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Portfolio > Asset Managers

Ibbotson on asset allocation

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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.

What could advisors learn about asset allocation from what you have studied over the years?

There are several important aspects of asset allocation: get your risk level correct, match it to your horizon, be diversified, be tax-efficient, and then get high alpha–but only after you’ve accomplished all those other things.

What do you recommend for people who are in the pre-retirement stage?

We call that the accumulation stage. The younger that you are, the more you should be in equities, [because] we think of people as having both ‘human capital’ which is the present value of all the income that they’re going to earn, plus their financial capital. Young people have a lot of human capital but not much financial capital. Human capital is sort of like a bond–potentially we’d recommend a 100% equity portfolio for someone in their 20s because they’re actually getting their bond-like income from their human capital. As they age, they should be taking on more and more bonds into their portfolio.

We integrate life insurance into the picture by knowing that we want to protect a certain portion of that human capital, and one way to do it is through life insurance. This [helps determine] how risky you want to be in your other assets–for example, the more insurance you have protecting your assets, the more ability you have to take risk in your other assets, so we try to integrate, in the accumulation stage, the life insurance with stock and bond decisions.

We [use] insurance products, basically immediate annuities, in the retirement stage in order to protect your–just the opposite–longevity risk. You would mix in some [immediate] annuities, since the stock and bond portfolio could protect the overall risk, but roughly half the people live beyond their life expectancy, and you couldn’t protect that very well with just stock and bond products. In the retirement arena we mix stocks and bonds with the annuity products, but also life insurance, because that’s a way to protect your bequest.

And you’re allocating only immediate annuities?

That would be a separate question, for tax angles or something like that if you were going to do variable-type annuities, but specifically to handle this longevity we’re focusing on the immediate annuities.

What about income for people in retirement?

Products that generate income are generally not very tax-efficient because, basically, that income can be taxed at the full, ordinary rate [up to 35%] …whereas the capital gains tax is 15%, and there may be state taxes on top of that, but it’s a much lower rate. I wouldn’t actually advise people to buy income-generating products. I think they’re actually better off–this would take some training on their part–but they’re actually better off if they could be selling off some assets to create some of this consumption, instead of buying the high-income products, which are quite taxable.

Roger Ibbotson has more to say on a host of issues. For a podcast containing more of his unique takes on investing and retirement, go to “Web Extras” at


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