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A history of asset allocation

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Global Tactical Asset Allocation Building responsive and resilient portfolios for today’s complex investment markets J.P. Morgan Investment Academy Series Thank you for joining us for the next installation in our Investment Academy series. I’m _____name ______/title_____, and today’s presentation is about Global Tactical Asset Allocation, a sophisticated investment solution that takes full advantage of active management to respond to constantly changing global markets.

1 A history of asset allocation
With growing technology and greater access to investments, today’s investing landscape is forever changed. 400 B.C. 1950 1960 1970 1980 1990 2000 2010 First documented strategic allocation The Talmud recommends “a third in land, a third in merchandise, a third in cash.” Modern Portfolio Theory Proposes the importance of diversification and selecting portfolios, not individual securities. Tactical asset allocation emerges A more actively managed approach adjusts the weight of assets in response to changing market conditions. Asset allocation expands beyond the U.S. Investors begin incorporating international assets into portfolios. Strategic and tactical allocation programs grow New computing abilities and legislation continue to evolve the investing landscape. Tactical overlay strategies go mainstream. Demand surges for downside protection. With the global financial crisis, investors seek strategic and tactical allocation solutions that offer downside protection. Although it’s a popular investment strategy today, the idea of asset allocation isn’t new. Our historic timeline shows that back in the 4th century Rabbi Issac bar Aha, writing in the Talmud, advised people to divide their wealth equally into land , merchandise and “ready to hand,” which in today’s parlance would equate to real estate, equities and cash. By the 1950s, Modern Portfolio Theory was developed by Nobel laureate Harry Markowitz. Ten years later, William Sharpe’s Capital Asset Pricing Model was embraced by institutional investors. Sharpe, also a Nobel prize winner, suggested an initial 50/50 stock and bond allocation. Several catalysts working together permanently changed the investment landscape. The growing computer power afforded by technology and the accelerating adoption of legislation gave way to greater access to investments by the middle class. While technology unleashed new, faster and better tools, global markets began to expand and become more standardized. They also became more volatile. Today’s contemporary asset allocation strategies blend multiple asset classes together in a single portfolio to address a variety of investor goals – from long-term growth to current income.

2 Investing in volatile markets
The traditional rules of investing are no longer providing the results investors seek. What’s also different is that the game rules for investors have changed. The traditional “Diversify, buy and hold, stay the course” advice so common with earlier generations of asset allocation hasn’t provided the results investors seek. Slide 6 from our popular Guide to the Markets illustrates what we call the “grand super cycle” that tracks past market cycles in the S&P 500, highlighting peak and trough valuations, as well as index levels, dividend yields and the 10-year U.S. Treasury yield. Slower economic growth and low current yields on the one hand, and higher volatility, rising asset class correlations and greater downside portfolio risk on the other, all add up to an especially challenging environment for today’s investors.

3 Investors need to be better diversified
This hypothetical “asset allocation” portfolio returned 118% over 10 years through June 2013, with less volatility, compared to the S&P 500’s return of 98%. Since the global financial crisis, we’ve learned that investors need to be better diversified to help reduce volatility and increase long-term returns. Even the definition of what makes an asset class core has expanded over the years to encompass groups of securities with different risk and return characteristics – like U.S. stocks, Government Bonds, Commodities and Real Estate. Slide 57 from the Guide tracks the performance of a hypothetical “asset allocation” portfolio. It’s made up of eight unique classes – that, over the past 10 years, would have reduced overall risk and returned 118% over the past 10 years, compared to the S&P 500 which returned 99% over the same period. Diversification works because not all asset classes move together. Some of you may recall prior discussions we’ve had about diversification, correlation and the efficient frontier. These are the building blocks of effective asset allocation. Correlation measures the relationship between the price movements of two securities or classes of securities in relation to one another. During extreme events these relationships and price movements can change – sometimes dramatically. During the global financial crisis, for example, the correlation of many asset classes rose in lockstep with one another as prices plummeted. More recent asset allocation research demonstrates that there is value in making more frequent, tactical decisions based on the economic climate.

