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June 18, 2014 at 07:58 AM
As advisors check out the wares at the nation’s premier fund show, the Morningstar Investment Conference, a recent research paper from the Chicago-based firm serves as a reminder that financial investments are just a part of a holistic view of a client’s wealth.
In “No Portfolio is an Island,” Morningstar researchers David Blanchett and Philip Straehl work off the insight that investors effectively “own” more than just stocks, bonds and cash, but also their human capital, real estate and pensions.
By taking these into account, as well as vital inputs such as age (when human capital is usually at its highest), holistic planners can more correctly optimize the allocation of financial assets in a portfolio.
The authors define human capital “as the total economic value of an individual’s set of skills and talents,” which “varies by age, health, education, occupation, industry and experience, among other variables, and is nontradeable.”
Just as financial assets have different return and risk characteristics — for example, annual returns on real estate investment trusts averaged 12.36% between 1993 and 2013 with a 19.76% standard deviation, whereas cash averaged 3.07% with a standard deviation of just 1.06% over the same period — so too do specific industries have varying returns at different times.
Comparing various industries to corporate bonds (because they share the characteristic of providing income, and from the same cash flow), the authors calculate various industry “discount rates” that are all over the map and vary from one period to another.
The growth of that income also varies, with health care workers seeing an average of 2.7% growth from 1992 projected through 2022, while miners face declining real wages at a rate of -0.9% over the same period.
Delving deeper, the authors look at correlations between financial assets and occupations and find that human capital more typically corresponds to fixed-income investments (echoing Moshe Milevsky’s question “Are You a Stock or a Bond?”).
Write Blanchett and Straehl:
