2011 Asset Class Summary

After suffering through wrenching volatility throughout 2011, investors in US Equities looking at their year-end statements find that the value of their portfolios were largely unchanged -- the S&P500 Index rose approximately 2% for the year.  Small-caps gained only 0.66% and the mid-cap index dropped -0.12%.  

These returns may not seem particularly rewarding given all the risk and volatility markets experienced. Surprisingly the US markets were relative winners in 2011 - global equity markets dropped almost 15% in 2011 and promising growth economies like India and Brazil saw their equity markets plummet by more than 20%.

An even bigger surprise in 2011 was the identity of the biggest winner among the 11 broad asset classes we track - TIPS (Treasury Inflation Protected Securities).   Who would have guessed that this conservative asset class - a hedge against inflation - would easily outperform riskier asset classes?  Especially given the largely benign inflation environment in 2011.

At the start of 2011 many advisers recommended moving away from bonds given the low returns and risk of rising interest rates. This would have likely proved a mistake for most investors given bond's relative strong performance among asset classes.

We expressed concern about emerging market allocations (in the context of asset allocation). We still have concerns about emerging market exposure, but we encourage investors to maintain their recommended allocation to emerging markets over the long-term. We also suggested conservative investors consider shortening the duration on their bond holdings - a move which would have reduced returns in 2011, but a move which we think remains prudent for 2012. TIPS low returns may seem even more absurd now, but TIPS remain an important component of our risk-controlled portfolios.

Volatility, as measured by VIX (CBOE's Volatility Index) dropped significantly in December, possibly signaling better equity market conditions ahead.  Volatility is one of the key drivers of Portfolio Research's allocation algorithm. This may be the light at end of the tunnel.  (Or it may be an approaching collision). Either way your best bet is a diversified portfolio.