4 Asset allocation trends
Investors are seeking more from their investments since the financial crisis, including superior risk-adjusted performance. Active management Requires more expertise and monitoring than ever Greater transparency Helps investors reach their goals and understand what they own Investor expectations Other trends we’re seeing in the industry reflect the changed global landscape since the financial crisis. Institutions, high net worth, retirement and retail investors now recognize that asset allocation is a lot harder to get right than many believed; you need more resources devoted to research to select the proper mix of assets and to monitor portfolio allocations. Investors also want more transparency – to better understand exactly what they own. With that knowledge comes a better sense for the types of risk investors are taking, and how they are being compensated for those risks. Risk management Provides knowledge of risks being taken and how investors are being compensated for those risks

5 Global tactical asset allocation
Investing anywhere in the world, including both developed and emerging markets. Let’s spend a minute talking about what global means for an asset allocation portfolio. A global strategy can invest all over the world – not just the U.S. One could argue that global investing is the new core and that asset allocation strategies should incorporate a better representation of today’s globally connected markets. American investors are exposed to some foreign markets by virtue of the fact that so many U.S. companies generate profits from overseas markets. Companies like Coca-Cola, Nike, Wal-Mart and Procter and Gamble, which expects developing markets to contribute 40% of its total revenues in compared to 20% just 10 years.* They are eager to market everything from laundry detergent to diapers and toothpaste to a growing consumer class outside the U.S. But research suggests that the average American investor remains underweight international assets, despite marked improvement over the last decade. *Source:http://finance.yahoo.com/news/procter-gambles-ceo-discusses-q html

6 Strategic versus tactical: understanding the difference
While strategic allocation takes the long view, tactical allocation actively responds to changing conditions. Strategic Destination oriented Longer term in nature Tactical Intermediate and shorter-time horizons Responsive to changing conditions Views may be alpha-focused to enhance returns or risk-oriented to protect capital Flexibility So far, we’ve talked about the importance and evolution of asset allocation and what it means to own a global portfolio. For the remainder of our discussion, I’d like to talk more about the meaning of the term tactical and how it differs from strategic allocation. To illustrate the distinction, let’s take a detour and talk for a minute about a road trip. Perhaps some of you remember the Rand McNally road atlas your parents used to keep in the family car. In the old days, your folks would use it to map out a long trip. If they were members of the local AAA club, they might consult with them and get what was called a “Triptik” – a customized map that would break up the trip in smaller maps in greater detail to make it easier to follow. Strategic planning, as it relates to a road trip, would involve the big decisions like where we want to go, which vehicle we’ll drive, when we’ll travel, road trip, and, generally, what route we want to take. But today, consider all the new technology available that makes road trips easier. Companies like Garmin and TomTom are revolutionizing the map business. Better yet, you can convert your Android or iPhone into a real time GPS system. The tactical aspects of our road trip might be divided into two categories, intermediate and short term. Intermediate stops might include pulling off the highway to get a bite to eat, spend the night at a hotel your phone app recommended, or even an unplanned side trip your original plan didn’t take into account. The shorter term tactics would relate to the information your GPS system would offer so you could avoid a traffic jam or an accident. You might get current weather updates that could make your trip safer and more pleasurable.

7 Asset allocation decision-making timeline: Strategic
With a time horizon of 10 years or longer, strategic allocation adjustments are infrequent. Strategic allocation Intermediate allocation Tactical allocation Time horizon 10+ years 1 – 3 years 3 – 12 months Allocation considerations Cycle-neutral, secular and structural trends Cyclical factors Momentum, technical and event-driven factors Review and implementation Long-term capital market views reviewed annually; infrequent adjustments Weekly review of qualitative views; structured review three times per year Weekly review of qualitative views; monthly run of qualitative models Sample allocation Overweight high yield and underweight investment grade Overweight lower beta sectors and underweight higher beta sectors So let’s review, briefly, the difference between strategic and tactical allocation decisions. This slide is an illustration of J.P. Morgan’s Global Multi Asset Group approach – other firms might use a similar approach. In this example of the strategic, long term allocation decisions, we generally mean a time horizon of 10 years or longer – and, aside from periodic rebalancing, the allocation would only be adjusted when long-term capital markets views change, or the life circumstances or objectives of the investor change. The manager seeks to achieve the stated objectives. There can be no guarantee they can be met.

8 Determining the strategic allocation framework
Strategic decisions consider the region, asset classes, types of securities and overall risk. Equities REITs Convertibles High yield Investment-grade fixed income Non-agency mortgages Emerging markets debt World-wide investments, including both developed and emerging markets Asset class Region Strategic allocation In determining the strategic allocation, the most robust strategies look at the world through various lenses, considering the region, the individual asset classes, the types of securities, and the overall risk levels. Strategic decisions determine what percentage should be invested in U.S. vs. international stocks, or foreign vs. U.S. bonds. The manager also selects the underlying managers – types of funds or assets, management styles, geographies and other risk/reward characteristics appropriate for a long- term investment. Today’s strategic allocation might suggest a range, for example, of 30% to 70% in stocks; 25% to 65% bonds; and 10% to 30% alternative asset classes. Capital structure Commercial paper Bank loans Bonds Convertibles Preferred stock Common stock

