CAM Asset Allocation Considerations and Historical Data

Asset Allocation Considerations
and Historical Data

Why High Yield Bonds Could be Considered as a “Core” holding and Investment Grade Corporates provide better value than Treasuries.

The first table below indicates that High Yield bonds outperformed the other major bond categories shown. Also, they have provided a better risk/reward trade-off than equities as measured by the Sharpe Ratio. Comparisons show that high yield bonds provided approximately 85% of the return of stocks with about 50% less risk and a Sharpe ratio more than 25% higher. Investment Grade Corporates outperformed Intermediate Treasuries with a higher Sharpe Ratio.

Risk and Total Return Comparisons
1980 - 2010
	Total Returns Geometric Means	Standard Deviation	Sharpe Ratio (Return/Unit Risk)
S&P 500 Stocks	11.4%	17.5%	0.44
Wilshire 5000 Stocks	11.3%	17.9%	0.42
Russell 2000	10.9%	22.6%	0.36
High Yield Bond Index	10.8%	9.7%	0.63
ML Corporate Bond Index	9.2%	7.8%	0.56
Intermediate US Gov't Bonds	8.7%	6.5%	0.58
30-Day US Treasury Bills	5.1%	1.0%	0.00

Source: Credit Suisse 1/20/11 2011 Leveraged Finance Outlook. Past performance is no guarantee of future results. Index returns do not reflect the deduction of fees, trading costs or other expenses. The Index is referred to for informational purposes only and the composition of the Index is different from the composition of the accounts included in the performance shown above. 2010 data not yet available.

The table below provides shorter term data which show that the return/risk of high yield and corporate bonds has approximated or exceeded that of equities.

Risk and Total Return Comparisons 1992-2010
	Total Returns (Geometric Mean)	Risk Standard Deviation	Sharpe Ratio (Return/Unit Risk)
Wilshire 5000 Stocks	8.4%	16.8%	0.67
S&P 500	8.1%	16.4%	0.38
Russell 2000	9.2%	21.8%	0.38
High Yield Bonds	8.7%	8.9%	0.66
ML Corporate Bond Index	7.0%	5.9%	0.68
Intermediate Government Bonds	6.6%	5.2%	0.67
US 30-Day US Treasury Bills	3.2%	0.5%	0.00

Source: 2011 Leveraged Finance Outlook. Past performance is no guarantee of future results. Index returns do not reflect the deduction of fees, trading costs or other expenses. The Index is referred to for informational purposes only and the composition of the Index is different from the composition of the accounts included in the performance shown above.

Correlations Between Various Assets 1980-2010

	30 Day U.S. T-Bill	U.S. Intermediate Gov't Bonds	U.S. Long Term Gov't Bonds	Barclays Aggregate Bond Index	CSFB High Yield Bond Index	S&P 500 Stock Index
30 Day U.S. T-Bill	1.00
U.S. Intermediate Gov't Bonds	0.08	1.00
U.S. Long Term Gov't Bonds	0.01	0.90	1.00
Barclays Aggregate Bond Index	0.07	0.93	0.91	1.00
CSFB High Yield Bond Index	-0.03	0.26	0.26	0.46	1.00
S&P 500 Stock Index	0.03	0.07	0.1.	0.21	0.54	1.00

The academic literature supports the position that interest rate anticipation is ineffective. “The academic literature does not support the view that interest rates can be forecasted with accuracy in order to realize positive active returns on a consistent basis”.2 “Academic literature generally holds that interest rate forecasts are unable to generate consistent risk-adjusted excess returns”. 3

1 Credit Suisse 1/22/2011 data from 1980-2010Annual Leveraged Finance Outlook. Past performance is no guarantee of future results. Index returns do not reflect the deduction of fees, trading costs or other expenses. The Index is referred to for informational purposes only and the composition of the Index is different from the composition of the accounts included in the performance shown above.

2 Fixed Income Readings for the Chartered Financial Analyst (CFA) program, copyright 20005 CFA Institute; chapter 3 – Managing Funds Against a Bond Market Index, Frank Fabozzi, PhD., CFA, Yale University (page 63).

3 Fixed Income Readings for the Chartered Financial Analyst (CFA) program copyright 2005 CFA Institute; chapter 6 –International Bond Management, Frank Fabozzi, PhD, CFA, Yale University; Hank Lynch, CFA, State Street Global Markets; Christopher Stewart, CFA, Wellington Management Company (pg. 171)

Another View of Diversifying a Bond Portfolio

The chart below provides the annual ranking of various fixed income classes in terms of total return performance. As it shows, from 1991 through 2010 High-yield Bonds were one of the best performing fixed income sectors. Also in a number of years their performance ranking is the opposite of that of Investment Grade Corporates and U. S. Government Bonds. So, including them in a portfolio makes sense both in terms of return potential and diversification. An even more compelling argument could be made for the higher quality segment of the high yield sector.