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

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

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

Returns and Diversification Data from MSCI

Returns and Diversification Data from MSCI

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

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

What to Expect 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 1-year premium Source: Graham and Harvey (2002)

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

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

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

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

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

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

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

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

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

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

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

U.S. Has Become a Riskier Global Investment Risk Ratings May 2001 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

All articles on www.duke.edu/~charvey 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