9 Asset allocation decision-making timeline: Intermediate and tactical
Tactical allocation is active and responsive, which helps to exploit opportunities and avoid loss. Strategic allocation Intermediate allocation Tactical allocation Time horizon 10+ years 1 – 3 years 3 – 12 months Allocation considerations Cycle-neutral, secular and structural trends Cyclical factors Momentum, technical and event-driven factors Review and implementation Long-term capital market views reviewed annually; infrequent adjustments Weekly review of qualitative views; structured review three times per year Weekly review of qualitative views; monthly run of qualitative models Sample allocation Overweight high yield and underweight investment grade Overweight lower beta sectors and underweight higher beta sectors This decision-making timeline incorporates a more active and responsive investment process that is shorter-term in nature. For example, in the intermediate, 1-3 year term, the manager might decide what mix of high yield vs. investment grade bonds should make up the fixed income slice of the pie. Or, in the very short term, the manager may choose to reduce or increase exposure to lower or higher risk stocks. In a way, an active tactical allocation process is reading the markets – like a map – to sidestep trouble or exploit an opportunity, while keeping the long- term destination in mind. The process involves assessing market valuations, volatility and correlation, risks and opportunities in the near and intermediate term. It often involves a combination of methods to assess these factors – including qualitative and quantitative analysis and involve cyclical, momentum, technical and event- driven factors. Like our road-trip analogy, the portfolio manager may see storms on the horizon and decide to gradually reduce exposure to assets in the portfolio that are more vulnerable. These so-called storms might be political or economic, and might reflect current views on interest rates, inflation, price volatility, correlation, or other investment risks. Similarly, the manager may see opportunities that haven’t yet been recognized by the markets and choose to increase expose to a certain region or market sector in an effort to boost returns. The manager seeks to achieve the stated objectives. There can be no guarantee they can be met.

10 Beyond strategic asset allocation
Tactical allocation also provides an active risk management dimension. May help limit portfolio losses caused by market spikes and downturns Acts as an added layer of protection Tactical Asset Allocation The tactical allocation process also provides an active risk management dimension. Like an added layer of protection, tactical decisions may help limit portfolio losses caused by short-term volatility spikes and prolonged market downturns. Some models can move assets into cash when negative risk-return signals exceed certain limits in specific sectors. Others can use hedging techniques in an effort to avoid exposure to negative markets at the individual asset class level while keeping the rest of the portfolio strategically invested.

11 Asset allocation moves within a GTAA portfolio
J.P. Morgan makes key tactical decisions and adjustments in view of market events and observations. Driver Outcome September Volatility was increasing, dividend yields were low and real estate concerns were growing Tactical decision: Brought the REITs allocation from 9% down to 0% in favor of global equities Dec 2010 – May More positive near-term views show attractive growth prospects within the emerging markets Shorter-term tactical decision: Increased allocation to emerging markets equity by selling U.S. and international equity May Our proprietary research pointed to the fact that need for inflation protection in the years approaching and in retirement Strategic modification: Added basket of inflation sensitive asset classes to the glide path, such as TIPS, commodities, REITs and global natural resources So, let’s take a look at a few examples where a tactical decision might have helped investors avoid trouble spots, or provided access to an opportunity. On the left are observations viewed as market drivers that influenced J.P. Morgan’s asset allocation specialists to adjust both the strategic and tactical views of some of our long-term portfolios. In the first example, back in 2007, a shorter-term tactical decision for an income-oriented portfolio might have under-weighted real estate assets when concerns about the real estate market were growing. During the December 2010 to May 2011 period, apparent growth opportunities would have suggested an over-weighting to emerging markets. In May 2011, research pointed to the need for inflation protection for retirement-oriented portfolios. A strategic decision was made to enhance the underlying asset class menu by adding access to assets with greater exposure to inflation-sensitive asset classes. Finally, in January 2012, as the housing market began to strengthen, an intermediate decision was made to increase exposure to mortgage securities. January Intermediate decision: A combination of helpful Fed policy and the recovery in key housing data Intermediate decision: Began building up the non-agency mortgage allocation

