All Asset All Access

All Asset All Access, December 2017

In this issue, Research Affiliates looks at what drove 2017’s strong performance and examines whether historically high valuations on mainstream equities are telling the whole story.

Rob Arnott, founding chairman and head of Research Affiliates, reflects on the All Asset strategies’ strong performance in 2017; Jim Masturzo, global tactical asset allocation specialist for Research Affiliates, looks into whether Shiller price/earnings ratios may be overstating U.S. stock valuations; and Brandon Kunz, asset allocation specialist for Research Affiliates, offers insight into the All Asset funds’ collaborative due diligence process. As always, their insights are in the context of the PIMCO All Asset and All Asset All Authority funds.

Q: As we approach year-end, could you share your reflections on the All Asset strategies’ performance in 2017?

Arnott: We are pleased that the All Asset funds (institutional class shares) have delivered strong returns this year (and last year) while providing their usual diversification away from mainstream U.S.-centric stock and bond exposure. Year-to-date returns through 30 November were 11.90% for All Asset and 9.99% for All Authority, following strong 2016 results of 13.34% and 13.73%, respectively. Income distributions were a material contributor to these returns, which is notable in a world of negligible yields and given our modest exposure to below-investment-grade bonds. Much of the portfolio is invested in assets that can grow income with inflation, not shrink it with defaults.

The figure features two tables showing performance data for seven trailing periods for the All Asset and All Asset All Authority Funds as of 30 September 2017. Both tables show trailing performance for three and six months, one, three, five, and 10 years, and since fund inception. The All Asset Fund table is compared with U.S. TIPS benchmark and the Consumer Price Index plus 5%, while All Asset All Authority is compared with the S&P 500 Index, and the CPI plus 6.5%. Data is detailed within.

For the most recent quarter-end performance data for the All Asset Fund and the All Asset All Authority funds, please click on the links below:

As many of our seasoned readers are aware, we manage the All Asset strategies to provide a reliable source of long-term real returns along with diversification away from mainstream holdings. As such, our strategies employ a disciplined, value-oriented, contrarian rebalancing philosophy with a focus on real-return-oriented Third Pillar markets (diversifying markets – including real assets, emerging markets and high yield bonds).

This context is important, because it informs how we assess our results. When reflecting upon the past year’s performance, we focus on the following. First, how did our “home base” – Third Pillar markets – fare? For example, while many investors were unhappy with our results in 2013–2015, those were bear market years for our core asset classes. Second, what changes in U.S. inflation expectations did we experience? And last, were markets broadly trending upward, or were there ample opportunities to capture gains from mean reversion?

At the start of 2017, many people wondered whether the 2016 rally in Third Pillar markets, notably emerging market (EM) equities, had already run its course. That’s understandable. In 2016, a basket of equally weighted Third Pillar markets1 swiftly rose by 11.0% after suffering a tough bear market period over the prior three years – marked by an 11.9% cumulative decline. Consider EM stocks (proxied by the MSCI EM Gross Index): From their low on 20 January 2016 through year-end, they had rebounded by 27.9%. The PIMCO RAE Fundamental PLUS EMG Fund – our primary vehicle for investing in EM stocks – was up 61.83% over the same span! Coming into this year, even after this sharp surge, we believed many Third Pillar markets remained undervalued, with substantial runway for further price appreciation. Year-to-date, the Third Pillar basket has delivered 9.7%, and EM equities have rallied an additional 30% – a positive for our strategies.

The figure is a table showing performance after fees for the PIMCO RAE Fundamental PLUS EMG fund, for six different trailing periods, ranging from year-to-date to since inception in 2006. Data for the MSCI Emerging Markets Index and MSCI EM Value Index are also included. Data as of 30 September 2017 are detailed within.

