An Overview of Other Asset Classes and Uncorrelated Alpha Strategies

Domestic Commercial Property

Property is the world’s largest asset class. Unfortunately, it is also one of the most opaque. Unlike most other asset classes, the assets in question are dissimilar, and trade infrequently at high transaction costs in markets where data collection efforts lag far behind those in markets for more liquid financial assets. Moreover, unlike the markets for financial assets, there are far fewer opportunities for shorting over-priced assets, and supply responds much more slowly to changes in demand, which sets the stage for repeated boom and bust cycles.

At the broadest level, the property asset class can be divided between residential and commercial, and between domestic and foreign assets. Here we will focus on commercial property. This asset class can be further sub-divided into property that is owned directly versus property that is owned via a vehicle that trades on an established stock exchange (e.g., real estate investment trusts in Canada and the US; listed property companies in Australia, or property mutual funds in Europe).

In comparison with the data available on residential real estate returns, commercial property markets provide a wealth of information. However, in comparison with the information normally available on financial assets, commercial property data is still quite sparse, and of very uneven quality. For example, returns data for directly owned commercial real estate tend to be based on individual appraisers’ valuations, which, for very human reasons, tend to change only slowly over time. As a result, price indexes for directly owned real estate show much lower levels of volatility than comparable indexes for commercial property that is owned via exchange traded instruments (such as listed property and real estate investment trusts).

In response to this criticism, direct owners of property sometimes note that exchange traded real estate securities probably overstate the volatility of the returns underlying property, as equity market “mood swings” are much more frequent that tenant lease payment renegotiations and building sales.

Theory suggests that the relative riskiness of commercial property should lie somewhere between bonds and equities, as it contains elements similar to both. Like a bond, the annual cash flows on a real estate investment (lease payments) are relatively fixed (although, unlike a bond’s coupon, they can be adjusted, often with a significant lag, to reflect changes in inflation). Like the equity market, however, the actual value of commercial real estate tends to increase as the economy grows, while the capital value of a bond remains fixed (unless it is a real return bond, in which case it changes in line with inflation).

On average, the correlation between real estate returns and domestic equity returns is higher than that between real estate and domestic bonds. This may be due to a natural tendency to re-invest some portion of one’s equity gains into real estate, and/or to the fact that both equities and real estate deliver good returns in a growing economy, with that growth often leading to interest rate increases that hurt total bond returns.

Foreign Commercial Property

Are any benefits to diversifying one’s listed property investments internationally?

Historically, global GDP growth has been the most important common long-term driver of returns on property investments across different the countries. In the short and medium terms, however, local factors have had a stronger impact, and given rise to significant diversification benefits from investing in both domestic and foreign property.

However, this appears to be changing. As the IMF noted in the 2018 Global Financial Stability Report, the correlation between residential housing markets around the world has reached an unprecedented level, driven by the increased mobility of people and capital, and much improved information flows. There is also evidence to believe that this trend is also underway in the listed commercial property sector.

This leads us to question whether listed foreign commercial property should continue to be treated as a separate asset class. For now we are still doing this, as in 2008 foreign commercial property provided important diversification benefits to US dollar based investors. However, as more data becomes available, our position on this may change.

It is also critical to note that when it comes to property ownership as a hedge against severe political unrest and hyperinflation, there is a very big difference between owning a financial product that tracks a traded listed property index, and owning a real commercial or residential property in a safe-haven country. The value of the former is subject to the risk of financial market disruption, while the latter continues to have an important role in the portfolios of investors who are based in countries where disruption risk is non-trivial (writes someone who in the past lived in Caracas).


The commodities asset class includes the raw materials used by every economy: energy inputs (e.g., oil, gas), foodstuffs (e.g., coffee, cocoa, sugar, wheat), metals (e.g., aluminum, copper, gold, silver), livestock (e.g., cattle, hogs), and timber.

In general, the returns on different commodities have low correlations with each other (see the IMF Report “The Myth of Comoving Commodity Prices” by Cashin, McDermott, and Scott for more on this). Commodity returns are tracked by a number of different indexes that share a common shortcoming: none of them includes timber, which we treat separately.

Commodities as an asset class, regardless of the index used to track it, have historically provided the best real hedge against inflation risk. On the other hand, when financial markets have encountered liquidity crises commodities have provided less protection than high quality bonds (but relatively better protection than equities).

But what happens under deflation? If deflation is a global phenomenon, commodity prices should decline, and the returns on this asset class will most likely be less than those on investment grade bonds. On the other hand, if deflation is more localized, then commodity prices coulc still rise. Along with exchange rate effects (as the global price for most commodities is set in U.S. dollars), this can lead to impressive returns on this asset class.

Investors wishing to diversify into commodities face another problem, assuming they are not going to hold large stocks of physical commodities (which is quite expensive). Commodity index funds generally invest not in physicals, but rather in a mix of commodity futures contracts that match the weights of different commodities in the index. The return on these funds comes from three sources: (1) the return on the collateral they must deposit when they buy the futures contracts. Generally, this is close to the return on short-term US Treasury Bills. (2) Unanticipated changes in the spot price of the commodities (as expected changes were reflected in the purchase price of the futures contract). And, crucially, (3), the gain or loss on the “roll yield” when the fund sells maturing futures contracts and replaces them with new ones.

