Ibbotson on asset allocation

When markets get volatile, investors get edgy. Some look at their portfolios and see assets that worked well before, but now look lackluster or may even be heading south. Never has the question of what to do with one’s portfolio been as important as it is today, with defined benefit pensions disappearing–often literally–and many investors headed toward retirement with defined contribution retirement accounts as their main source of retirement funding. How can advisors guide their clients to retirement portfolio allocations that fund longer retirements, as well as keep them comfortable when markets gyrate?

Enter Roger Ibbotson, Ph.D., founder of Ibbotson Associates, Yale professor, and now chairman and CEO of a hedge fund, Zebra Capital Management. Ibbotson is well known for his historical data, iconic heartbeat charts showing the results of $1 invested in stocks, bonds, or T-Bills since 1925, and his industry-leading asset allocation work with institutions. Earlier this year he sold Ibbotson Associates, the company he founded in 1977, to Morningstar (the deal closed in March). Staff Editor Kate McBride sat down with Roger Ibbotson at the Morningstar Conference in Chicago in late June.

How has your life changed since you sold Ibbotson Associates to Morningstar?

Actually my life hasn’t changed that much because when I had Ibbotson Associates I participated in management, in research, and I’d been speaking for the firm. I’m not part of the management anymore, at Morningstar, but I’m still part of the research team, essentially. It’s actually a bigger vehicle: more data, more analysts, and more people to work with in research. Of course I’m financially stable; I’m more diversified in my portfolio.

I’m [teaching] half time at Yale. I also have a hedge fund, Zebra Capital, so I spend some time at that and I spend some time as a Morningstar consultant.

Would you tell us about Zebra Capital?

Zebra Capital is a U.S. equity hedge fund. It has a market-neutral product and a net-long hedge fund. They’re all quantitatively based, so you can imagine that I focus on the quantitative areas and our hedge fund uses quantitative techniques to create high returns at low risk.

How do you allocate investments in a higher interest rate environment?

Well, [that] makes something like cash more desirable. We look at a cash base, plus an equity-risk premium on top of that. We’re not in any way negative about equities in this kind of environment; it’s just that the trade-off between cash and long-term bonds tends to shift so that we’re tending to shorten up our bond portfolios.

Are you allocating across more than stocks, bonds, and cash?

Usually we try to make it a minimum of five asset classes, which would be: small caps, large caps, international caps, some sort of a longer-term or intermediate-term bonds, and cash or something like cash; that would be the minimum number of asset classes; but we get into lots of asset classes, depending on–we’re doing this for clients, so we usually have a universe to pick from–but we may bring in alternative investments like commodities, or different forms of cash like TIPS, and there could be real estate in the portfolios, or different types of international [assets]. This is mostly driven by the set of assets that are available to us in particular in an advisory arrangement that we’ve made.