 The fundamental nature of assets
Cash and fixed interest returns are components of the return on equity. Over the long term, they are exposed to the same economic risks. Long term holdings of low risk assets do not diversify natural risk. Over the long term, nominal lower risk assets are exposed to greater risks than equities because of inflation. Over the short term equities are higher risk investments because they are exposed to stock market (valuation risks) and short term economic risks. Over the short term, lower risk assets provide greater income and capital security. Over time the risk of equity investment relative to the risk of low risk investment falls and the risk of low risk investment relative to equities rises. At some point in time low risk assets become higher risk assets than equities. This time frame is referred to by TAMRIS as the period of “significant short term stock market and economic risk” and is key to defining the optimal long term asset and liability allocation.
The red line (above graph) shows the relative risk on equities falling over time, the solid blue, the relative risk on low risk assets over time. The dashed red line shows that the actual time frame is affected by both valuation and economic risks and that the period of risk shifts and the box the management of allocation in response to excess valuation and economic risk.
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