Asset/Liability Management 2nd Annual Foundation Conference February 5, 2014 CLAconnect.com/privateclient Tony Hallada, CEO Steven D. Jones, CFA, CFP, CAIA Director, Institutional Investment Services
Agenda Brief History Benefits Liability Stream Option 1: Cash Reserve Option 2: Cash Matching Option 3: Duration Matching Option 4: Monte Carlo Simulation Option 5: Targeted Scenarios - Stress Testing Portfolio Construction Market Outlook 2014 2
Brief History ALM was pioneered by banks and insurance companies. In highly levered organizations, changes in the balance sheet can overwhelm operating results. 3
Brief History (cont.) Ideally, assets are selected that move in tandem with liabilities. Properly matching assets to liabilities can help stabilize residual equity. Later adopted by corporations to manage their DB pension plans. 4
Benefits Supports strategic planning efforts Allows operations to drive success by stabilizing residual equity Helps avoid forced selling of assets Provides insight and guidance towards defining the appropriate Time Horizon, Return Objective, and Risk Tolerance Supports compliance with UPMIFA 5
Supports Compliance with UPMIFA In managing and investing an institutional fund, the following factors, if relevant, must be considered: (A) general economic conditions; (B) the possible effect of inflation or deflation; (C) the expected tax consequences, if any, of investment decisions or strategies; (D) the role that each investment or course of action plays within the overall investment portfolio of the fund; (E) the expected total return from income and the appreciation of investments; (F) other resources of the institution; (G) the needs of the institution and the fund to make distributions and to preserve capital; and (H) an asset s special relationship or special value, if any, to the charitable purposes of the institution. * * SOURCE: UNIFORM PRUDENT MANAGEMENT OF INSTITUTIONAL FUNDS ACT (Model Act) 6
Liability Steam ALM requires construction of liability stream Part art / part science Definition net cash flows associated with an investment 7
Liability Steam (cont.) Possible data sources for constructing your liability stream: - Business plan (revenue, expenses, capital budget) - Projections from Sources and Uses of Funds Statement - Pro Forma financial projections (EBIDA) 8
Option 1: Cash Reserve Set aside enough cash to cover 12-36 months of possible cash outflows. Advantages - Simple - Low risk Disadvantages - Low return on cash investments 9
Option 2: Cash Matching Create a structured bond portfolio with principal and interest payments coming due as needed to cover all expected cash outflows. Advantages - Simple - Low risk Disadvantages - Interest rates at historic lows - Future cash flow needs may change 10
Option 3: Duration Matching Used to manage interest rate risk (banks, insurance, DB plans) Duration is (roughly) the PV, time-weighted average maturity Residual equity is immune to changes in interest rates when Duration Assets = Duration Liabilities $12 PV Calculation $10 PV(Assets) $8 $6 PV(Liabilities) $4 $2 $0 Funded Status 3.50 3.75 4.00 4.25 4.50 4.75 5.00 5.25 5.50 5.75 6.00 Interest Rates 11
Option 3: Duration Matching (cont.) Advantages - Flexible, allows tailored risk exposures Disadvantages - Complex, may require professional management - Requires periodic rebalancing 12
Option 4: Monte Carlo Simulation Computerized statistical modeling technique used to randomly generate of a large number of possible outcomes. Advantages - May help identify unexpected extreme outcomes Disadvantages - Too many possible outcomes to draw meaningful insight - Dependant upon underlying probability distribution 13
Option 4: Monte Carlo Simulation (cont.) STEPS Define simulation o Number of Trials o Expected Return / Standard Deviation o Liability Stream or Payout Ratio o Measure(s) of Success Monte Carlo - Probability Distribution 14
Option 5: Targeted Scenarios - Stress Testing Scenario Analysis Business modeling technique used to monitor key organizational metrics. Advantages - Generates targeted results, more easily understood Disadvantages - Garbage in / garbage out - Real world may vary substantially from expectations 15
Option 5: Targeted Scenarios - Stress Testing STEPS Define liability stream Determine least-risk portfolio - Not necessarily 90-day T-bills - What asset best moves in tandem with liability stream? Examples: DB pensions are interest rate sensitive Perpetuity investors are inflation sensitive Stress test - Incrementally increase expected risk/return - Examine potential impact on key business metrics 16
Portfolio Construction Once the target risk/return has been identified, it s time to construct a portfolio that can reasonably be expected to achieve the desired result in an efficient manner. Construct portfolio asset allocation is primary driver Desired result match expected risk/return target Efficient manner Sharpe ratio 17
THE OTHER SIDE OF THE CREDIT SUPER CYCLE The Debt Deleveraging Cycle 18
U.S. Banks Have Restored Their Balance Sheets and Are Now Back to Record Profitability. Source: FDIC 19
Corporations Have Delevered 20
Corporations Have Delevered 21