For the most recent quarter-end performance data for the RAE Fundamental Plus EMG Fund, please click on the link below:

Let’s turn to the second consideration: changes in inflation expectations. We’ve regularly discussed the strong relationship between changes in breakeven inflation and the returns of the All Asset strategies. Generally, when expected inflation levels increase (over rolling 12-month periods), we expect our strategies to benefit from an added tailwind. Let’s rewind the tape back to February 2016, when 10-year breakeven inflation reached a cyclical low of 1.2%. Not surprisingly, the subsequent rise in inflation expectations to 1.95% by the end of 2016 rewarded our strategies. Inflation expectations then rose to 2.08% in the first few weeks of this year before dipping to 1.66% around midyear, and have since recovered to just under year-end 2016 levels. So in 2017, the All Asset funds have delivered returns without the added tailwind from rising inflation expectations … yet.

Finally, returns have ranged quite widely across asset classes year-to-date through November (although less so than in most years). EM, EAFE (Europe, Africa and Far East) and U.S. equities have delivered over 20% returns, while returns for EM currencies, high yield bonds and REITs (real estate investment trusts) have been near the high single-digits and those for U.S. TIPS (Treasury Inflation-Protected Securities) and core bonds have been in the low single-digits.2 It’s no secret that the markets have pummeled value stocks this year, but the All Asset funds have earned solid returns despite this value headwind within equities.

While the environment in 2017 has been painful for value stocks, there’s a silver lining. Our exposure to the PIMCO RAE Fundamental strategies means we are trading into what we view as compelling bargains, which in turn may set the stage for future potential outperformance. The cheaper value becomes, the more attractive our prospective returns, in our opinion. Should value rebound, and particularly if continued easy central bank policies ignite inflation, we are confident in the All Asset strategies’ ability to deliver both diversification and the potential for continued solid real returns. We wouldn’t say the same for mainstream stocks and bonds, with their current anemic yields and what we consider to be nosebleed valuations.

As we close the year, we want to thank our investors for their trust, confidence and commitment. In the next issue, we’ll shift away from the rearview mirror and look forward. My colleagues and I are excited to share our market outlook with you in early 2018!

Q: The Shiller price/earnings (P/E) ratio has been indicating that U.S. stocks are rich for some time, but the market keeps going up. Could data from the financial crisis be inflating the Shiller P/E?

Masturzo: At Research Affiliates, we are firm believers in the long-term mean reversion of asset prices, a belief driven by our experience and observations across markets.3 Over time, markets may stray from fair value to become rich or cheap, but eventually they revert back toward fair value. While valuation metrics such as the Shiller P/E (aka the cyclically adjusted P/E, or CAPE) can be valuable guideposts on a market’s richness or cheapness, and while the Shiller P/E specifically has been a powerful predictor of future equity returns over the five- to 10-year horizon, let’s also acknowledge that valuation metrics alone provide little guidance in the way of short-horizon timing.

The Shiller P/E is a ratio of the current market price to an average of earnings per share over the previous 10 years, net of inflation. The intent is to capture at least one full peak-to-trough business cycle, in order to get a realistic gauge of average corporate earnings and therefore a more consistent basis to evaluate equity market pricing over time. The current Shiller P/E captures both the earnings trough in 2008–2009 (during the global financial crisis) and the peak in 2014–2015. The resulting current Shiller P/E value for the S&P 500 is 30.1x (as of 31 October 2017), which has been eclipsed only twice in the past 140 years, in 1929 and 1999.4 So when judged by historical standards, current U.S. equity valuations are extremely rich.

Given the depth of the financial crisis, during which real earnings per share dropped to the mid-single-digits (versus the current 10-year average of $82), many may wonder if the current Shiller P/E level is disproportionately biased up by extremely low outlier earnings. While this can be a useful thought experiment, it should be done with caution: The impetus to ignore trough (or peak) earnings is often driven by recent experience. For instance, back in 2010, when the financial crisis was still a fresh wound for investors, would anyone have considered ignoring results from that period? Also, one should ask if investors with large U.S. equity allocations might be more biased to ignore trough earnings, to help justify their current holdings, as opposed to similarly ignoring peak earnings. Keep these biases in mind as we consider the following results.

There are many ways to mitigate the effects of the financial crisis on the current Shiller P/E level. Our objective is to remove only those data points corresponding to periods that could be outliers, and not to discount the entire crisis period (which would result in a Shiller P/E based on peak earnings and with no recession).

