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Transcript of Asset Allocation Decision
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The Asset Allocation
DecisionSession 3
Course : Z1462 Investment Analysis
and Portfolio Management
Eective Period : e!ruary 2"16
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These slides have been adapted from:
Frank K. Reilly & Keith C. Brown. (2!2". Analysis
of Investments and Management of Portfolios. !.
Cen#a#e $earnin#. %B': )*+,*-*2-*
These slides have been adapted from:
Frank K. Reilly & Keith C. Brown. (2!2". Analysis
of Investments and Management of Portfolios. !.
Cen#a#e $earnin#. %B': )*+,*-*2-*
/0knowled#ement
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© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Chapter 2: The /sset /llo0ation
1e0ision
Chapter 2: The /sset /llo0ation
1e0ision
Analysis of Investments& Management of Portfolios
10! "#$$%&
Reilly& Brown
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hat is /sset /llo0ation3hat is /sset /llo0ation3
•
Asset Allocation' $t is the process o( decidinghow to distribute an investor)s wealth a*ongdi((erent countries and asset classes (orinvest*ent purposes.
• Asset Class' $t re(ers to the group o( securitiesthat have si*ilar characteristics, attributes, andris+return relationships.
•
$nvestor' #epending on the type o( investors,invest*ent ob-ectives and constraints vary
– $ndividual investors – $nstitutional investors
2/ © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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%ndivid4al %nvestor $ife Cy0le%ndivid4al %nvestor $ife Cy0le
•
inancial lan reli*inaries – Li(e $nsurance' roviding death bene(its and,
possibly, additional cash values• er* li(e and whole li(e insurance
•niversal and variable li(e insurance
– &onli(e $nsurance• !ealth insurance 3 #isability insurance
• Auto*obile insurance 3 !o*erental insurance
– Cash Reserve• o *eet e*ergency needs
• "4ual to si5 *onths living e5penses
26 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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%ndivid4al %nvestor $ife Cy0le%ndivid4al %nvestor $ife Cy0le
•
Li(e Cycle hases. he (our li(ecycle phasesare shown in "5hibit 2.1 7the third and (ourth
phasesspending and gi(tingare shown as
concurrent8 and described here.
– Accu*ulation phase' "arly to *iddle years o(
wor+ing career 7"5hibit 2.28
– Consolidation phase' ast *idpoint o( careers.
"arnings greater than e5penses – 9pending:i(ting phase' ;egins a(ter retire*ent
2< © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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56hibit 2.!56hibit 2.!
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%ndivid4al %nvestor $ife Cy0le%ndivid4al %nvestor $ife Cy0le
• Li(e Cycle $nvest*ent :oals
– &earter*, highpriority goals
– Longter*, highpriority goals
– Lowerpriority goals
> "5hibit 2.2 shows growth (ro* an initial ? 10,000invest*ent over 20,@0, and /0 years at assu*ed
annual returns o( = and B. he *iddleaged
person who invest ? 10,000 when he or shecan a((ord itD will only reap the bene(its o(
co*pounding (or 20 years or so be(ore
retire*ent.2
© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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56hibit 2.256hibit 2.2
© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.2E
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The 7ortfolio 8ana#ement 7ro0essThe 7ortfolio 8ana#ement 7ro0ess
•
olicy 9tate*ent – 9peci(ies invest*ent goals and acceptable ris+ levels
– 9hould be reviewed periodically
– :uides all invest*ent decisions
• 9tudy Current inancial and "cono*ic conditions
and (orecast (uture trends – #eter*ine strategies to *eet goals
– Re4uires *onitoring and updating
210 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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The 7ortfolio 8ana#ement 7ro0essThe 7ortfolio 8ana#ement 7ro0ess
•
Construct the ort(olio – Allocate available (unds to *ini*iFe investor)s ris+s and
*eet invest*ent goals
• Monitor and pdate – "valuate port(olio per(or*ance
– Monitor investor)s needs and *ar+et conditions
– Revise policy state*ent as needed
–
Modi(y invest*ent strategy accordingly
211 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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The 7ortfolio 8ana#ement 7ro0essThe 7ortfolio 8ana#ement 7ro0ess
1. olicy 9tate*ent
ocus' $nvestor)s shortter* and longter* needs,(a*iliarity with capital *ar+et history, and e5pectations