Consumers Are Delevering 13.4 13.3 13.2 13.1 13.0 12.9 12.8 12.7 12.6 12.5 12.4 12.3 12.2 12.1 12.0 11.9 11.8 11.7 11.6 11.5 11.4 11.3 11.2 11.1 11.0 10.9 10.8 10.7 10.6 10.5 10.4 10.3 10.2 10.1 10.0 9.9 Household Debt Service Ratio's Potential Impact On Growth Nominal GDP Gain/Annum When: Gain/ % Debt Service Ratio is: Annum of Time Above 12.8% 2. 3 12. 0 Between 11% and 12.8% 5. 5 59. 4 * Below 11% 6. 9 28. 6 Source: Department of Commerce Bureau of Labor Statistics Federal Reserve Board Low Debt Service Real GDP Gain/Annum When: Gain/ % Debt Service Ratio is: Annum of Time Above 12.8% 0. 2 12. 0 Between 11% and 12.8% 2. 9 59. 4 * Below 11% 3. 2 28. 6 Nonfarm Payrolls Gain/Annum When: Gain/ % Debt Service Ratio is: Annum of Time Above 12.8% -0. 8 12. 0 Between 11% and 12.8% 1. 3 59. 4 * Below 11% 1. 9 28. 6 Chart has been reanalyzed due to data revisions. Quarterly Data 3/31/1980-6/30/2013 High Debt Service Household Debt Service Ratio (Minimum Debt Service Payment on Mortgage Debt and Consumer Credit as a % of Disposable Personal Income) ( ) 13.4 13.3 13.2 13.1 13.0 12.9 12.8 12.7 12.6 12.5 12.4 12.3 12.2 12.1 12.0 11.9 11.8 11.7 11.6 11.5 11.4 11.3 11.2 11.1 11.0 10.9 10.8 10.7 10.6 10.5 10.4 10.3 10.2 10.1 10.0 9.9 DAVIS 145 1980 1985 1990 1995 2000 2005 2010 Copyright 2013 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo/. 22
Consumers Are Delevering 23
The Last Stage of Delevering is the Federal Government 24
The Last Stage of Delevering is the Federal Government 25
Outlook for 2014 Buying assets from banks continues to be the number one investment opportunity. We believe we are in a long-term bull market for equities. Growth stocks continue to be the number one opportunity in the public market. The IBD 50 or simple ETF strategies most likely should perform best in this type of environment. Gold most likely continues its descent in its current bear market due to fiscal improvement at the sovereign government level. High quality bonds will be challenging over the next 12-24 months as the 10-year treasury moves toward our target of 3.50 percent by mid-2014 and 4.25 percent by mid-2015. 26
Outlook for 2014 (continued) High yield municipal bonds, distressed debt, and floating rate investments continue to be the best place to invest in the bond market. Re-flationary fixed income should add value to a fixed income allocation again in 2014 (REITs, MLPs, Royalty Trusts). Stocks will most likely have a large correction some time near the end of Q1 2014 and that will be the next buying opportunity. Private real estate and private credit are much more attractively valued than the public markets. Buy real estate from banks and servicers. Buy debt from banks and servicers. 27
Tony R. Hallada CEO CliftonLarsonAllen Wealth Advisors, LLC PROFILE Tony is the CEO, managing principal, and an investment committee member of CliftonLarsonAllen Wealth Advisors, LLC. Based on Tony s belief in life planning, he challenges conformity and motivates people to discover the abundant possibilities life holds. EXPERIENCE IN SERVING CLIENTS Tony s clients benefit from a close, personal relationship with him and objective advice aimed at getting them where they want to go in life. He has a broad range of experience in the capital markets and financial services industry, and is passionate about offering boutique investment strategies. During his more than 20-year tenure, he has also served as the vice president of Nuveen Investments and John G. Kinnard & Company. In addition, his clients appreciate the work experiences he gained at his family s closely held Ford and International Harvester dealership. Between the ages of 12 and 21, he worked in all facets of the family business. By the time he graduated from college, he was a shareholder and was managing the front end of the dealership. EDUCATION/PROFESSIONAL INVOLVEMENT Tony earned a BA from the University of Wisconsin-Madison and is a graduate of the University of Minnesota Carlson School of Business Executive Management Program. Tony is a member of the Financial Planning Association. He holds FINRA Series 7, 63, 65, and 24 licenses, and Minnesota Life and Health Insurance licenses. In 2012 and 2013, he was named a Five Star Wealth Manager by Twin Cities Business. SPECIAL INTERESTS Tony resides in Medina, Minnesota with his wife Teresa, son Mason, and daughter Hannah. His hobbies include golf, basketball, biking, skiing, and reading. Tony is an active church member, coaches his son s baseball team, and finds personal fulfillment in mentoring kids, especially those who have been adopted. CONTACT INFORMATION 612-376-4529 tony.hallada@claconnect.com CLAconnect.com/privateclient
Steven D. Jones, CFA, CFP, CAIA Director, Institutional Investment Services CliftonLarsonAllen Wealth Advisors, LLC PROFILE Steven is the Director of the Institutional Investment Services at CliftonLarsonAllen Wealth Advisors, LLC. He has over thirty years of investment management experience with expertise in all major asset classes, and specializes in asset/liability management, macroeconomic analysis and asset allocation strategies. EXPERIENCE IN SERVING CLIENTS Steven began serving institutional clients in 1990, as a portfolio manager for a major trust company in St. Louis. In 2006, he joined LarsonAllen Financial and expanded his client facing skills to include high net worth individuals. In 2009, Steven joined Hammond Associates as a Senior Investment Consultant where he served foundations, endowments, healthcare and high net worth clients. EDUCATION/PROFESSIONAL INVOLVEMENT Steven is a CFA charterholder and serves as the Immediate Past President of the CFA Society of St. Louis. He also holds the following designations: Chartered Alternative Investment Analyst (CAIA) and the Certified Financial Planner (CFP). Steven received his MBA from Washington University in St. Louis and his BSBA from the University of Missouri-Columbia, where his major was Finance & Banking. SPECIAL INTERESTS Steven currently resides in St Louis with his wife and youngest daughter. His eldest daughter is attending the University of Missouri-Columbia. Steven is an active member of the St. Gerard parish. He likes to ride bikes with his wife on the many trails in-and-around St. Louis. Steven s hobbies include guitar, singing, exercising, movies and watching the Rams and Cardinals. CONTACT INFORMATION Mobile 314-795-1095 steven.jones@claconnect.com CLAconnect.com/privateclient