12 How tactical asset allocation relates to investor needs
True global diversification and effective asset allocation are hard for investors to achieve on their own. Investor challenges Traditional sources of income at all-time lows Interest rates expected to rise Global diversification hard to achieve without professional help Tactical oversight requires greater resources Inflation Portfolio constraints Volatility/drawdown risks Seek to ensure appropriate levels of risk Access to difficult to invest in asset classes Non-agency mortgages Emerging market debt Solutions Asset allocation framework Nimble with risk Increased diversification among asset classes Let’s step back and look at the big picture in terms of the challenges investors face, and how a global tactical asset allocation solution could address their ever-changing needs. Today we’ve talked about the fact that global investing is more complicated than ever – with slower economic growth worldwide, low current yields, higher volatility, rising asset class correlations and greater downside portfolio risk. We also acknowledge that most Americans are underweight exposure to foreign investment opportunities – and that true global diversification and effective asset allocation is a lot harder to get right than many believed. It requires more resources devoted to research, analysis and portfolio monitoring. Investors also want more transparency – to understand what they own, the types of risk they are taking, and how they are being compensated for those risks.

13 Global tactical asset allocation
A contemporary GTAA strategy may be an appropriate solution for many of today’s investors. A contemporary investment strategy that: Optimizes diversification across a large, global universe of investments Enables the manager to make gradual adjustments to the neutral strategic asset mix based on an assessment of current market cycles and conditions To capitalize on an opportunity to enhance returns or to shield the portfolio from unwanted risk Seeks to generate long-term competitive returns by exploiting shorter-term opportunities Aims to reduce overall portfolio risk and limit portfolio losses caused by short-term volatility A contemporary, GTAA strategy may be an appropriate solution for many of today’s investors. It: Optimizes diversification across a large, global universe of investments Enables the manager to make gradual adjustments to the neutral strategic asset mix based on an assessment of current market cycles and conditions in an effort to enhance long-term returns Seeks to generate long-term competitive returns by exploiting shorter-term opportunities, and Aims to reduce overall portfolio risk and limit portfolio losses caused by short-term volatility

14 Building responsive, resilient portfolios
GTAA is a timely strategy for achieving any number of investor goals. As a complement to other holdings As a complete, stand-alone portfolio solution As a component of a broader asset allocation strategy So how does global tactical asset allocation fit in an investor’s overall portfolio? The decision to incorporate a GTAA strategy will depend on an investor’s circumstances. These would include their long-term goals and objectives, their tolerance for risk and their overall time horizon for these assets. Are they investing for their retirement in years? Looking to build a legacy for their children or grandchildren? Or perhaps they’ve recently retired and are looking for an income solution that also provides room for their assets to grow. A global tactical asset allocation solution could be the best way to achieve any of these goals. Further, it can be used as: A solid stand-alone investment solution A versatile complement to other assets An anchor for a broad-based asset allocation program

15 Summary GTAA provides the framework for successful, long-term investing. The world has changed Global tactical asset allocation is a contemporary investment strategy that optimizes diversification across a global universe of investments that seeks to generate long-term value by exploiting shorter-term opportunities Active risk management can provide an added layer of protection to limit portfolio losses caused by short-term volatility and prolonged market downturns. A well-diversified asset allocation program — one that combines a strategic selection of assets, and has the flexibility to make more frequent, tactical allocation decisions based on the economic climate — can provide the framework for successful, long-term investment in today’s global financial markets. We’ve covered a lot of territory today. Let me try to summarize the most important points. One could argue that global investing is essential for today’s long-term investors – as U.S. investments alone may not be the most effective way to achieve their goals. Robust asset allocation strategies also should incorporate more alternatives to capitalize on the largest opportunity set available. We defined Global Tactical Asset Allocation as a contemporary investment solution that optimizes diversification across a global universe of investments; one that seeks to generate long-term value by exploiting shorter-term opportunities and the unique characteristics of various asset classes and management styles representing a range of countries, sectors, currencies . A well diversified asset allocation program – one that combines a strategic selection of assets, and has the flexibility to make more frequent, tactical decisions based on the economic climate, can provide the framework for successful, long-term investment in today’s global financial markets.

16 Thank you Thank you for your time today and the opportunity to share our views on Global Tactical Asset Allocation – a solution that combines a strategic selection of assets, and has the flexibility to make more frequent, tactical decisions based on the economic climate. We look forward to bringing you more insights from our Investment Academy series. It’s a vast, global marketplace that’s constantly changing and an exciting time to be an investor.

17 Disclosures The above commentary is intended solely to report on various investment views held by J.P. Morgan Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation. J.P. Morgan Asset Management is the marketing name for the asset management businesses of JPMorgan Chase & Co. Those businesses include, but are not limited to, J.P. Morgan Investment Management Inc., Security Capital Research & Management Incorporated and J.P. Morgan Alternative Asset Management, Inc. © J.P. Morgan Chase & Co., July 2013


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