EFFICIENT PORTFOLIO UPDATE

Transcription

1 EValue EFFICIENT PORTFOLIO UPDATE January 08 January 08

2 Contents Introduction Model returns Asset allocations. 0 Risk Levels Risk Levels Risk Levels Commentary Implemented Portfolios. 0 Risk Levels Risk Levels Risk Levels EValue Ltd CONTENTS

3 INTRODUCTION This report describes the EValue s and the model of investment assets that underlies them. The model describes the possible future behaviour of investment assets. It is stochastic, meaning that it considers more than one possible outcome and that both the range of investment returns and correlation between the behaviour of different assets are as important as the average level. The model also responds to changing market conditions so the expected level and range of returns depends upon such things as interest rates, bond yields and the level of dividends. The EValue s are the s that give the highest average outcome given limits on the amount that can be allocated to particular assets and the amount of risk. Simply put the asset allocations are the ones that look best according to the model and the rules about what is allowed in them. Because the model depends upon market and economic conditions, so do the s and the main purpose of the document is to describe and explain the changes. Full details of the rules applied can be found in the dedicated Summary of Methodologies document. MODEL RETURNS The aim of the EValue asset model is to give the most realistic and objective possible view of investment outcomes. We want the model to be as data-driven as possible so its foundation is empirical analysis of historical data (and a great deal of academic research and practical experience). We also want the model to make sense in all economic conditions, interest on cash deposits changes a lot over time for example, and so it must pay attention to current conditions and, if we wish to avoid unnecessarily dramatic shifts the model must be updated regularly. To support this, the empirical analysis looks at what assets do under different conditions as well as what they do on average. The principles of the model design include: Long run behaviour in line with historical behaviour Long run holdings make sense of asset class sizes Self-consistency In the long run conditions tend to fixed terms that we call a steady state and it is in that condition that the model best follows these principles. Expected returns from that state have the following properties: Large asset classes must have a large enough return to justify such large allocations Risky asset classes must offer enough return to justify investors taking such high levels of risk Uncorrelated assets need lower returns to justify their allocations However, at particular market conditions, returns can be quite different from those in the steady state. In general, the rate of return drifts back to the steady state but the rate at which it does so varies and sometimes it can be very slow. 08 EValue Ltd MODEL RETURNS

4 The steady state is determined by our empirical analysis and will not change until that is revisited. Both risk and return vary with investment term reflecting, among other considerations, average returns drifting back towards the steady state and the way that, in the short term, bond returns go up if rates go down due to capital appreciation but the lower interest rates reduce returns in the long run. Although average returns are important and will often change when the model is updated, the average is simply the average of a wide range of possible outcomes and changes in the average are usually slight in comparison to those ranges. What this means is that an improvement in the expected return that suggests that one asset will return more than another on average typically leaves a great many possibilities that the reverse happens and should not be interpreted as a forecast that one asset will definitely outperform another. ASSET ALLOCATIONS Asset allocations are set for investors in a variety of different situations and vary by Investment term Risk appetite The approach we follow is to find the allocation that offers the best average return over the wide variety of simulated situations for a given level of risk or uncertainty about the full range of outcomes. As such the portfolios are efficient their expected returns are not matched by any lower risk portfolio. Since the returns change over time, so will the allocations. It is worth bearing in mind that the s are assessed only on the level of their outcomes, not directly on what kind of allocation they come from. Sometimes that can mean allocations that appear different in terms of may be much less different in terms of likely outcomes. The portfolios are defined for specific s and investment terms and are expressed as the percentage of total holding assumed held in each of a defined set of asset classes. The portfolio risk definition is consistent for each update to the portfolios. The portfolios are calculated to be efficient for investments made at that time and held for the duration of the client s investment objective. Previous portfolios have been defined on a consistent basis so will still be expected to be achieving their original risk objective. As markets change, the efficiency of previous portfolios may reduce. Client portfolios should be reviewed in line with the frequency agreed with the client. 08 EValue Ltd ASSET ALLOCATIONS

5 . 0 Risk Levels Table : EValue efficient portfolio update as of January 08 Term (yrs) Risk Level Index linked bonds Return (%) Risk (%) continued 08 EValue Ltd ASSET ALLOCATIONS

