fingham

Defining Alternative Asset Classes

I go:
15% US stock market - mostly index, plus some value-oriented no-load managers (FAIRX, UMBIX)
19% Alpha-seeking (brilliant mutual fund managers who pursue non-correlated strategies)
14% International developed market (mostly EFA, plus some WGRNX)
5% Emerging markets (VWO)
5% US REITs (VNQ)
5% International REITs
7% Natural resources/commodities
15% US Government bonds/insured munis/money market funds (mix depends on yield curve and spread of taxable vs tax free yields)
15% TIPS

Defining Alternative Asset Classes

My investable "alternative" asset classes are:

International REITs - WPS (I have an equal allocation of domestic REITs via VNQ)

Natural Resources - PCL, RYN, PCH (timberland), PRFE (energy), GLD and GDX (gold)

Great Fund Managers who are not closet indexers: PRPFX - (excellent inflation hedge with high Sharpe Ratio - heavy in commodities, currencies, and small-caps) and Ken Heebner's CGMFX and CGMRX.

TIPS. David Swensen strongly makes the case for TIPS as an asset class, which I buy into. Academic research indicates their powerful diversification effect.

I like Granger's ideas above, though one I've already passed on. ARBFX has nearly 2% fees, low net returns and a negative Sharpe Ratio. With five year CAGR of just 5%, it's too volatile for me to hold. I want to get paid for risk. Low correlation isn't enough.

I think a very important question we need to answer is, how much exposure is meaningful? How thin do we slice the pie? How big should our "alternative" category (or any category) be? How big should any sub-slice within it be to be helpful in moving us toward diversified returns?

A World Market Cap Approach to Allocation

I think using market cap is a risky way to allocate. As Robert Arnott has shown with his "fundamentally" weighted indexes, cap weighting tends to overweight what's overvalued and underweight what is undervalued. How about looking at the fundamentals in the markets in question? GDP, or, the cumulative value of revenues, and/or dividends, of the public companies in those markets, might give a more realistic weighting criteria (Robert Arnott's other factors, book value and earnings, may be too difficult to compare from country to country due to varying financial reporting standards. Even revenue is probably not strictly comparable, but it is probably more comparable that earnings or book value). With the recent run-up in non-US stocks, particularly "emerging markets", a cap weighting is probably taking on excessive risk (despite the obvious attraction of being relatively easy to calculate).