2. "5a*ine current and pro-ect (inancial, econo*ic,political, and social conditionsocus' 9hortter* and inter*ediateter* e5pectedconditions to use in constructing a speci(ic port(olio
@. $*ple*ent the plan by constructing the port(olioocus' Meet the investor)s needs at the *ini*u* ris+levels
/. eedbac+ loop' Monitor and update investor needs,environ*ental conditions, port(olio per(or*ance
212
56hibit 2.,
© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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The 'eed For / 7oli0y tatementThe 'eed For / 7oli0y tatement
• nderstand investor)s needs and articulate
realistic invest*ent ob-ectives and constraints – Ghat are the real ris+s o( an adverse (inancial
outco*e, and what e*otional reactions will $ haveH
–
!ow +nowledgeable a* $ about invest*ents and the(inancial *ar+etsH
– Ghat other capital or inco*e sources do $ haveH!ow i*portant is this particular port(olio to *y overall(inancial positionH
– Ghat, i( any, legal restrictions a((ect *eH
– !ow would any unanticipated port(olio value change*ight a((ect *y invest*ent policyH
21@ © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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The 'eed For / 7oli0y tatementThe 'eed For / 7oli0y tatement
•
9ets standards (or evaluating port(olioper(or*ance
– he state*ent provides a co*parison standard in
-udging the per(or*ance o( the port(olio *anager.
– A bench*ar+ port(olio or co*parison standard is
used to re(lect the ris+ an return ob-ectives
speci(ied in the policy state*ent.
– $t should act as a starting point (or periodic
port(olio review and client co**unication with the
*anager.
© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.21/
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The 'eed For / 7oli0y tatementThe 'eed For / 7oli0y tatement
•
%ther ;ene(its – $t helps reduces the possibility o( inappropriate or
unethical behavior on the part o( the port(olio*anager.
–
A clearly written policy state*ent will help createsea*less transition (ro* one *oney *anager toanother without costly delays.
– $t also provides the (ra*ewor+ to help resolve any
potential disagree*ents between the client andthe *anager.
© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.216
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Constr40tin# the 7oli0y tatementConstr40tin# the 7oli0y tatement
•
Constructing the policy state*ent begins witha pro(ile analysis o( the investor)s current and(uture (inancial situations and a discussion o(invest*ent ob-ectives and constraints.
• %b-ectives
– Ris+ – Return
•
Constraints – Li4uidity, ti*e horiFon, ta5 (actors, legal and
regulatory constraints, and uni4ue needs and
pre(erences
© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.21<
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Constr40tin# the 7oli0y tatementConstr40tin# the 7oli0y tatement
•
$n general, there are (or decision involved inconstructing an invest*ent strategy '
– Ghat asset classes should be considered (or
invest*ent H
– Ghat policy weights should be assigned to each
eligible asset class H
– Ghat are the allowable allocation ranges based on
policy weights H
– Ghat speci(ic securities or (unds should be
purchased (or the port(olio H
© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.21=
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%nvestment 9be0tives%nvestment 9be0tives
•
Ris+ %b-ectives – Ris+ ob-ective should be based on investor)s
ability to ta+e ris+ and willingness to ta+e ris+.
– Ris+ tolerance depends on an investor)s current
net worth and inco*e e5pectations and age.• More net worth allows *ore ris+ ta+ing
• Iounger people can ta+e *ore ris+
– A care(ul analysis o( the client)s ris+ tolerance
should precede any discussion o( return
ob-ectives.
21 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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%nvestment 9be0tives%nvestment 9be0tives
•
Return %b-ectives – he return ob-ective *ay be stated in ter*s o( an
absolute or a relative percentage return.
– Capital reservation' Mini*iFe ris+ o( real losses
– Capital Appreciation' :rowth o( the port(olio inreal ter*s to *eet (uture need
– Current $nco*e' ocus is in generating inco*e
rather than capital gains
– otal Return' $ncrease port(olio value by capital
gains and by reinvesting current inco*e with
*oderate ris+ e5posure
21E © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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%nvestment Constraints%nvestment Constraints
•
Li4uidity &eeds – Jary between investors depending upon age,
e*ploy*ent, ta5 status, etc.
