1. Capital Market Charts Series (Modern Portfolio Theory Review) IFS-A Charts 1-3 Reminder: You must include the Modern Portfolio Theory Disclosure pages with all charts you select to use, either individually or as a group. Information as of December 31, 2004 unless otherwise noted

2. Modern Portfolio Theory Review
Efficient Frontiers B
Efficient Frontier D
Targeted Return E C
Inefficient Portfolio*
In the 1950’s, Harry Markowitz became the first person to define the relationship between risk & return. He asserted that a rational investor will only accept more risk if he receives an equal or greater amount of opportunity in return. He, therefore, established a frontier of optimal portfolios, which were named the “efficient frontier.” His theory states every point on the frontier is the most efficient portfolio given the risk & return considerations.
See Disclosure Page.
* An inefficient portfolio is one in which the targeted return is achieved while assuming a greater risk level than warranted as measured by standard deviation. For example, Portfolio C takes greater risk than Portfolio E to achieve similar investment results. A
Standard Deviation
For illustrative purposes only. This does not reflect the performance of any specific investment. See Disclosure Page.

3. Diversification & Its Effect on Risk
Positive Correlation
Positive Correlation 25 20 15
Return % 10 5
R-squared (R2) is the percent that explains the direction of a manager’s return relative to the market. Correlation is a measure of diversification since it evaluates the manner in which two things relate together. When two assets perform the same way during a business cycle, they are considered to have perfect “positive correlation.”
See Disclosure Page.
period 1
period 2
period 3
period 4
period 5
period 6
Asset A
Asset B
50% A/ 50% B
For illustrative purposes only. This does not reflect the performance of any specific investment. See Disclosure Page.

4. Diversification & Its Effect on Risk
Negative Correlation 25 20 15
Return % 10 5
R-squared (R2) is the percent that explains the direction of a manager’s return relative to the market. Correlation is a measure of diversification since it evaluates the manner in which two things relate together. When two assets perform exactly the opposite during a business cycle, they are considered to have perfect “negative correlation.”
See Disclosure Page.
period 1
period 2
period 3
period 4
period 5
period 6
Asset A X
Asset B _
50% A/ 50% B
For illustrative purposes only. This does not reflect the performance of any specific investment. See Disclosure Page.

5. Glossary
ALPHA:
A measure of the manager’s relative value added as compared to a blended market index. The alpha measures the risk-adjusted return above (+) / below (-) the security market line. The security market line represents the blend between U.S. T-bills and a market index. A positive alpha implies that the manager has added value to the return of the portfolio over that of the market. Returns with negative alpha do not reflect any positive contribution by the manager over the performance of the market. An alpha of zero implies that a manager has provided a return that is equivalent to the market return for the manager’s specific risk class. Alpha does not factor in volatility risk. Alpha assumes the manager is fully diversified. Alpha will vary from quarter to quarter, so the alpha of any five-year period should be used carefully. Alpha = Return - (Beta x Index Return)
BETA:
Beta is a measure of how a manager’s portfolio has performed in relationship to the market (market or systematic risk). A manager that has performed directly in line with the market will have a beta of A manager whose returns were more volatile than the market will have a beta of greater than 1.00, and a manager with less volatile returns will have a beta of less than Disregarding the impact of stock selection (unsystematic risk), over 3-5 year, we expect a fully diversified portfolio with a beta of 1.20 to have about a 20% higher return than the market. Similarly, for a portfolio with a beta of .80, we expect a 20% lower return than the market over time.
CORRELATION:
This statistic measures how well a portfolio’s returns have moved in tandem with an index or other portfolios. Correlation coefficients fall between and A correlation coefficient of 1.00 between a portfolio and an index means that the portfolio returns have moved in perfect tandem with the index. (If the index goes up, the portfolio goes up). A correlation coefficient of means that the portfolio returns have moved in perfect negative tandem with the index. (If the index goes up the portfolio goes down).
R-SQUARED:
R-squared measures how well a portfolio is diversified against the market index. The more diversified a portfolio is, the less risk related to an individual security (unsystematic risk) it has. R-squared values can range from 0 to 1.00, with the market index at For a portfolio with an R-squared of .90, 90% of the portfolio risk can be attributed to “being in the market” (systematic risk). The remaining 10% is associated with company/issue specific (unsystematic) risk. Higher R-Squared values indicate more reliable alpha and beta statistics and are useful in assessing a manager’s investment style.
STANDARD DEVIATION:
Standard deviation measures the volatility of a portfolio’s returns compared to the average return of the portfolio. Approximately 68% of the time, the total return will vary from its average total return by no more than plus or minus the deviation figure. Since it measures total variation of return, standard deviation is a measure of total risk, unlike beta, which measures market risk.
Disclosures
For illustrative purposes only. This information does not reflect the performance of any specific investment.
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