacy and
Investment Philosophy: What the Textbooks Should Say
Jason D. Pride, CFA, Director of Investment Strategy
It is our belief that each This is a lofty goal, since the some practitioners may adopt these
investor—whatever his philosophy must accommodate teachings verbatim, we seek to
or her background, long- and short-term asset allocation challenge and improve upon the
experience or training— provisions, as well as security and core assumptions, modifying theories
should employ a manager selection. At Glenmede, to better align with real-world
systematic protocol in when we invest in companies, asset implementation.
the pursuit of growth and stability. An classes and managers, our investment
investment process should embody philosophy captures our beliefs about First, let’s consider the standard
an investment philosophy. Grounded how markets work and how, as an approach to long-term asset
by best practices, this philosophy investment manager and advisor, we allocation. Eugene Fama, an
should stem from a set of beliefs that seek to earn returns for our clients. economist known for his work on
prescribe how to generate superior portfolio theory and asset pricing,
risk-adjusted returns in varying market Over the years, many academics famously argued that markets
environments and cycles. have put forth beliefs about how are efficient and the only free
investment markets work. While lunch is diversification. While we
Glenmede Perspectives Spring 2012 3
Investment Philosophy
What the Textbooks Say What They Should Say
Long-term asset allocation dominates returns; Diversification is a free lunch, but starting-point valuations drive long-
maintain a diversified investment portfolio. term returns. Modify policy portfolios to emphasize undervalued assets.
Short-term asset allocation (market timing) Abstinence is easier to preach than practice. Every investment decision
is a sin. Don’t do it. has a market timing component. Follow a systematic approach.
Manager/security selection: Index Inefficiencies and skills exist but they face headwinds (e.g., fees,
efficiently priced assets, use active transaction costs and risk). Look for value-adding processes capable
management elsewhere. of overcoming the headwinds. Know your limitations!
strongly agree about the benefits of when a portfolio becomes allocation, we can conclude that
diversification, we question whether overinvested in overpriced assets, effective portfolio structuring requires
markets are in fact perfectly efficient. resulting in an unnecessary a balance between diversification
If they are, why do numerous well- performance drag. In a 2011 study, and valuation discrepancies, tilted in
documented studies confirm the our own Val deVassal, Director of favor of the value opportunities.
continued advantages of value- Quantitative Research, argued that
oriented investing over market the S&P 500, an index believed to be Many long-time efficient market
indexes? This advantage has also a well-diversified measure of the stock advocates may find our measured
been confirmed by the continued market, was inefficiently structured dispute of this basic academic assertion
success of a wide body of value due to the habitual overweighting of disconcerting. Some may wonder
investors, including Benjamin the most expensive stocks. Assessing whether we have even become
Graham, Warren Buffett, John the S&P 500 over the period from advocates of market timing. Our
Templeton and Seth Klarman. 2001 to 2010, he demonstrated answer to this hypothetical question
that an equally weighted portfolio would be, “Well, in some ways.”
The valuation effect is the Achilles of the same 500 stocks would have
heel of the diversification argument. This leads to a second assertion
returned 6.3%, while the actual index we dispute: the widely held belief
Unconstrained diversification may returned only 1.4%. If we extend this
actually result in “diworsification”: that market timing is a “sin” to be
observation to apply to overall asset avoided. We have come to recognize
that, in fact, every investment
decision has an element of timing,
Perfectly Efficient? Starting-Point Valuations Drive Long-Term Returns even for the most passive investor.
As investments perform differently
S&P 500 U.S. Government Long Bond over time, balanced portfolios
20% 12% can quickly become unbalanced.
Average 3-year forward return (annualized)
Average 3-year forward return (annualized)
18% 17.7% 10.4% Perhaps a manager outperforms or
16%
10% underperforms, or cash inflows or
14% 13.2%
outflows are greater than expected.
8%
In such situations, investors must
12%
6.5% decide what to do and when to do it.
10% 6%
Thus, even the most basic situation
8% 7.6%
4.0% involves a timing decision.
4%
6%
4%
2.5% Recognizing the reality and
2%
2%
2.3% frequency of these circumstances, we
believe it is essential that investors
0% 0%
5–12 12–16 16–21 21–45 7% operate within a systematic and
Cyclically Adjusted P/E Starting Yield disciplined process. While we assert
Source: Glenmede, Robert Shiller, Ibbotson; Source: Glenmede, Robert Shiller, Ibbotson; that valuation should be a key
data from 1/26 to 1/09. data from 1/26 to 1/09, based on long
government bond returns for given component, we acknowledge that
buckets of 10-year Treasury yield.
continues on back page
Glenmede Perspectives Spring 2012 4Investment Philosophy: What the Textbooks Should Say
continued from page 4
A practical investment philosophy
Momentum: A Better Timing Tool must encompass multiple aspects of
the investment landscape. Further,
3-Month Forward Return S&P 500 Momentum we find there is no single academic
8% 9% Average 6-month forward return study absolute in decree. While
7.2%
7% 8% 7.78% some are more easily adaptable than
7.17%
7% others, all seem to miss some of the
6%
implementation realities.
