abacus
planning group
smart financial decisions
Investment
Philosophy » Tenets
2008
abacusplanninggroup.com
abacus
smart financial decisions
Advisory process
6 Ongoing
Communication
Review, Research
and Performance
Measurement
Establish/Define Client 1
Goals and Objectives
Education and 2
Asset Allocation
Strategy
Investment 3
Policy
Guidelines
5 Implementation
of Investment
Strategy
Investment/Fund Research 4
2
abacus
smart financial decisions
Advisory process
1 Establish/define Client
goals and objectives
5 Ongoing
communication,
review, research,
and performance
measurement
2 Education/Asset
Allocation strategy
5 Investment strategy
implementation
4 Investment/Fund
research
3 Investment Policy
guidelines
3
abacus
smart financial decisions
Investment tenets
Asset allocation is the primary determinant of returns
90% strategic
10% tactical
Extensive diversification across multiple asset classes
Protection against downside volatility – limit losses
Insulation against a variety of future scenarios
Written investment policy guidelines
4
abacus
smart financial decisions
Investment tenets
Globalization of portfolios
Broad exposure to non-traditional investments
Low cost, tax-efficient investments
Asset location as well as asset allocation
Frequent rebalancing to target weights
Manage clients’ portfolios and emotions
greed vs fear
5
abacus
smart financial decisions
What is asset allocation?
Asset Allocation is the process of
combining multiple asset classes
in a portfolio in order to meet
your investment objectives.
» US Large Company Stock
» US Small Company Stock
» International Stock
» Emerging Markets Stock
» Bonds
» Real Assets
» Absolute Return
6
abacus
smart financial decisions
Why is asset allocation important?
Security Selection
4%
Asset Class
Selection 94%
Market Timing
2%
Definitions
Asset Class Selection
How assets are allocated in a portfolio.
Market Timing
Shifting portfolio assets in and out of
the market
Security Selection
Finding “underpriced” companies or
industries.
The vast majority of a portfolio’s
returns variance is determined by asset
class selection and only a small portion
is determined by market timing and
security selection.
Source: Brinson, Hood, Beebower and Singer study of 91 large pension plans over 10 year period.
7
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smart financial decisions
Stocks and bonds: risk versus return
1970 - 2006
13%
return
1
2
80% Stocks, 20% Bonds
60% Stocks, 40% Bonds
11
50% Stocks, 50% Bonds
Minimum risk portfolio:
25% Stocks, 75% Bonds
1
0
risk
100% Bonds
9%
10%
Morningstar, Inc.
11
1
2
1
3
1
4
1
5
1
6
17%
8
abacus
smart financial decisions
Effects of adding multiple asset classes
return
Portfolio B
Portfolio A
As we add additional asset classes, the
efficient frontier shifts to the “Northwest”. In
this example, the resulting Portfolio B offers
a higher expected return with lower expected
risk.
risk
9
abacus
smart financial decisions
Multiple layers of diversification
Client assets
Stocks
Real Assets
International
Stocks
U.S. Stocks
Large-Cap
Real Estate
Natural
Resources
Absolute
Return
Bonds
Government
Bonds
Corporate
Bonds
Mortgage
Backed
Large-Cap
Domestic
Domestic
High-Quality
Core
Small-Cap
International
International
High-Yield
Value
Emerging
Markets
Convertible
Bonds
Merger
Arbitrage
Option
Hedging
Emerging
Markets
Small-Cap
10
abacus
smart financial decisions
Insulate portfolios against various economic
and market scenarios
Global GDP
Growth
Commodity Price
Inflation
High .70
High (5.5%) .65
Moderate .30
High .45
Low (3.5%) .35
Moderate .55
© 2008 Strategic Economic Decisions, Inc.