To achieve this trade-off, we start by removing the 12 months when cumulative earnings were the lowest (see table). Under this method, recalculating the current Shiller P/E with the remaining nine years of higher earnings lowers the current value from 30.1x to 28.4x, a 6% drop, but still in the 95th percentile historically.

A more balanced adjustment that might better gauge average (or non-outlier) earnings might also remove the 12 months of the highest earnings. In this case, the Shiller P/E level rises back up a bit, to 29.1x. Alternatively, we could simply use median 10-year real earnings in the calculation, instead of average earnings. This causes the current Shiller P/E level to drop to 27.5; however, that is still in the 94th percentile historically.

The figure is a table showing how three adjustments affected the Shiller P/E (price/earnings ratio). The adjustments include removing the lowest consecutive 12 months of earnings, removing the lowest and highest consecutive 12 months of earnings, and median earnings. These are all compared with the original method. Data as of 31 October 2017 on earnings per share, Shiller P/E value, and Shiller P/E percentile are detailed within.

Any way you slice it, the current Shiller P/E value looks rich when compared to historical levels. This leads to another question: Does the historical average level of the Shiller P/E of 17x provide an apt point of reference for fair value today? Market participants have proposed a number of adjustments that would raise today’s Shiller P/E “fair value” level to 21x or 22x, which would make today’s actual level appear less rich by comparison. While some of these adjustments may initially appear defensible, especially over the next three to five years, many are expected to be met with offsetting headwinds that could push the average back down. (For an in-depth discussion of these adjustments and a detailed look at the pros and cons of the Shiller P/E, see “CAPE Fear,” a paper my colleagues Robert Arnott, Vitali Kalesnik and I co-authored this year).

Still, if we apply the most liberal adjustments, which drop the current implied valuation level and raise the historical average “fair value” level, we would still see the S&P 500 overvalued by a conservative estimate of 20%. Does this mean that U.S. stock prices can’t possibly rise further? Of course not. But as valuations continue to stretch, the probability of further price gains continues to fall. Therefore, when investing capital for our clients, we prefer to look around the globe for markets where valuations are cheaper and prices are more likely to rise, and where higher yields translate to higher income for investors.

Q: How do you monitor and conduct due diligence on the underlying funds within the All Asset suite?

Kunz: Our portfolio due diligence process is part and parcel of our collaboration with PIMCO on the All Asset funds. Our asset allocation team meets with the portfolio managers of the underlying PIMCO funds at least annually, with more frequent interactions in the event of asset class dislocations or before material tactical movements into or out of a particular asset class. Any changes to an underlying fund’s investment team, investment process or “home base” positioning may also influence the frequency of due diligence meetings with portfolio managers. Whatever the catalyst, these interactions allow us to gather the insight needed to maintain accurate models of each fund’s “home base” exposures, determine if a subjective adjustment to our overall portfolio positioning is merited and confirm each fund’s liquidity profile.

To maintain model accuracy, we monitor our assigned “home base” factor exposures for each underlying fund versus its current exposures on a daily basis. However, we fully expect current factor exposures to deviate from assigned averages, since each fund is actively managed.

To seek to avoid negating alpha potential of the underlying PIMCO funds, we intentionally don’t react to such tactical deviations from “home base” positioning. However, if large and persistent deviations from the modeled factor exposures occur, we meet with the underlying fund’s portfolio manager to understand why. If the deviation is expected to persist, we may update our model for that fund. If the deviation appears more tactical than strategic, we would look to understand the rationale for the shift and likely leave the model unchanged in order to preserve that incremental source of value-add potential for our end clients.

In discussions with portfolio managers, we also affirm guidance related to the daily, weekly and monthly liquidity profile of the underlying fund. This exercise has nothing to do with the All Asset funds’ right to liquidity; each underlying fund is already a daily liquidity vehicle. Rather, it’s about understanding the level of flows that each underlying market can absorb so that we trade responsibly – balancing our desire to make allocation shifts with the liquidity characteristics of the market and the underlying portfolio manager’s ability to generate alpha potential, which also accrues to our investors.

