Valuation Campbell R Harvey Ph D Professor Duke

Valuation Campbell R. Harvey, Ph. D. , Professor, Duke University http: //www. duke. edu/~charvey 1

The Plan • • International track record Returns and diversification Long horizon vs. short horizon What can we expect from U. S. equities? What to expect from international? Alternative views: dynamic strategies, hedge funds Research frontier – changing views of diversification • Importance of GPR 2

The Track Record Investments Wilshire Mid Cap Thirty Year Treasury STRIP Twenty Year Treasury STRIP Wilshire Large Cap Wilshire 5000 Ten Year Treasury STRIP EAFE X-Japan Seven Year Treasury STRIP Credit MBS Aggregate Wilshire Small Cap Five Year Treasury STRIP Government Three Year Treasury STRIP Two Year STRIP EAFE One Year Treasury STRIP Source: Erb and Harvey (2002) 3

Returns and Diversification 4 Data from MSCI

Returns and Diversification Data from MSCI 5

The Long Horizon Data from Dimson, Marsh and Stauton (2002) 6

What to Expect Data from Dimson, Marsh and Stauton (2002) 7

What to Expect 8 Source: Goldman Sachs (2002)

What to Expect • Ten-year risk premium around 3. 5% and stable whereas one-year risk premium quite variable 10 -year premium Source: Graham and Harvey (2002) 1 -year premium 9

What to Expect U. S. Equity and Bond Returns are Positively Correlated Source: Erb and Harvey (2002) 10

What to Expect World Real Equity and Real Bond Returns are Positively Correlated Source: Erb and Harvey (2002) 11

What to Expect Inflation Negatively Related to Real Bill Returns Source: Erb and Harvey (2002) 12

What to Expect Inflation Negatively Related to Real Intermediate Bond Returns Source: Erb and Harvey (2002) 13

What to Expect Inflation Negatively Related to Real Bond Returns Source: Erb and Harvey (2002) 14

What to Expect Inflation Negatively Related to Real Equity Returns Source: Erb and Harvey (2002) 15

U. S. Has Become a Riskier Global Investment • The U. S. has become much more risky – High sensitivity to some GPRs – Disagreement on strength of economy – Financial information less credible • These factors suggest shifting exposures from equity to safer fixed income 16

U. S. Has Become a Riskier Global Investment ICRG Political Risk 17 Data from PRS

U. S. Has Become a Riskier Global Investment ICRG Political Risk 18 Data from PRS

U. S. Has Become a Riskier Global Investment ICRG Political Risk 19 Data from PRS

U. S. Has Become a Riskier Global Investment Risk Ratings December 2002 20 Data from PRS

U. S. Has Become a Riskier Global Investment Risk Ratings May 2001 21 Data from PRS

Conclusions • International investment is mainly about returns – diversification, while important, is often “oversold” • Expected returns depend on fundamental values today – not just historical return performance. • U. S. risk has increased suggesting a reallocation from equity to fixed income 22

Readings • All articles on www. duke. edu/~charvey – The Drivers of Expected Returns in International Markets (2000) – Global Tactical Asset Allocation (2001) with Magnus Dahlquist – The Term Structure of Equity Risk Premia (2002) with Claude Erb 23