Impact of Productivity-driven
offsets
Long-Run OECD
Inflation (Non-Core)
Low .25
4.5%
High .75
3.0%
Low .25
3.5%
High .75
2.0%
Low .35
3.5%
High .65
2.0%
Low .35
2.5%
High .65
1.0%
11
abacus
smart financial decisions
Non-traditional assets
Expand portfolio opportunity set
Low correlation with traditional asset
classes
12
abacus
smart financial decisions
Benefits of reducing volatility
Lower Volatility Portfolio
Higher Volatility Portfolio
Year
1
2
3
4
5
6
7
8
9
Growth of $1,000,000
$1,120,000
$1,209,600
$1,185,408
$1,398,781
$1,468,721
$1,615,593
$1,664,060
$1,780,545
$2,012,015
Annual Return
12.0%
8.0%
-2%
18%
5%
10%
3%
7%
13%
Growth of $1,000,000
$1,270,000
$1,079,500
$1,414,145
$1,725,257
$1,483,721
$1,602,419
$1,313,983
$1,576,780
$1,955,207
Annual Return
27%
-15%
31%
22%
-14%
8%
-18%
20%
24%
10
$2,132,736
6%
$1,857,447
-5%
Average Annual Return
Compound Annualized Return
8%
7.9%
8%
6.4%
13
abacus
smart financial decisions
Stocks, bonds, and bills after taxes and inflation
$100
$54.83
Compound annual return
Stocks
Municipal bonds
Government bonds
Treasury bills
5.1%
1.4%
0.4%
–0.7%
$10
$3.03
$1.39
$1
$0.55
$.10
1926
1936
1946
1956
1966
1976
1986
1996
2006
14
abacus
smart financial decisions
Investment policy guidelines
Investment objective
Investment management
Investment directives
Asset allocation
Rebalancing
Return objectives and risk tolerance
Portfolio monitoring
15
abacus
smart financial decisions
World stock market capitalization
4%
5%
9%
43%
12%
27%
» United States
» International/European
» Japan
» United Kingdom
» Other Pacific
» Canada
Capitalization calculated at year-end 2006. Estimates are not guaranteed. © 2007 Morningstar, Inc. All rights reserved. 3/1/2007
16
abacus
smart financial decisions
Home Country Bias
Local Markets are more volatile
Annualized Volatility
25
20
15
10
5
0
Canada
Japan
Local Index
UK
US
MSCI World index*
*Unhedged in local currency. All data from January 1, 1973 through December 31, 2005
Source: “Home Country Bias: Where Traditional Asset Allocation Falls Short” Alliance Bernstein March 2006
17
abacus
smart financial decisions
The lower the costs, the more you keep
1.60%
Industry average
\\ US Large-Cap Stock
1.40%
\\ US Small-Cap Stock
1.20%
\\ International Large Cap Stock
\\ International Small Company Stock
1.00%
\\ Emerging Markets Stock
0.80%
apg
costs » smart
\\ Fixed Income
\\ Real Assets
0.60%
\\ Absolute Return
0.40%
0.20%
0.00%
APG
INDUSTRY AVERAGE
18
abacus
smart financial decisions
Managing asset location
Based on Tax
Efficiency
$5,485,881
$5,208,722
Stocks in
Bonds in
$5,035,322
Pro-Rata
$5,118,229
19
Source: Gobind Daranani, Ph.D. and Chris Cordaro
abacus
smart financial decisions
Mutual fund tax-efficiency
Tax Efficient
Taxable Account
Vanguard Municipal Bonds Funds
DFA US Large Company
DFA US Large-Cap Value
Artisan International
DFA International Large-Cap
Gateway
Harbor International
DFA Emerging Markets
DFA International Small Cap
DFA Two Year Global Bond
DFA Microcap
Calamos Growth and Income
Merger
PIMCO Foreign Bond
DFA Real Estate Securities
PIMCO Total Return
PIMCO Diversified Income
Cohen and Steers International Realty
PIMCO Commodity Real Return
Tax Inefficient
Tax Deferred Accounts
20
Source: Gobind Daranani, Ph.D. and Chris Cordaro
abacus
smart financial decisions
Benefit of looking often and rebalancing as needed
Excess return associated with various rebalancing ranges and time periods
Over a ten year period from January 1, 1992 to December 31, 2004.
Look intervals in market days
Rebalance Bands
250
125
60
20
10
5
5%
10%
0.27
0.22
0.19
0.20
0.21
0.20
0.30
0.25
0.27
0.24
0.27
0.26
15%
20%
0.29
0.33
0.33
0.35
0.35
0.32
0.31
0.36
0.38
0.40
0.45
0.43
25%
0.17
0.30
0.27
0.32
0.37
0.44
21
Source: “Opportunistic Rebalancing: A New Paradigm for Wealth Managers” Gobond Daranani Journal of Financial Planning January 2008
abacus
smart financial decisions
Money changes everything
Region of the brain where signals of fear
and anger are generated. Very quick
observation and response mechanism;
“flight or fight”.
