The Myth of Asset Allocation or Would you rather beat the market or make money?

Transcription

1 The Myth of Asset Allocation or Would you rather beat the market or make money? John O. Low Institutional Investor Counsel American Asset Management Group, Inc. 50 West Montgomery Avenue Suite 110 Rockville, MD Phone American Asset Management Group, Inc.

2 Archetypal Investment Philosophies Absolute Return vs. Relative return Risk Ascent of Relative Return o 1952-MPT o 1960s-EMH o 1964-CAPM Secular Market Cycles The Investment Policy Statement and IPS Conclusion

3 Risk Systematic Risk a.k.a. undiversifiable risk or market risk The risk inherent in the entire market or an entire market segment. * changes in interest rates war consumer prices employment/unemployment factors political/regulatory changes Non-Systematic Risk a.k.a. diversifiable risk or unsystematic risk Risk that is unique to a certain asset or company. ** labor strikes and other problems natural disaster/weather problems result of unfavorable litigation Management corporate fraud/malfeasance, *. [Financial Dictionary, <a href=" Risk</a>] **[Financial Dictionary, <a href=" Risk</a>]

4 Modern Portfolio Theory [MPT] Harry Markowitz 1952/1959 Volatility = Risk Mathematical model/proof showing that diversification could reduce volatility (risk) Efficient Frontier Underlying assumption: Correlation is the key-- assets in a portfolio should NOT be chosen on their own individual merits, but rather in consideration of how their changes in price (volatility) relate to the other assets in the portfolio.

5 Efficient Frontier

6 Efficient Market Hypothesis Eugene Fama 1960s PhD. Thesis for University of Chicago Booth School of Business. Republished and refined in 1970 Weak prices already reflect all past publicly available information Semi-Strong prices reflect all publicly available information AND instantly change to reflect new information Strong prices also instantly reflect all private/insider information

7 Capital Asset Pricing Model [CAPM] Bill Sharpe (among others) 1964 Defines volatility (risk) as beta Mathematical model for individual asset pricing (beta coefficient)

8 Dominant and Secondary Risks RELATIVE RETURN (BENCHMARK) INVESTING MARKET SECURITY ABSOLUTE RETURN INVESTING SECURITY MARKET

9 Why? Wall Street Sales Machine Training Research/punditry Regulatory Environment Secular Bull Market Easterling, Ed. Unexpected Returns. Fort Bragg: Cypress House, Print.

10

11

12

13 Time Frame Duration Number of Recessions Starting P/E Finishing P/E Yrs 6 Mos % Yrs 9 Mos % Yrs 6 Mos % AVERAGE 18 Yrs 7 Mos % Present (as of July 9, 2012) 11 Yrs 5 Mos % Decline (Inf. Adjusted) Pring Turner Capital Group

14 Relative Return Manager

15 Absolute Return Manager

16 Relative vs. Absolute Easterling, Ed. Unexpected Returns. Pps

17 The Investment Policy Statement Any organization that has assets to invest should also have appropriate policies to guide these investments. One set of policies does not fit every organization but each organization needs to define its own goals and understand its own fiduciary responsibilities. Here is a list of the basic points to cover. Any investment policies should be developed with the advice of a financial professional or be reviewed by legal counsel define general objectives (preserve and protect the assets; achieve aggressive growth) delegate day-to-day asset management to an independent finance committee or a professional manager set asset allocation parameters (include diversification) describe asset quality (itemize quality ratings for stocks, bonds, or short-term reserves based on your risk tolerance) define the investment manager's accountability (include risk in transactions, social responsibility, reporting requirements, and coverage of cash flow needs) establish a system for regular review of the policies Thomas A. McLaughlin, Financial Committees (BoardSource 2004). Robert P. Frye, Jr., Minding the Money: An Investment Guide for Nonprofit Board Members (BoardSource 2004).

18 Sample Asset Allocation Models EXAMPLE 1: UCRP [$3.2b] EXAMPLE 2: 501(c)3 reserve acct. [$2.6mm]

19 The Investment Policy Statement Primacy Self-authored Vision Clarity Flexibility Revisited

20 John O. Low Institutional Investor Counsel American Asset Management Group, Inc. 50 West Montgomery Avenue Suite 110 Rockville, MD Phone This presentation is copyrighted 2012 by American Asset Management Group, Inc. and is its property. No unauthorized duplication or rebroadcast is allowed. The owner gratefully acknowledges Ed Easterling, and Crestmont Research for their help.