6 continued Term (yrs) Risk Level Index linked bonds Return (%) Risk (%) Annual rate of return that gives mean portfolio value at the end of the investment term Standard deviation of annual returns 08 EValue Ltd ASSET ALLOCATIONS

7 Chart : Asset allocations for -year portfolios Chart : Asset allocations for 0-year portfolios 08 EValue Ltd ASSET ALLOCATIONS

8 Chart : Asset allocations for -year portfolios Chart : Asset allocations for 0-year portfolios 08 EValue Ltd ASSET ALLOCATIONS 8

9 Chart : Asset allocations for +-year portfolios Chart : Changes in over years 08 EValue Ltd ASSET ALLOCATIONS 9

10 Chart : Changes in over 0 years Chart 8: Changes in over years 08 EValue Ltd ASSET ALLOCATIONS 0

11 Chart 9: Changes in over 0 years Chart 0: Changes in over + years 08 EValue Ltd ASSET ALLOCATIONS

12 . Risk Levels Table : EValue efficient portfolio update as of January 08 Term (yrs) Risk Level Index linked bonds Return (%) Risk (%) continued 08 EValue Ltd ASSET ALLOCATIONS

13 continued Term (yrs) Risk Level Index linked bonds Return (%) Risk (%) Chart : Asset allocations for -year portfolios Annual rate of return that gives mean portfolio value at the end of the investment term Standard deviation of annual returns 08 EValue Ltd ASSET ALLOCATIONS

14 Chart : Asset allocations for 0-year portfolios Chart : Asset allocations for -year portfolios 08 EValue Ltd ASSET ALLOCATIONS

15 Chart : Asset allocations for 0-year portfolios Chart : Asset allocations for +-year portfolios 08 EValue Ltd ASSET ALLOCATIONS

16 0 0 0 Chart : Changes in over years Chart : Changes in over 0 years 08 EValue Ltd ASSET ALLOCATIONS

17 0 0 0 Chart 8: Changes in over years Chart 9: Changes in over 0 years 08 EValue Ltd ASSET ALLOCATIONS

18 0 0 0 Chart 0: Changes in over + years. Risk Levels Table : EValue efficient portfolio update as of January 08 Term (yrs) Risk Level Index linked bonds Return (%) Risk (%) continued 08 EValue Ltd ASSET ALLOCATIONS 8

19 continued Term (yrs) Risk Level Index linked bonds Return (%) Risk (%) Chart : Asset allocations for -year portfolios Annual rate of return that gives mean portfolio value at the end of the investment term Standard deviation of annual returns 08 EValue Ltd ASSET ALLOCATIONS 9

20 Chart : Asset allocations for 0-year portfolios Chart : Asset allocations for -year portfolios 08 EValue Ltd ASSET ALLOCATIONS 0

21 Chart : Asset allocations for 0-year portfolios Chart : Asset allocations for +-year portfolios Chart : Changes in over years 08 EValue Ltd ASSET ALLOCATIONS

22 0 0 0 Chart : Changes in over 0 years Chart 8: Changes in over years Chart 9: Changes in over 0 years 08 EValue Ltd ASSET ALLOCATIONS

23 0 0 0 Chart 0: Changes in over + years COMMENTARY The economy No news is good news for the economy. Steady growth happens steadily and exciting news tends to feature someone slipping up. To be sure, the Federal Reserve and, for the first time in a decade, the Bank of England raised rates but that was so expected that longer term interest rates actually fell in response. This is not to say that there isn t anything interesting happening or that there isn t any cause for concern. UK growth is now significantly lagging other major economies and growth and the general rate of growth is forecast to slow over the next couple of years despite current levels being where central banks used to think about stimulus. Perhaps the most curious development has been the flattening of yield curves rises in short term interest rates are not being matched by longer term interest rates and, in the UK, even moving in the opposite direction. Inversion short term interest rates higher than long term rates is still a way off but with hindsight may have been the best herald of the financial crisis. It certainly suggests that if normalisation is happening it won t take things back to where they were before the crisis. Markets Markets have enjoyed the economic calm and equities continued their steady progress without any significant upset in the bond markets. Asset prices have been much more steady than a knife-edge balance between greed and fear would suggest. Probably the biggest story in the markets has been the weakness of the dollar. The reasons for this are unclear, possibly a sign of external interest in US assets having peaked (which may be another step in the rise of China), and hard to interpret. 08 EValue Ltd COMMENTARY