Where you should be
processing moves in the
stock market.
This region saves you
from the lion but kills you
in the market.
Where you are processing
moves in the stock market.
Region of the brain where
pieces of information are
categorized, and stored
allowing for the processing
of themes and long-term
plans.
22
abacus
smart financial decisions
Dangers of market timing
$54,118
Growth of
$1,000
$49,604
$40,194
$25,217
$16,993
$9,015
Annualized
Compound
Return
Total
Period
11.07%
Missed 1
Best Day
10.82%
Missed 5
Best Days
10.21%
Missed 15
Best Days
8.86%
Missed 25
Best Days
7.74%
One-Month
T-Bills
5.96%
Performance of the S&P 500 Index January 1970-December 2007
Dimensional Fund Advisors (DFA)
The S&P data are provided by Standard & Poor’s Index Services Group. US bonds and bills data © Stocks, Bonds, Bills, and Inflation Yearbook™,
Ibbotson Associates, Chicago (annually updated work by Roger G. Ibbotson and Rex A. Sinquefield).
23
abacus
smart financial decisions
Asset class and Chaos Theory
1991
Highest
Returns
Lowest
Returns
1992
Small
Small
Stocks
Stocks
1993
1994
1995
1998
Small
Stocks
30 Day
T-Bills
LT Gov’t
Bonds
Large
Stocks
LT Gov’t
Bonds
Small
Stocks
LT Gov’t
Bonds
Int’l
Stocks
30 Day
T-Bills
Large
Stocks
Large
Stocks
Int’l
Stocks
LT Gov’t 30 Day
Bonds
T-Bills
Intl
Stocks
1999
2001
Int’l
Stocks
LT Gov’t
Bonds
Large
Stocks
30 Day
T-Bills
LT Gov’t
Bonds
2000
Small LT Gov’t
Stocks
Bonds
Small
Small
Stocks
Stocks
LT Gov’t
Bonds
30 Day
Int’l
Stocks T-Bills
1997
Large
Large
Stocks
Stocks
Int’l
Stocks
Large
Stocks
30 Day
T-Bills
1996
Int’l
Stocks
Small
Stocks
Small
Stocks
2003
2004
Small LT Gov’t
Stocks
Bonds
Small
Stocks
30 Day
T-Bills
Int’l
Stocks
LT Gov’t
Bonds
Large
Stocks
LT Gov’t
Bonds
2002
Int’l
Int’l
Stocks
Stocks
Small
Stocks
Int’l
Stocks
Large
Stocks
2005
26
2006
Int’l
Stocks
Small
Stocks
Large
Large
Stocks
Stocks
LT Gov’t
Bonds
30
30Day
Day
T-Bills
T-Bills
LT Gov’t
Bonds
Large
Stocks
Small
Stocks
Large
Stocks
30 Day
T-Bills
LT Gov’t
Bonds
\\ Large stocks \\ Small stocks \\ International stocks \\ Long-term Gov. bonds \\ Treasury bills
24
abacus
smart financial decisions
Behavioral finance
Daily stock returns and sunshine
Time period: January 1, 1927 - December 31, 1989
Methodology: Classify trading by (%) of cloud cover
over New York City
0 - 20% = Sunny
Optimistic
100% = Cloudy/Rainy Depressed
Time period
1/2/27 - 7/5/62
7/6/62 - 12/31/89
Sunny
0.032%
0.065%
Cloudy
-0.016%
-0.028%
Difference
0.048%
0.093%
How can sunshine affect stock returns, other than
by purely behavioral reasons?
