value based asset allocation

Q3 commentary from Richard Pzena’s Pzena Investment Management. Very interesting discussion of asset allocation:

Is the answer to this challenging question simply to choose low volatility combined with stable returns or is the answer to select an option that produces the best long-term real growth of principal?

To address this issue we have attempted to model three different time periods over the last 22 years to compare the results of a 100% allocation to value equities (cheapest quintile price to book value excluding the most volatile stocks), 100% to bonds (10 year U.S. Treasury Bonds) or 100% to hedge fund of funds (HFRI Fund of Funds Composite Index).

In our analysis we made the following assumptions about our spending rate:
1. Initial spending rate is 4% of the beginning principal
2. Real spending growth is 2% per year (in excess of inflation)
3. Funds are needed equally over the course of the year

The three scenarios we considered were:
1. Starting at the beginning of 1990 and capturing a full cycle of equity returns
2. Buying at the absolute top of the internet bubble (3/1/2000)
3. Buying just prior to the financial meltdown (11/1/2007)

Link to full letter.