Asset Alloca*on Strategies

Transcription

1 Asset Alloca*on Strategies January 2012 Jessica N. Por*s, CFA, Senior Vice President, 8182 Maryland Avenue, 6th Floor, St. Louis, Missouri 63105, phone ,

2 THE PORTFOLIO MANAGENT AND ASSET ALLOCATION PROCESS Goals and Assump-ons Development and Implementa-on of Strategy Tac-cs Follow- Through Iden*fy Target Return, Risk Tolerances and Social Restric*ons Develop ital Market Expecta*ons Based on Return, Correla*on, Standard Devia*on of Asset Classes Asset Alloca*on (mix) Decision Equity Fixed Income Other Asset Classes Ac*ve Management Passive Management PorSolio Measurement Adjustment 1

3 WHAT IS RISK? Ø Short- Term Risk Financial theory regarding risk and return relahonships usually focuses on standard deviahon. Measures the amount of variahon in returns around the average. Which Assets are Risky? and when are they? ury Bills Ø Long- Term Risk Endowment does not ensure the future of the ministry. Opportunity cost. Risk Stocks Failure to keep pace with inflahon. Time 2

4 WHAT IS AN ASSET CLASS? 1970s 1980s 2000s US Stocks US Stocks Stocks InternaHonal Stocks DomesHc InternaHonal High Yield Real Estate Timberland Venture ital Cash Cash Cash Stocks Stocks InternaHonal Stocks InternaHonal Stocks Emerging Market Stocks REITs DomesHc InternaHonal High Yield Emerging Market Real Estate Energy Timberland Private Equity 3

5 VOLATILITY: RANGE OF RETURNS, September 2011* 80.0% 60.0% 61.2% 40.0% 20.0% 33.3% 29.6% 23.0% 19.5% 19.7% 18.3% 13.3% 11.3% 11.3% 11.4% 11.1% 11.0% 11.3% 0.0% % % - 6.6% - 3.8% - 3.4% 4.1% 6.4% % % % 1 Year 3 Year 5 Year 7 Year 10 Year 15 Year 20 Year Source: Crandall Pierce * Rolling periods using monthly observahons 4

6 THERE IS NO CLEAR WINNER EVERY YEAR Past Qtr YTD 2011 *10 Yr ROR *20 Yr ROR 9.5% 59.9% 29.1% 74.8% 8.1% 38.4% 23.1% 35.2% 38.7% 66.4% 22.8% 14.0% 10.3% 55.8% 25.6% 34.1% 32.2% 39.4% 11.4% 78.5% 29.1% 3.8% 6.6% 16.1% 10.0% Best Performing 9.0% - 0.3% 51.2% 46.2% 18.4% 15.8% 32.9% 23.8% 2.7% 1.3% 37.6% 37.2% 23.0% 21.6% 33.4% 31.8% 28.6% 20.3% 43.1% 33.2% 11.6% 10.3% 8.4% 8.2% 9.6% - 1.4% 48.5% 47.3% 22.3% 20.7% 14.0% 7.1% 26.9% 23.5% 11.8% 11.6% 5.2% % 58.2% 37.2% 26.9% 24.5% 3.5% - 6.1% 5.8% - 1.4% 8.8% 6.5% 8.8% 8.5% - 3.1% 46.1% 13.8% 18.9% - 1.0% 31.0% 21.4% 30.5% 15.6% 27.3% 7.0% 5.3% - 6.0% 46.0% 18.3% 5.3% 22.2% 8.8% % 34.5% 18.9% % - 7.2% 6.1% 8.2% - 8.1% 41.7% 11.4% 18.1% - 1.5% 28.4% 16.5% 22.4% 8.7% 21.3% - 3.0% 2.5% % 39.2% 16.5% 4.9% 18.4% 7.1% % 31.9% 16.7% % - 8.7% 5.7% 8.0% - 9.6% 41.2% 7.8% 17.1% - 1.8% 25.8% 11.4% 12.9% 8.6% 21.0% - 5.9% - 2.4% % 30.0% 14.3% 4.7% 15.8% 7.0% % 27.2% 15.5% % % 5.5% 7.6% Worst Performing % % % 30.5% 24.6% 16.0% 7.6% 7.4% 7.0% 13.4% 10.1% 9.8% - 1.8% - 2.0% - 2.4% 19.2% 18.5% 14.4% 11.3% 6.4% 6.0% 12.7% 9.7% 7.7% 1.9% 1.2% - 2.5% 7.4% 2.4% 0.4% - 9.1% % % - 5.6% - 9.2% % % % % 29.8% 29.0% 28.7% 11.1% 10.9% 6.3% 4.6% 4.1% 2.7% 13.4% 11.9% 9.1% 5.5% 1.9% - 0.2% % % % 26.5% 20.6% 19.7% 15.1% 15.1% 7.8% % % % % % % 5.0% 4.8% 3.4% 6.7% 6.7% 5.9% % 14.1% 5.0% 8.2% - 2.9% 11.6% 4.0% 2.1% - 6.5% - 0.8% % % % 4.1% 4.3% 2.4% 4.3% - 1.6% % 5.9% 6.5% % % 3.0% 5.5% % 12.5% % 2.9% - 7.3% - 5.2% 3.6% % % - 1.5% % % % 2.1% 2.0% 1.6% 3.5% - 9.8% % - 1.4% 5.3% % % 2.8% 4.5% *As of September 30, Source: Standard & Poors, Frank Russell, Barclays ital, MSCI 5

