A Year-End Overview of Major Asset Class Valuation Drivers and Best Regimes

Asset Class	Fundamental Value Drivers	Best Regime for Relative Outperformance
*Real Return (Inflation Indexed) Bonds*	Average real economic growth rate (higher average growth = higher real rate = lower real return bond prices) Volatility of real economic growth (higher volatility = lower real rate = higher real return bond prices) Investor risk aversion (higher risk aversion = lower real rate = higher real return bond prices) Investor uncertainty and time discount rate (higher uncertainty = lower time discount rate = lower real rate = higher real return bond prices)	High Inflation
*Nominal Return Government Bonds (assumed to have no credit/default risk)*	Real Return Bond Yield (higher = higher rate on nominal government bonds = lower bond prices) Expected inflation (higher = higher rate on bonds = lower bond prices) Volatility of inflation rate over past three years (higher volatility = higher rate on bonds = lower bond prices)	High Uncertainty, especially for shorter maturities
*Private Sector Nominal Return Credit Bonds*	Nominal Government Bond Yield Expected Real Economic Growth and Volatility of Real Economic Growth – both drive expected default rate (higher expected default rate = higher bond yield = lower bond price)	Normal Times
*Commercial Property Securities (e.g., REITs)*	Net Operating Income or Dividend Yield (NOI or Div divided by market value of property) Expected real growth in NOI or Dividends (long term average is .2%, due to few limits on capacity/supply growth; however, over shorter periods, when demand/supply can become significant, growth rate can be higher) Market value of property also driven by the yield on real return bonds (higher rates = lower property market value)... ...And by the risk premium investors require to hold this asset class. Over the long term, we assume this is 3%; however, it will vary in the short term, falling when asset prices are rising, and rising when uncertainty increases and prices are falling	High Inflation
*Long-Only Commodity Futures Based Index Funds*	Yield on Real Return Bonds (collateral yield) Diversification Return (highest when index contains a mix of commodities whose returns have low correlations with each other; when prices are quickly rising, as in 2007, correlations also tend to rise, reducing diversification return) Roll return (negative when futures prices are higher than spot prices) Unexpected changes in spot prices (due to supply side shocks and/or unexpected changes in future demand forecasts) The yield on real return bonds (higher = lower asset price) The risk premium investors require to hold this asset class. Over the long term, we assume this is 3% due to commodities’ historically low correlation with returns on most other asset classes. In the short term, however, it varies, falling when asset prices are rising, and rising when uncertainty increases and prices are falling	High Inflation and the later stages of Normal Times
*Timber*	Net Operating Income or Dividend Yield (NOI or Div divided by market value of property) Growth of NOI or Dividends driven by: Biological growth rate of trees Harvesting rate Change in real forest product prices Change in value (if any) of carbon sequestration credits Market value of timber also driven by yield on real return bonds (higher rates = lower market value of timberland) The risk premium investors require to hold this asset class. Over the long term, we assume this is 3% due to timber’s historically low correlation with returns on most other asset classes. In the short term, however, it varies, falling when asset prices are rising, and rising when uncertainty increases and prices are falling	High Inflation
*Gold*	Fundamental valuation of gold remains an unresolved question Higher expected inflation, higher uncertainty, and lower USD exchange rate all associated with higher gold prices	High Inflation and High Uncertainty
*Direct Oil and Gas Investments*	Finding and development cost for new reserves (lower = cheaper reserve growth = higher asset price) Production rate (higher = higher cash flow = higher asset price) Reserve depletion rates (higher = shorter reserve life = lower asset price) Changes in real oil and gas prices (higher = higher asset price) Yield on real return bonds (higher rates = lower asset price) The risk premium investors require to hold this asset class. Over the long term, we assume this is 3% due to oil and gas properties’ historically low correlation with returns on most other asset classes. In the short term, however, it varies, falling when oil and gas prices are rising, and rising when uncertainty increases and oil and gas prices are falling	Normal Times and High Inflation
*Developed Country Equities*	Current dividend yield (higher = higher asset price) Expected real growth rate of dividends. Over long periods, this is equal to the rate of total factor productivity growth (higher = higher asset price) Current real return bond yield (lower = higher asset price) The risk premium investors require to hold this asset class. Over the long term, we assume this is 2.5% to 4.0%. In the short term, however, it varies, falling when equity prices are rising, and rising when uncertainty increases and equity prices are falling	Normal Times
*Emerging Market Equities*	Drivers are the same as developed market equities However, expected rate of productivity growth and risk premium are both higher	Normal Times
*Equity Volatility*	Volatility in real macroeconomic growth Volatility in inflation level Level of investor uncertainty Amount of leverage employed in the economy and especially by financial institutions	High Uncertainty
*Foreign Currency/Exchange Rate changes affecting foreign bonds, property and equity*	Over the long-term, exchange rate changes should offset differences in nominal government bond yields Over shorter periods, many other factors drive changes in exchange rates, including policy actions by governments, liquidity needs of corporations, and cross border investment and borrowing flows	Varies by currency. Historically, USD and CHF have performed well in periods of High Uncertainty.

| Overview of Our Valuation Methodology | Global Asset Class Valuation Updates Detail | Uncorrelated Alpha Strategies Detail | Global Asset Class Valuation Updates Detail | Global Asset Class Returns | Table: Market Implied Regime Expectations and Three Year Return Forecast | Feature Article: End of 2009 Review: Learning From the Past, Anticipating the Future, and Adapting Quickly in the Present | This Month's Letters to the Editor: Followup on Luck, How Does One Get Lucky?; Deloitte's Study - Skill versus Luck; Vanguard's New ETFs | Table: Fundamental Asset Class Valuation and Recent Return Momentum | Product and Strategy Notes: Four Gift Book Ideas, Muni Market Update; Commodity Futures vs. Direct Oil and Gas Investments; New Research on Alpha/Beta Allocation; and Highlights from Research Studies | December 2009 Issue: Key Points | Investor Herding Risk Analysis | A Year-End Overview of Major Asset Class Valuation Drivers and Best Regimes | December 2009 Economic Update |