Our focus has always been on providing our clients with long-term investment portfolios that balance risk and return in ways that best fit their objectives. However, markets are constantly in flux, and even well-diversified portfolios are subject to damaging outcomes, as evidenced by the events of 2008. Our conviction, long-term strategic asset allocation, remains the most important influence on returns over time. However, by adjusting an investor’s asset mix around his or her long-term plan in response to changing market conditions, it is possible to reduce risk and the impact of extreme market environments, without sacrificing long-term returns. Equally important are the advantages of a fundamental indexing approach, which according to Arnott is to produce a model portfolio based on a company’s recent footprint in the macro-economy. Additionally, utilizing a fundamental index methodology creates focus on relative value and avoids the traditional capitalization weighted investing or best guess price expectations. Our asset allocation approach aligns dynamic asset allocation and fundamental indexing for portfolio construction, thereby aligning an investor’s short-term and long-term perspectives with prevailing market conditions and risk/return integration.

In an environment coined the “new normal” according to PIMCO and Bill Gross, “historical models and econometric forecasting based on the experience of the past several decades may not only be useless, but counterproductive.” This new normal is not just a traditional inventory based recession, but rather an overleveraging process that has no quick fixes, and we should expect slow growth for the next 6 to 7 years, according to a recent study by the McKinsey Global Institute (MGI). By facilitating low rates and rapid money growth, the economy will respond. However, the deleveraging process is a crisis which will unfold overtime with pockets of risk and opportunity for investors; we feel that we are starting to see many warning signs which may have been overshadowed by Obama-nomics. The end-game is unclear and debated around many specific topics: the Federal Reserve’s quantitative easing strategy is scheduled to end in March 2010, increased taxes, bear-market rally or new bull market, strong operating earnings for the S&P 500 in the 4th quarter, government inflated GDP results, a jobless recovery with labor wages contracting, and possibly a few sovereign debt debacles. Mr. Market has seen enough! Continued economic weakness and deflation is going to dominate the markets for now.

Capturing change is order; diversification is opportunity.

If you analyze the past ten years of market returns, the S&P 500 has returned -3.5% and the U.S. Government Debt has an actual 3.5% return. From a 3 year market perspective, Large-Cap Value is down -12.27% and Large-Cap Growth is down -4.84% according to Morningstar. In fact, bonds outperformed equities in the 1980s and 1990s, in what was claimed as the strongest/longest stock bull market. Almost a lost decade without diversification or a traditional static asset allocation would have been average at best. At this juncture, we have had our 70% rally from the March low. Now what? It’s time for a retracement. According to David Rosenburg of Gluskin/Sheff, “Now, since this is a technically-driven market, we are bound to get a 50% reversal of the bear market rally, which would take us to 912 on the S&P 500, so keep your seatbelts on”. But according to Jeremy Grantham of GMO, “the market is worth only 850 or so; thus, any advance from here will make it once again seriously overpriced, although the high quality component is still relatively cheap.” If we want less-risk going forward, one must align risks and returns with valuations, reduce active management risk, incorporate dynamic asset allocation as an overlay process, and measure diversification opportunities when volatility fluctuates.

Into this next decade we start with low interest rates and overvalued equities - can investors meet long-term investment objectives under such non-stable markets? This is the dilemma. Investors need to understand that the economic outlook is uncertain, and bear markets remain a fact of life. Even with a dynamic asset allocation process focused around risk management, a managed portfolio can lose value; thus a well thought out strategy needs to be implemented to deal with the market risk.

Asset Classes to consider:

U.S. High Quality: Income producing securities
U.S. Treasury Bonds and TIPS: 5 year obligations
U.S. Baa Corporate Bonds Or higher quality (AA+)
International Equities Large-Cap
International Equities Small-Cap
Emerging Market Bonds: As per Bill Gross: "look, in other words, for savings-oriented economies".
Commodities: Agriculture, Oil and Timber
Opportunistic Asset Classes: Long/Short Strategies and Alternative Investment Strategies


Cross Creek Financial is an alternative business name for Cross Creek Capital Management, LLC a New Jersey based registered investment adviser. For more information please contact us for a copy of our Form ADV, Part II. Phone: 866-798-0354 or email cfranco@crosscreekfinancial.com