7 COMBINING ASSET CLASSES TO BUILD ASSET ALLOCATIONS Lower Risk PorColio Fixed Income PorColio Higher Return PorColio Cash 10% Cash 10% 50% Stocks 10% Cash 40% 90% 60% Stocks 30% Return* 7.7% 8.1% 9.1% Risk* 4.1% 6.0% 6.8% *Based on quarterly historical data from 3/31/1976 through 9/30/11. Asset classes represented by 90- Day US T- Bills,, and Barclays ital US Aggregate. 6

8 THE IMPORTANCE OF ASSET ALLOCATION Components of Total Fund Returns Asset Alloca*on 85% Ø Allocate To Styles and Managers vs. vs. DomesHc vs. InternaHonal Ø Allocate To Broad Categories Equity Fixed Income 15% Style, Manager and Security Selec*on AlternaHves 7

9 THE ASSET ALLOCATION DECISION Ø Ø Modern PorSolio Theory RaHonale: Obtain the highest possible expected return for a given level of risk. Process: Maximize return and minimize risk of the porcolio for each level of desired risk/return combinahon. ImplementaHon: Combine assets whose expected returns are not highly correlated with one another. Thus, a porcolio s return is driven by three different components: Return for each individual asset class. Standard deviahon of each individual asset class. CorrelaHons between each asset class. Return Risk Correlation 8

10 CAPITAL MARKET EXPECTATIONS Long- Term Expected Risk and Return Return Market- Neutral GIC's T- Bills Hedged Equi*es Conver*bles Real Estate Interna*onal Stocks Stocks Stocks Venture ital Stocks Risk 9

11 THERE IS MORE TO THE STORY: CORRELATION Nega*ve Correla*on A Perfect World Expected Return 25% 20% 15% 10% Standard DeviaHon = 0% Expected Return = 12% Asset A Asset B 12% Assets A and B Combined 5% 0% Time If two assets have a perfect negahve correlahon, one asset s return will increase while the other asset s return will decrease by the same amount. The net effect is the perfect world scenario where equal allocahon among the two assets will result in one asset offsehng the other, causing the volahlity to approach zero, while the average porcolio return remains greater than any one asset by itself. 10

12 CORRELATION DETERMINES DIVERSIFICATION BENEFITS 1 Correlation to Equity Best Diversifiers US Equity Int'l Equity Dev. Mkts Emerging Markets Debt Emerging Markets Equity High Yield Public Real Estate Commodities Corporate International Government TIPs Over the long- term, greater use of lower correlated assets lends itself to lower porcolio level volahlity. Over the short- term, correlahons can converge in periods of market distress. 11

13 THE EFFECT OF CORRELATION* 100% 80% 60% 100.0% 100.0% 100.0% 60.0% 20.0% 50.0% Cash Fixed Income Equity Alterna*ves 40% 20% 40.0% 30.0% 0% Cash Fixed Income Total Equity Moderate Balanced AlternaHve Balanced Expected Return 2.2% 3.4% 7.9% 6.5% 6.8% Standard Devia*on 2.0% 3.8% 20.0% 12.0% 10.9% Return/Risk 111.5% 91.0% 39.4% 54.3% 61.8% * 10 year expected return based on Summit s current capital market assumphons (inclusive of manager alpha). 12

14 MAINTAINING TARGET ALLOCATIONS 100% 95% 90% Drifting Portfolio Rebalanced Portfolio Rebalanced Portolio vs. 'Drifting' Portfolio Total Equity Allocation (1/1/73-06/30/11) 10.60% 10.58% Rebalanced Portfolio vs. 'Drifting' Portfolio Historical Risk- Return Characteristics (1/1/73-06/30/11) 65/35 Rebalanced 85% 10.56% 80% 75% 10.54% 70% 10.52% 65% 60% 10.50% 55% 50% 4Q77 4Q79 4Q81 4Q83 4Q85 4Q87 4Q89 4Q91 4Q93 4Q95 4Q97 4Q99 4Q01 4Q03 4Q05 4Q07 4Q % 65/35 Drifting 10.46% 11.00% 11.50% 12.00% 12.50% 13.00% 13.50% Maintain the risk level chosen when the asset alloca-on policy was adopted A rebalanced porcolio has superior risk/return characteris-cs Rebalancing can help to manage volahlity. Porcolios that are rebalanced even once per year are significantly less volahle than porcolios that have not been rebalanced. 13