24 Asset prospects Steady and consistent economies and markets mean only modest changes in asset outlooks and smaller relative movements. Lower long term interest rates mean generally lower returns and strong equity performance has more than kept up with fundamentals so equities in general don t buck the trend. The two asset classes that have struck out on their own are Emerging Markets and. The outlook for emerging markets is keeping up with market prices so expectations have risen. The reverse is true of property and the outlook at current prices is lower. Allocations Small relative changes in asset prospects mean small changes in s. IMPLEMENTED PORTFOLIOS For the implementation of portfolios, EValue has agreed to present s rounded to the nearest one-hundredth of a per cent and this is what is shown in Table on page 9. However, portfolio risk and performance statistics, allocation change charts and commentaries all refer to the accurate allocations (see section on page ). This may lead to some discrepancies but these rounding effects should not be significant.. 0 Risk Levels 08 EValue Ltd IMPLEMENTED PORTFOLIOS

25 Table : EValue implemented portfolios as of January 08 Portfolio over - yrs Government Bonds Index Linked Bonds Corporate Bonds UK Equity US Equity Europe Equity Japan Equity Emerging Markets Portfolio over -0 yrs Government Bonds Index Linked Bonds Corporate Bonds UK Equity US Equity Europe Equity Japan Equity Emerging Markets Portfolio over - yrs Government Bonds Index Linked Bonds Corporate Bonds UK Equity US Equity Europe Equity Japan Equity Emerging Markets Portfolio over -0 yrs Government Bonds Index Linked Bonds Corporate Bonds UK Equity US Equity Europe Equity Japan Equity Emerging Markets Portfolio over + yrs Government Bonds Index Linked Bonds Corporate Bonds UK Equity US Equity Europe Equity Japan Equity Emerging Markets EValue Ltd IMPLEMENTED PORTFOLIOS

26 . Risk Levels 08 EValue Ltd IMPLEMENTED PORTFOLIOS

27 Table : EValue implemented portfolios as of January 08 Portfolio over - yrs Government Bonds Index Linked Bonds Corporate Bonds UK Equity US Equity Europe Equity Japan Equity Emerging Markets Portfolio over -0 yrs Government Bonds Index Linked Bonds Corporate Bonds UK Equity US Equity Europe Equity Japan Equity Emerging Markets Portfolio over - yrs Government Bonds Index Linked Bonds Corporate Bonds UK Equity. 8. US Equity Europe Equity Japan Equity Emerging Markets Portfolio over -0 yrs Government Bonds Index Linked Bonds Corporate Bonds UK Equity.. 0 US Equity Europe Equity Japan Equity Emerging Markets Portfolio over + yrs Government Bonds Index Linked Bonds Corporate Bonds UK Equity US Equity Europe Equity Japan Equity Emerging Markets EValue Ltd IMPLEMENTED PORTFOLIOS

28 . Risk Levels 08 EValue Ltd IMPLEMENTED PORTFOLIOS 8

29 Table : EValue implemented portfolios as of January 08 Portfolio over - yrs Government Bonds Index Linked Bonds Corporate Bonds UK Equity 9.. US Equity Europe Equity Japan Equity Emerging Markets Portfolio over -0 yrs Government Bonds Index Linked Bonds. 0 0 Corporate Bonds UK Equity US Equity Europe Equity Japan Equity Emerging Markets Portfolio over - yrs Government Bonds... 0 Index Linked Bonds Corporate Bonds UK Equity US Equity Europe Equity Japan Equity. 8.0 Emerging Markets Portfolio over -0 yrs Government Bonds Index Linked Bonds Corporate Bonds UK Equity 9. 0 US Equity Europe Equity Japan Equity Emerging Markets Portfolio over + yrs Government Bonds Index Linked Bonds Corporate Bonds UK Equity US Equity Europe Equity Japan Equity Emerging Markets EValue Ltd IMPLEMENTED PORTFOLIOS 9