Average Return
6%
5%
4.94%
Perhaps this is why so few wealth
Return
5%
4%
3.2% 4% management firms are able to
3.18%
3%
3% articulate a clear and comprehensive
2% 1.9%
2.0%
1.6%
investment philosophy. In our
2%
1.0% pursuit of superior returns for
1% 1%
our clients, we acknowledge and
0%
90th+ 75th– 50th– 25th– 10th– 10th
0%
Quartile Quartile Quartile Quartile
willingly challenge the popular
90th 75th 50th 25th 1 2 3 4 academic assertions, both empirically
Valuation Percentile and in practice, in order to define
Source: Glenmede. Valuation percentiles Source: Glenmede, S&P 500 trailing 6-month our distinct investment philosophy.
represent the level below, above or between return buckets broken into quartiles; lowest
which a certain percentage of observations to highest, 1/27–1/11.
may be found—e.g., 90th+ are the most Clients deserve this thoughtful
expensive 10% periods in the sample.
consideration and the delivery of
a practiced and disciplined
investment process.
this method has its shortcomings. markets). This ideology is rooted in
When looking at shorter intervals, the belief that less efficient markets
valuations can be an insufficient provide the greatest opportunity.
timing tool except at the extremes. However, this is too simple and
Market and fundamental trends often neither grasps nor directly addresses
last longer than initially expected, the underlying issues.
and their eventual turnarounds are
typically hard to predict. For this Inefficiencies exist in all markets,
reason, we are patient in the short even in large-capitalization stocks
term, riding market and fundamental where many fundamental factors
trends until valuations reach have shown surprisingly strong
extreme levels or until fundamental efficacy over long periods. Yet the
indicators turn. resulting opportunities face significant
headwinds from fees, transaction costs
Let’s now turn from high-level asset and embedded risks. Under-recognized
allocation and portfolio structuring to is the fact that these headwinds are
manager and security selection. Here, typically higher in the less efficient
popular wisdom supports use of index markets. Adding to this, it is
funds when investing in efficiently important for investors to know the
priced assets (large-cap stocks) and limits of their abilities and expertise
selecting individual securities or (e.g., if you lack the needed insight to
active managers in less efficient select international securities, source
markets (municipal and emerging this function accordingly).
Philadelphia • Cleveland • Morristown • New York • Princeton • Wilmington
www.glenmede.com Please email your questions or comments to mailbox@glenmede.com.
Glenmede Perspectives Spring 2012Strategic Hires
Howard E. N. Wilson, Executive Director of Relationship Management
Through the strategic appointment of talented professionals, Glenmede continues to enhance the level of
ongoing care and service we provide to clients. Over the past month, we have been fortunate to welcome
the following to our team:
Matthew C. Beardwood, AIF Michael H. Sinoway Jonathan L. Stanley, CFA
Business Development, Delaware Manager Research, Philadelphia Portfolio Management, New York City
With an established track record, In his role, Michael is responsible An industry veteran, Jon’s
Matt will be instrumental in supporting for conducting fundamental and appointment as a senior Portfolio
business development initiatives in quantitative research of long- Manager underscores the ongoing
the Delaware, Maryland, Virginia and only and hedge fund strategies. momentum of our New York office
Washington, D.C., areas. With prior experience in trading, and further demonstrates that
derivatives and alternative assets, his Glenmede is recognized as a leading
appointment further enhances our company by tenured professionals
resources committed to the selection within wealth management.
and ongoing monitoring of external
managers and strategies.
CUSTOMIZED EDUCATIONAL OPPORTUNITIES
Glenmede hosted more than 120 events since 2011 in support of client interests.
CLIENT SEMINARS, PANELS & WORKSHOPS
• Women and Wealth Workshops
• Tax and Estate Planning
PHILANTHROPIC WORKSHOPS Legislative Updates
& ROUNDTABLES
• Business Succession Planning for
• Philanthropic Strategies Entrepreneurs Series ECONOMIC & MARKET UPDATES
for Families • Hedge Funds and Private • Timely insights into the state of the
• Endowment and Foundation Equity Workshops economy and the markets
CIO Roundtables • Financial Planning Seminars • Updates on the evolving tax and
estate planning landscape
PRIVATE CLIENT EVENTS
Arizona, California, TRUST AND ESTATE ATTORNEY
• Exclusive partnerships with
leading cultural organizations Connecticut, Delaware, EVENTS & SPONSORSHIPS
in each of our major markets Florida, Illinois, New Jersey, • National and local ACTEC events
New York, Ohio,
• Regional and local Estate
Pennsylvania, Planning Council events
Rhode Island, Texas,
Washington, D.C.
Please contact your Relationship Manager to learn about upcoming events.
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