15 IMPORTANCE OF STICKING WITH ASSET ALLOCATION DECISIONS $50 US Equity Fund Flows and Market Performance 1800 Equity Flows ($Billions) $40 $30 $20 $10 $0 - $10 - $20 - $30 - $ $50 Investors sell stocks prior to a big rally - $60 0 Jan- 90 Jun- 92 Nov- 94 Apr- 97 Sep- 99 Feb- 02 Jul- 04 Dec- 06 May- 09 Oct

16 RISK ASSETS HAVE UNDERPERFORMED* $3.00 $2.50 $2.00 BC Agg NCREIF of a Dollar Since 12/31/1999 $1.50 $1.00 $0.50 $0.00 Dec- 99 Dec- 00 Dec- 01 Dec- 02 Dec- 03 Dec- 04 Dec- 05 Dec- 06 Dec- 07 Dec- 08 Dec- 09 Dec- 10 *As of September 30,

17 CORRELATIONS CHANGE WITH MARKET CONDITIONS Fixed Income Long uries Correlations: All periods, Emerging Domestic International Market Equities Equities Equities Private Equity Commodities Private Real Estate Gold Hedge Funds Fixed Income (0.13) (0.02) (0.01) Long uries (0.12) (0.13) (0.08) (0.00) Domestic Equities International Equities Emerging Market Equities (0.12) Private Equity (0.05) 0.06 (0.00) Commodities 1.00 (0.07) 0.40 (0.13) Private Real Estate Gold Hedge Funds 1.00 Correlations: Turbulent periods with equity drops of at least 10% Fixed Income Long uries Domestic Equities International Equities Emerging Market Equities Private Equity Commodities Private Real Estate Gold Hedge Funds Fixed Income Long uries (0.01) (0.03) (0.03) Domestic Equities (0.04) 0.48 International Equities (0.02) 0.50 Emerging Market Equities Private Equity (0.17) 0.15 (0.03) Commodities 1.00 (0.14) 0.43 (0.01) Private Real Estate Gold Hedge Funds 1.00 Correlations: Sustained growth periods Fixed Income Long uries Domestic Equities International Equities Emerging Market Equities Private Equity Commodities Private Real Estate Gold Hedge Funds Fixed Income (0.11) (0.06) 0.04 (0.02) Long uries (0.17) (0.06) Domestic Equities (0.07) (0.04) 0.62 International Equities (0.10) Emerging Market Equities (0.17) Private Equity 1.00 (0.05) (0.05) (0.19) 0.03 Commodities 1.00 (0.08) 0.54 (0.06) Private Real Estate Gold Hedge Funds

18 NEW WAYS TO CONSIDER, ORGANIZE, AND IMPLENT INVESTMENT STRATEGY GROWTH Highest expected return. VolaHle. High correlahon to risk assets. Typically equity based (ownership). Investment can lose +20% in a single year. Liquid, semi- liquid and illiquid investments considered. Focus on best risk- adjusted return opportunihes. INCOME Bond- like real return. Less volahlity. Less correlahon to risk assets. Typically debt based. Pool not expected to lose >5% in one year. Very liquid, except where illiquid yield enhancers appropriate. Focus first on return of principal, not return on principal. DIVERSIFICATION Zero to low real return. Designed to truncate fat volahlity tails. NegaHve correlahon to other pools. Debt / Hedge Funds / CommodiHes. Insurance: it will have a cost in upward trending markets. Liquid and semi- liquid. Asset classes that perform during inflahon, deflahon, or extreme volahlity. Use these criteria to bucket asset classes/strategies. 17

19 QUESTIONS AND ANSWERS Disclaimer: (Summit) has prepared this report for the exclusive use by the client for which it was prepared. The informahon herein was obtained from various sources, such as the client s custodian(s) accounhng statements, commercially available databases, and other economic and financial market data sources. While Summit believes these sources to be reliable, Summit does not guarantee nor shall be liable for the market values, returns or other informahon contained in this report. The market commentary, porcolio holdings and characterishcs are as of the date shown and are subject to change. Past performance is not an indicahon of future performance. No graph, chart, or formula can, in and of itself, be used to determine which securihes or investments to buy or sell. Any forward- looking projechon contained herein is based on assumphons that Summit believes may be reasonable, but are subject to a wide range of risks, uncertainhes and the possibility of loss. Accordingly, there is no assurance that any eshmated performance figures will occur in the amounts and during the periods indicated, or at all. Actual results and performance will differ from those expressed or implied by such forward- looking projechons. Any informahon contained in this report is for informahon purposes only and should not be construed to be an offer to buy or sell any securihes, investment consulhng or investment management services. 18