– lanned vacation e5penses and house down
pay*ent are so*e o( the li4uidity needs.• i*e !oriFons
– $n(luences li4uidity needs and ris+ tolerance.
– Longer invest*ent horiFons generally re4uires
less li4uidity and *ore ris+ tolerance. – wo general ti*e horiFons are preretire*ent and
postretire*ent periods.
220 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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%nvestment Constraints%nvestment Constraints
•
a5 Concerns – Capital gains or losses' a5ed di((erently (ro*
inco*e
– nrealiFed capital gains' Re(lect price
appreciation o( currently held assets that have notyet been sold
– RealiFed capital gains occur when the asset hasbeen sold at a pro(it
–
radeo(( between ta5es and diversi(ication' a5conse4uences o( selling co*pany stoc+ (ordiversi(ication purposes
221 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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%nvestment Constraints%nvestment Constraints
•
a5 concerns 7continued8 – $nterest on *unicipal bonds e5e*pt (ro* (ederal
inco*e ta5 and (ro* state o( issue
– $nterest on (ederal securities e5e*pt (ro* stateinco*e ta5
– Contributions to an $RA *ay 4uali(y as deductible(ro* ta5able inco*e
– a5 de(erral considerations
222
Rate)TaxMarginal-(1
YieldMunicipal
YieldTaxableEquivalent
© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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8ethods of Ta6 1eferral8ethods of Ta6 1eferral
•
Regular $RA – a5 deductible – a5 on returns de(erred until withdrawal
• Roth $RA –
&ot ta5 deductible – a5(ree withdrawals possible
• Cash Jalue Li(e $nsurance – unds accu*ulate ta5(ree until they are withdrawn
•a5 9heltered Annuities
• "*ployer)s /017+8 and /0@7b8 lans – a5de(erred invest*ents
22@ © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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$e#al and Re#4latory Fa0tors$e#al and Re#4latory Fa0tors
•
Li*itations or penalties on withdrawals• iduciary responsibilities
– he rudent $nvestor RuleD nor*ally apply
• $nvest*ent laws prohibit insider trading
• $nstitutional investors deserve specialattentions since legal and regulatory (actors*ay a((ect the* 4uite di((erently 7e.g. ban+s
vs. endow*ent (unds8.
22/ © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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;ni
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The %mportan0e of /sset /llo0ationThe %mportan0e of /sset /llo0ation
•
An invest*ent strategy is based on (ourdecisions – Ghat asset classes to consider (or invest*ent
– Ghat policy weights to assign to each eligible class
– Ghat allocation ranges are allowed based on policyweights
– Ghat speci(ic securities to purchase (or the port(olio
• According to research studies, *ost 7E0B8 o(
the overall invest*ent return is due to the (irsttwo decisions, not the selection o( individualinvest*ents 7see "5hibit 2.=8
22
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56hibit 2.)56hibit 2.)
© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.22=
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56hibit 2.*56hibit 2.*
© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.22
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The %mportan0e of /sset /llo0ationThe %mportan0e of /sset /llo0ation
•Returns and Ris+s o( #i((erent Asset Classes – !istorically, s*all co*pany stoc+s have generated
the highest returns, so have the volatility
– $n(lation and ta5es have a *a-or i*pact on returns
– Returns on reasury ;ills have barely +ept pacewith in(lation
– Measuring ris+ by the probability o( not *eetingyour invest*ent return ob-ective indicates ris+ o(
e4uities is s*all and that o( bills is large becauseo( their di((erences in e5pected returns
– ocusing only on return variability as a *easure o(ris+ ignores reinvest*ent ris+
© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.22E
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© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.2@0
56hibit 2.