25
abacus
smart financial decisions
Model portfolios risk vs return
Aggressive Growth
Expected return
Higher potential return
8.64%
Growth Portfolio
Worst 1 in 40
Expected return
25.10%
8.18%
Moderate Growth
Worst 1 in 40
Expected return
22.67%
7.46%
Balanced Growth
Worst 1 in 40
Expected return
18.36%
7.29%
Conservative
Growth
Worst 1 in 40 -
16.40%
Expected return
6.42%
Worst 1 in 40
11.44%
Higher potential risk
26
abacus
smart financial decisions
Conservative asset allocation
PORTFOLIO 1
10%
13%
7%
6%
50%
Large cap
Small cap
Private Equity
International Large
International Small
Emerging Markets
Fixed Income
Real Assets
Absolute Return
Expected Return 6.42%
Range (8.44%) – 24.37
Worst 1 in 40 years (11.44%)
$114,400 in losses per million invested
27
abacus
smart financial decisions
BalancedPORTFOLIO
growth asset
allocation
2
10%
8%
17%
8%
10%
40%
3%
Large cap
Small cap
Private Equity
International Large
International Small
Emerging Markets
Fixed Income
Real Assets
Absolute Return
Expected return 7.06%
Range (9.97%) – 27.74%
Worst 1 in 40 years (16.40%)
$99,700 in losses per million invested
28
abacus
smart financial decisions
Moderate growth asset allocation
PORTFOLIO 3
10%
10%
20%
10%
30%
4% 4%
12%
Large cap
Small cap
Private Equity
International Large
International Small
Emerging Markets
Fixed Income
Real Assets
Absolute Return
Expected return 7.46%
Range (12.27%) – 32.43%
Worst 1 in 40 years (18.36%)
$183,600 in losses per million invested
29
abacus
smart financial decisions
Growth portfolio
asset
allocation
PORTFOLIO 4
10%
10%
24%
20%
12%
5% 4%
15%
Large cap
Small cap
Private Equity
International Large
International Small
Emerging Markets
Fixed Income
Real Assets
Absolute Return
Expected return 8.18%
Range (14.43%) – 37.50%
Worst 1 in 40 years (22.67%)
$226,700 in losses per million invested
30
abacus
smart financial decisions
Aggressive
growth
asset
allocation
PORTFOLIO 5
15%
10%
26%
10%
5%
13%
5%
16%
Large cap
Small cap
Private Equity
International Large
International Small
Emerging Markets
Fixed Income
Real Assets
Absolute Return
Expected return 8.64%
Range (16.70%) – 41.07%
Worst 1 in 40 years (25.10%)
$251,000 in losses per million invested
31
abacus
smart financial decisions
Portfolio returns
ANNUAL RETURNS THROUGH 12/ 31/ 2007
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
BALANCED PORTFOLIO
8.7%
14.3%
6.2%
3.5%
-2.0%
24.3%
12.8%
8.7%
14.1%
8.4%
9.7%
13.5%
10.4%
MODERATE GROWTH PORTFOLIO
9.0%
16.8%
5.0%
2.3%
-4.2%
27.4%
13.8%
9.4%
15.6%
8.1%
10.0%
14.7%
11.0%
GROWTH PORTFOLIO
9.4%
20.0%
3.3%
1.0%
-6.8%
30.9%
15.0%
10.4%
17.4%
8.2%
10.4%
16.1%
11.9%
AGGRESSIVE GROWTH PORTFOLIO
9.8%
22.8%
2.3%
-0.3%
-8.7%
33.2%
15.7%
10.9%
18.6%
8.1%
10.7%
17.0%
12.4%
S&P 500 TOTAL
28.6%
21.1%
-9.1%
-11.9%
-22.1%
28.7%
10.9%
4.9%
15.8%
5.5%
5.9%
12.8%
8.6%
8.7%
-0.8%
11.6%
8.4%
10.3%
4.1%
4.3%
2.4%
4.3%
7.0%
6.0%
4.4%
4.6%
23.4%
16.0%
-5.0%
-7.2%
-12.3%
20.3%
8.9%
4.2%
12.6%
5.9%
6.1%
10.2%
7.5%
LEHMAN AGG BOND
70% S&P 500 / 30% LEHMAN BOND
10 YEARS
5 YEARS
3 YEARS
Annual Return
18.0%
16.0%
14.0%
BALANCED PORTFOLIO
MODERATE GROWTH PORTFOLIO
GROWTH PORTFOLIO
AGGRESSIVE GROWTH PORTFOLIO
S&P 500 TOTAL
LEHMAN AGG BOND
70% S&P 500 / 30% LEHMAN BOND
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
10 YEARS
5 YEARS
3 YEARS
32
