Graphs

Unlike 2009 and 2010, 2011 was a year in which most risks were not rewarded. It is important to bear in mind that if risk were rewarded every year, it wouldn’t be risk and investors would have no right to expect a positive real return. One of the noteworthy events that contributed to the high level of market volatility was the downgrade of U.S. government debt by Standard and Poors which was precipitated by a near political failure to reach an agreement on raising the limit on the amount of money that Uncle Sam can borrow. On the international front, we saw numerous uprisings in Arab countries and the near financial implosion of the European Union. Both of these stories will continue to play out in 2012.

Domestic Equities

As shown in the table below, 2011 was a difficult but not horrendous year for both small cap and value indexes:

Returns of IFA Domestic Equity Indexes for 2011

Size/Style

Value

Blend

Growth

Large

-3.14%

2.10%

1.89%

Small

-6.29%

-3.15%

-1.40%

Source: dfaus.com, vanguard.com, and ifaindexes.com

For the mixture of domestic equity indexes used in the majority of IFA’s index portfolios, the 2011 return was -1.92%. For small value, the hardest hit of the group, the 2011 return was about 1.1 standard deviations below the mean (based on 50 years of returns data) which is expected to happen about one in every seven years (i.e., getting a return of 1.1 or more standard deviations below the mean).

International (Developed) Equities

As shown in the table below, 2011 was an even more difficult year for international equities, particularly in the small cap and value segments:

Returns of IFA International Equity Indexes for 2011

Size/Style

Value

Blend

Large

-16.85%

-12.28%

Small

-17.46%

-15.35%

Source: dfaus.com and ifaindexes.com

A portion of these negative returns is attributable to the strengthening of the US dollar, particularly with respect to the Euro. For the mixture of international equity indexes used in the majority of IFA’s index portfolios, the 2011 return was -16.63%. For international small value, the hardest hit of the group, the 2011 return was about 1.8 standard deviations below the mean (based on 50 years of returns data) which is expected to happen about one in every thirty years (i.e., getting a return of 1.8 or more standard deviations below the mean).

Emerging Markets Equities

As shown in the table below, emerging markets provided no place to hide in 2011:

Returns of IFA Emerging Markets Indexes for 2011

Emerging Markets

-17.41%

Emerging Markets Value

-25.62%

Emerging Markets Small

-22.62%

Source: dfaus.com and ifaindexes.com

For the mixture of emerging markets indexes used in the majority of IFA’s index portfolios, the 2011 return was -21.96%. For emerging markets value, the hardest hit of the group, the 2011 return was about 1.9 standard deviations below the mean (based on 50 years of returns data) which is expected to happen about one in every thirty-seven years (i.e., getting a return of 1.9 or more standard deviations below the mean).

Real Estate

For 2011, the IFA real estate index was up 1.81%. This index is a blend of domestic and international real estate investment trusts (REITs). Domestic REITs were up 8.95% while international REITs were down 7.75%. International REITs were hard hit by the European financial crisis and the strengthening of the U.S. dollar.

Fixed Income

Continuing to play its role as a risk reducer with respect to equities, all of IFA’s fixed income indexes ended 2011 with positive returns:

Returns of IFA Fixed Income Indexes for 2011

One Year

0.59%

Two Year Global

0.78%

Short-Term Government

3.39%

Five Year Global

4.51%

Source: dfaus.com and ifaindexes.com

Since the two global fixed income indexes are currency-hedged, they were not adversely affected by the strengthening of the U.S. dollar. The higher duration fixed income funds enjoyed a higher return than the lower duration funds due to their increased sensitivity to changes in interest rates, which fell in 2011. Interest rates begin the year 2012 at very low levels relative to their historical averages. For the mixture of fixed income indexes used in the majority of IFA’s index portfolios, the 2011 return was 2.32%.

IFA Index Portfolio Returns

Putting it all together, the 2011 returns of six of the IFA Index Portfolios are shown below:

Returns of IFA Index Portfolios for 2011
(net of a .90% advisory fee)

IFA Index Portfolio 10

-0.34%

IFA Index Portfolio 30

-2.11%

IFA Index Portfolio 50

-3.87%

IFA Index Portfolio 70

-5.63%

IFA Index Portfolio 90

-7.39%

IFA Index Portfolio 100

-8.65%

Source: www.ifabt.com (Returns not yet finalized)

For the riskiest IFA portfolio (Index Portfolio 100), the 2011 return was about 1.3 standard deviations below the mean (based on 50 years of returns data) which is expected to happen about one in every eleven years (i.e., getting a return of 1.3 or more standard deviations below the mean). To summarize, 2011 was a difficult year for equity investors, especially those who were internationally diversified and tilted towards the compensated risk factors of small cap and value. Regarding IFA’s outlook for 2012, it’s the same as it is at the beginning of every year (or every day for that matter)—the market has done its job of setting prices so that investors can expect an appropriate return to compensate them for the risks they take. What will actually happen will depend on the news which nobody knows in advance.