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/sset /llo0ation 4mmary/sset /llo0ation 4mmary
•olicy state*ent deter*ines types o( assetsto include in port(olio
• Asset allocation deter*ines port(olio return*ore than stoc+ selection
• %ver long ti*e periods, siFable allocation toe4uity will i*prove results
• Ris+ o( a strategy depends on the investor)s
goals and ti*e horiFon
2@1 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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2@2
/sset /llo0ation 4mmary/sset /llo0ation 4mmary
•
Asset Allocation and Cultural #i((erences – 9ocial, political, and ta5 environ*ents in(luence the
asset allocation decision
– "4uity allocations o( .9. pension (unds average
6B – $n the nited Kingdo*, e4uities *a+e up =B o(
assets
– $n :er*any, e4uity allocation averages B
–
$n apan, e4uities are @=B o( assets – 9ee "5hibits 2.11 and 2.12
© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.2@2
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© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.2@@
56hibit 2.!!56hibit 2.!!
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© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.2@/
56hibit 2.!256hibit 2.!2
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The %nternet %nvestments 9nlineThe %nternet %nvestments 9nline
• http'www.ssa.gov
• http'ww.ibbotson.co*
• http'www.*(ea.co*
• http'$nvest*ent9trategiesCalculatorsde(ault.asp
• http'www.asec.org
• http'www.(inancialengines.co*• http'www.c(ainstitute.org
• http'www.troweprice.co*
• http'www.thea*ericancollege.edu
• http'www.c(p.net
• http'www.nap(a.org
• http'www.(panet.org
• http'www.decisioneering.co*
2@6 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
http://www.ssa.gov/http://ww.ibbotson.com/http://www.mfea.com/http:/InvestmentStrategies/Calculators/default.asphttp://www.mfea.com/http:/InvestmentStrategies/Calculators/default.asphttp://www.asec.org/http://www.financialengines.com/http://www.cfainstitute.org/http://www.troweprice.com/http://www.theamericancollege.edu/http://www.cfp.net/http://www.napfa.org/http://www.fpanet.org/http://www.decisioneering.com/http://www.decisioneering.com/http://www.fpanet.org/http://www.napfa.org/http://www.cfp.net/http://www.theamericancollege.edu/http://www.troweprice.com/http://www.cfainstitute.org/http://www.financialengines.com/http://www.asec.org/http://www.mfea.com/http:/InvestmentStrategies/Calculators/default.asphttp://www.mfea.com/http:/InvestmentStrategies/Calculators/default.asphttp://ww.ibbotson.com/http://www.ssa.gov/
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/ppendi6: 9be0tives and Constraints
of %nstit4tional %nvestors
• Mutual unds – ool investors (unds and invests the* in (inancial
assets as per its invest*ent ob-ective
• "ndow*ent unds – hey represent contributions *ade to charitable or
educational institutions
2@
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/ppendi6: 9be0tives and Constraints
of %nstit4tional %nvestors
• ension unds – Receive contributions (ro* the (ir*, its e*ployees,
or both and invests those (unds
– 1efined Benefit pro*ise to pay retirees a
speci(ic inco*e strea* a(ter retire*ent – 1efined Contrib4tion do not pro*ise a set o(
bene(its. "*ployees) retire*ent inco*e is not anobligation o( the (ir*
© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.2@=
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/ppendi6: 9be0tives and Constraintsof %nstit4tional %nvestors
• $nsurance Co*panies – Li(e $nsurance Co*panies
• earn rate in e5cess o( actuarial rate
•
growing surplus i( the spread is positive• (iduciary principles li*it the ris+ tolerance
• li4uidity needs have increased
• ta5 rule changes
© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.2@
9 C
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/ppendi6: 9be0tives and Constraints
of %nstit4tional %nvestors
• $nsurance Co*panies – &onli(e $nsurance Co*panies
• cash (lows less predictable
• (iduciary responsibility to clai*ants
• Ris+ e5posure low to *oderate
• li4uidity concerns due to uncertain clai* patterns
• regulation *ore per*issive
© 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.2@E
/ di 9b ti d C t i t
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/ppendi6: 9be0tives and Constraints
of %nstit4tional %nvestors
• ;an+s – Must attract (unds in a co*petitive interest rate
environ*ent
– ry to *aintain a positive di((erence between their
cost o( (unds and their return on assets – &eed substantial li4uidity to *eet withdrawals and
loan de*ands
– ace regulatory constraints
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#$A%& '()