The All Asset strategies represent a joint effort between PIMCO and Research Affiliates. PIMCO provides the broad range of underlying strategies – spanning global stocks, global bonds, commodities, real estate and liquid alternative strategies – each actively managed to maximize potential alpha. Research Affiliates, an investment advisory firm founded in 2002 by Rob Arnott and a global leader in asset allocation, serves as the sub-advisor responsible for the asset allocation decisions. Research Affiliates uses their deep research focus to develop a series of value-oriented, contrarian models that determine the appropriate mix of underlying PIMCO strategies in seeking All Asset’s return and risk goals.

Further reading

Recent editions of All Asset All Access offer in-depth insights from Research Affiliates on these key topics:

  • A revealing look at why a negative correlation with mainstream assets isn’t required to benefit from diversification (November 2017)
  • A deep dive into the All Asset strategies’ dynamic risk positioning (October 2017)
  • A retrospective look at the All Asset Fund’s performance in the 15 years since its launch (September 2017)
  • Outlook for inflation and real return investing (August 2017)
  • Outlook for credit markets, plus a framework for creating long-term asset class forecasts (July 2017)
  • The case for diversification amid an aging bull market for U.S. stocks (June 2017)
1 Third Pillar consists of an equally weighted allocation to U.S. high yield (Bloomberg Barclays U.S. Corporate High Yield Index), long U.S. TIPS (Bloomberg Barclays U.S. Treasury Inflation Notes: 10+ Year Index), EM local bonds (JPMorgan Government Bond Index-Emerging Markets Global Diversified Index (Unhedged)), EM equities (MSCI EM Index), REITs (Dow Jones Select U.S. REITs Index) and diversified commodities (Bloomberg Commodity TR Index).

2 Proxies are as follows: EM (MSCI EM Gross Index), 32.9%; EAFE (MSCI EAFE Gross Index), 24.6%; U.S. (S&P 500), 20.5%; EM currencies (JPM ELMI Plus), 10.5%; High yield bonds (Bloomberg Barclays US High Yield), 7.2%; REITs (FTSE Nareit All REITS), 9.4%;U.S. TIPS (Bloomberg Barclays U.S. Treasury Inflation Protected Notes), 2.1%; core bonds (Bloomberg Barclays U.S. Aggregate Bond), 3.1%.

3 For additional information, see “Our Investment Beliefs,” published October 2014 by Chris Brightman, Jonathan Treussard and Jim Masturzo.

4 The Shiller P/E of the S&P 500 is based on Robert Shiller’s online data, which begins in January 1871.
The Author

Robert Arnott

Founder and Chairman, Research Affiliates

Jim Masturzo

CIO, Multi-Asset Strategies, Research Affiliates

Brandon Kunz

Partner, Head of Multi-Asset Solution Distribution, Research Affiliates

Related Funds


Investors should consider the investment objectives, risks, charges and expenses of the funds carefully before investing. This and other information are contained in the fund’s prospectus and summary prospectus, if available, which may be obtained by contacting your investment professional or PIMCO representative or by visiting Please read them carefully before you invest or send money.

The terms “cheap” and “rich” as used herein generally refer to a security or asset class that is deemed to be substantially under- or overpriced compared to both its historical average as well as to the investment manager’s future expectations. There is no guarantee of future results or that a security’s valuation will ensure a profit or protect against a loss.

Past performance is not a guarantee or a reliable indicator of future results. The performance figures presented reflect the total return performance for the institutional Class shares (after fees) and reflect changes in share price and reinvestment of dividend and capital gain distributions. All periods longer than one year are annualized. The minimum initial investment for Institutional class shares is $1 million; however, it may be modified for certain financial intermediaries who submit trades on behalf of eligible investors.

Investments made by a Fund and the results achieved by a Fund are not expected to be the same as those made by any other PIMCO-advised Fund, including those with a similar name, investment objective or policies.  A new or smaller Fund’s performance may not represent how the Fund is expected to or may perform in the long-term.  New Funds have limited operating histories for investors to evaluate and new and smaller Funds may not attract sufficient assets to achieve investment and trading efficiencies.  A Fund may be forced to sell a comparatively large portion of its portfolio to meet significant shareholder redemptions for cash, or hold a comparatively large portion of its portfolio in cash due to significant share purchases for cash, in each case when the Fund otherwise would not seek to do so, which may adversely affect performance.