The Roll Yield is positive when the price for the maturing contract is higher than the price of the longer-maturity contract that replaces it. Technically, this is called “backwardation” (the opposite situation is “contango”). In theory (technically, the Theory of Storage), commodities for which supply is constrained, storage is expensive, and demand is high should be backwardated.

However (and this is a critical however), the Theory of Storage logic assumes no change over time in the demand by investors willing to purchase futures relative to the supply of contracts sold by commodity producers. This assumption has been violated in recent years, which have seen a dramatic increase in the amount of investment committed to long-only commodity futures based index funds.

Some observers have argued that this increase in demand for commodity futures has overwhelmed any changes that have taken place on the supply side that are driven by the Theory of Storage. They conclude that this has resulted in a permanent change in the structure of many commodity futures markets that has made contangoed conditions, and hence negative roll returns, much more likely. We are persuaded of the logic of this argument.

This raises serious questions about the wisdom of continuing to include futures-based commodity index products in a portfolio, in the absence of new products that do a better job of controlling for negative roll yields.


The underlying diversification logic for investing in timber is quite simple: the key return driver is the biological growth of forest plantations, which has essentially no correlation with factors driving returns on other asset classes. That said, the correlation of timber returns with other asset classes should be different from zero, as it also depends on the price of timber products (which depends, in part, on GDP growth) as well as changes in real interest rates and investor behavior – factors affect returns on other asset classes as well as timber.

However, investors in timber face a number of significant challenges. First, the underlying assets are not uniform – they are divided between softwoods and hardwoods, at different stages of maturity, located in different countries, face different supply conditions (e.g., development, harvesting, and environmental regulations and pest risks), and different demand conditions in end-user markets.

Second, the majority of investment vehicles containing these assets are illiquid limited partnerships, and the few publicly traded timber investment vehicles (e.g., timber REITs) provide insufficient liquidity to serve as the basis for indexed investment products. That said, as you can see in our discussion of model portfolio results, the inclusion of a mix of these timber REITs has been beneficial between December 2007 and December 2017.

Finally, the two indexes that attempt to measure returns from timberland investing (the NCREIF Index in North America, and IPD Index in Europe) are regional in coverage and utilize an appraisal based valuation methodology, which tends to understate the volatility of returns and their correlation with other asset classes.


In our view, gold is ultimately a hedge against a sharp decline in global confidence in the United States and U.S. government debt as the most liquid, lowest risk asset class in the world financial market. Because it is a form of insurance, one would expect that gold as an asset class would have a similar return profile – negative most of the time (in effect, reflecting the cost of the insurance premium), but steeply positive under certain conditions.

This has caused us to view gold not as a distinctive asset class (though that is possible), but rather as an asset that, along with currency (and perhaps gems) is part of an investor’s liquid reserve.

This raises another critical point: If one views gold as an asset class, then it would make sense to invest in it via the same type of futures based fund that other commodity index produces use. However, if one views gold in its traditional role – as a store of value that protects against the worst of times (e.g., hyperinflation that destroys the value of currency, or financial asset seizure by a rogue government) – then the possession of physical gold (coins, not bullion) is critical. For this reason, in our previous work, we have focused on either the holding of gold coins, or on investment products that have as an option the right to liquidate one’s financial position and receive gold in return.

Uncorrelated Alpha Strategies

While they are not asset classes, and while we generally have an aversion to active management strategies (including, perhaps especially, the profusion of very narrowly defined index funds), we also recognize the potential portfolio benefits of an allocation to hedge fund strategies that are designed to have a low correlation to returns on broad asset classes, especially domestic equity.

Two of these “uncorrelated alpha” strategies are Equity Market Neutral and Global Macro. The former focuses on picking undervalued stocks while neutralizing exposure to overall market returns. The latter actively overweights or underweights broad asset classes on the basis of the expected change in their relative valuations.

As you can see in the discussion of our
model portfolios' performance over the 15 years ended in December 2017, the returns generated by a mix of these strategies proved to be beneficial. However, we should also point out that most of that return came from the Global Macro (also known as Global Tactical Asset Allocation) strategy, and far less from Equity Market Neutral. We have a strong suspicion that at least part of this gap reflects the rise of quantitative/algorithmic trading strategies in public equity markets, which has made them much more efficient, and thus made the Equity Market Neutral strategy more difficult.

In contrast, given the complex mix of constantly evolving factors that drive changes in broad asset class returns and foreign exchange rates around the world, successful Global Macro strategies are more difficult to replicate with an algorithm, and thus have remained relatively more successful.

Now that you have an estimate of the minimum required rate of return you need to earn to reach your goals, and the asset classes you can invest in to achieve them, how should you construct your portfolio?

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