There’s more to an investor’s total economic worth than stock and bonds, according to a new paper by two Morningstar researchers.
“Other assets, such as human capital, real estate and pensions, often represent a significant portion of an investor’s total wealth, but are not frequently considered when building portfolios despite the fact that they share common risks with financial assets,” David Blanchett, head of retirement research, said in a statement.
Blanchett and Philip Straehl, senior research consultant and portfolio manager, coauthored the study, which shows that industry-specific human capital, region-specific housing wealth and pensions have statistically significant exposures to certain asset classes and risk factors.
Investors should consider these factors when building portfolios, the authors assert. This would, of course, also apply to their financial advisors.
Through a series of optimizations, the researchers compared the asset allocation differences between portfolios that were optimized only for financial assets versus ones that considered total wealth.
They determined that the optimal allocation varied materially when vocation, location and pension benefits were considered, with average asset class differences exceeding 20 percent.
Blanchett and Straehl also found that given the bond-like nature of human capital (which they defined as the total economic value of an individual’s set of skills and talents), portfolios that incorporated this asset tended to have lower allocations to intermediate- and long-term bonds and higher allocations to large-growth U.S. equities and commodities.
They also found that investors who worked in the manufacturing, utilities and government sectors saw the largest changes to their optimal portfolios after the researchers factored industry-specific human capital into the asset allocation optimization.
Their total-wealth-optimized portfolios were significantly more aggressive than average, largely because of lower human capital volatility in these professions.