Differences in the Fund’s performance versus the index and related attribution information with respect to particular categories of securities or individual positions may be attributable, in part, to differences in the pricing methodologies used by the Fund and the index.

There is no assurance that any fund, including any fund that has experienced high or unusual performance for one or more periods, will experience similar levels of performance in the future. High performance is defined as a significant increase in either 1) a fund’s total return in excess of that of the fund’s benchmark between reporting periods or 2) a fund’s total return in excess of the fund’s historical returns between reporting periods. Unusual performance is defined as a significant change in a fund’s performance as compared to one or more previous reporting periods.

A word about risk:

The fund invests in other PIMCO funds and performance is subject to underlying investment weightings which will vary. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed.  Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Commodities contain heightened risk including market, political, regulatory, and natural conditions, and may not be suitable for all investors.  Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Investing in securities of smaller companies tends to be more volatile and less liquid than securities of larger companies.  Inflation-linked bonds (ILBs) issued by a government are fixed-income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Derivatives and commodity-linked derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Commodity-linked derivative instruments may involve additional costs and risks such as changes in commodity index volatility or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Investing in derivatives could lose more than the amount invested.  The cost of investing in the Fund will generally be higher than the cost of investing in a fund that invests directly in individual stocks and bonds.  Diversification does not ensure against loss.

There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

Bloomberg Barclays U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis. The Bloomberg Barclays U.S. Corporate Index covers USD-denominated, investment-grade, fixed-rate, taxable securities sold by industrial, utility and financial issuers. It includes publicly issued U.S. corporate and foreign debentures and secured notes that meet specified maturity, liquidity, and quality requirements. Securities in the index roll up to the U.S. Credit and U.S. Aggregate indices. The U.S. Corporate Index was launched on January 1, 1973. The Bloomberg Barclays U.S. Corporate High-Yield Index the covers the USD-denominated, non-investment grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below. The index excludes Emerging Markets debt.   Bloomberg Barclays U.S. TIPS: 1-10 Year Index is an unmanaged index market  comprised of U.S. Treasury Inflation Protected securities having a maturity of at least 1 year and less than 10 years. Bloomberg Barclays U.S. Treasury Inflation Notes: 10+ Year is an unmanaged index market comprised of U.S. Treasury Inflation Protected securities with maturities of over 10 years.  The Bloomberg Commodity Total Return Index is an unmanaged index composed of futures contracts on 22 physical commodities. The index is designed to be a highly liquid and diversified benchmark for commodities as an asset class.  The Consumer Price Index (CPI) is an unmanaged index representing the rate of inflation of the U.S. consumer prices as determined by the U.S. Department of Labor Statistics.  There can be no guarantee that the CPI or other indexes will reflect the exact level of inflation at any given time. The Dow Jones U.S. Select Real Estate Investment Trust (REIT) Index is an unmanaged index subset of the Dow Jones Americas U.S. Select Real Estate Securities (RESI) IndexSM. This index is a market capitalization weighted index of publicly traded Real Estate Investment Trusts (REITs) and only includes only REITs and REIT-like securities. JPMorgan Emerging Local Markets Index Plus tracks total returns for local currency-denominated money market instruments in 24 emerging markets countries with at least U.S. $10 billion of external trade. JPMorgan Government Bond Index-Emerging Markets Global Diversified Index (Unhedged) is a comprehensive global local emerging markets index, and consists of regularly traded, liquid fixed-rate, domestic currency government bonds to which international investors can gain exposure. The MSCI EAFE Index is an equity index which captures large and mid cap representation across Developed Markets countries* around the world, excluding the US and Canada. With 928 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.  The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 21 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey. The National Association of Real Estate Investment Trusts (NAREIT) Equity Index is an unmanaged market weighted index of tax qualified REITs listed on the New York Stock Exchange, American Stock Exchange and the NASDAQ National Market System, including dividends.  The S&P 500 Index is an unmanaged market index generally considered representative of the stock market as a whole. The index focuses on the Large-Cap segment of the U.S. equities market. It is not possible to invest directly in an unmanaged index.

This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2017, PIMCO.

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