1. ©2013, College for Financial Planning, all rights reserved. Module 9 Asset Management & Investment Strategy During Retirement Chartered Retirement Planning Counselor SM Professional Designation Program

2. Learning Objectives 9–1: Explain the purpose, attributes, and key elements of a sound investment policy. 9–2: Explain the concept of asset allocation and its implication for investors. 9–3: Explain the decisions, strategies, and principles of portfolio management involved in practicing asset allocation. 9–4: Describe advantages and disadvantages of different asset classes. 9-2

3. Learning Objectives 9–5: Explain the four steps of the asset allocation process. 9–6: Calculate measurements of risk and return used in portfolio management of retirement investments. 9–7: Calculate the intrinsic value of stock investments and their earnings multiplier used in stock investment strategies pursued before and during retirement. 9–8: Perform basic bond valuation and price volatility calculations as they apply to ladder and barbell strategies used by bond investors. 9-3

4. Questions to Get Us Warmed Up 9-4

5. Learning Objectives 9–1: Explain the purpose, attributes, and key elements of a sound investment policy. 9–2: Explain the concept of asset allocation and its implication for investors. 9–3: Explain the decisions, strategies, and principles of portfolio management involved in practicing asset allocation. 9–4: Describe advantages and disadvantages of different asset classes. 9-5

6. Investment Policy Definition A coherent set of guidelines for managing financial assets. Purposes To provide a foundations of goals, time horizons, and constraints on which the client portfolio is constructed; and To provide a basis for review, performance evaluation, and adaptation to changing conditions. 9-6

7. Investment Policy Attributes The policy must be realistic. The policy should have a long-term perspective. The policy must be clearly defined. Key elements A clear statement of the client’s investment goal Identifying suitable and unsuitable investment vehicles and investment strategies A statement of the acceptable risk level and how risk will be managed An approximate asset allocation among suitable classes of assets A provision for periodic review 9-7

8. Learning Objectives 9–1: Explain the purpose, attributes, and key elements of a sound investment policy. 9–2: Explain the concept of asset allocation and its implication for investors. 9–3: Explain the decisions, strategies, and principles of portfolio management involved in practicing asset allocation. 9–4: Describe advantages and disadvantages of different asset classes. 9-8

9. Asset Allocation Asset allocation is investing a portfolio over several asset classes such as stocks, bonds, cash equivalents, real estate, and foreign stocks that have low correlations. The effect of asset allocation is the reduction of risk through diversification. The goal is to optimize returns for any given level of risk. 9-9

10. Risk & Return 1926-2012 Asset Class Geometric Mean Return Standard Deviation Large-company stocks9.8%20.2% Small-company stocks11.9%32.3% Intermediate-term U.S. government bonds5.4%5.6% L-T corporate bonds6.1%8.3% L-T U.S. government bonds5.7%9.7% U.S. Treasury bills3.5%3.1% Inflation3.0%4.1% Source: Ibbotson SBBI 2013 Classic Yearbook 9-10

11. Asset Allocation Asset allocation is investing a portfolio over several asset classes such as stocks, bonds, cash equivalents, real estate, and foreign stocks that have low correlations. The effect of asset allocation is the reduction of risk through diversification. The goal is to optimize returns for any given level of risk. 9-11

12. Asset Allocation Considerations Importance of time horizon Portfolio mix will change over time Longevity risk 9-12

13. Learning Objectives 9–1: Explain the purpose, attributes, and key elements of a sound investment policy. 9–2: Explain the concept of asset allocation and its implication for investors. 9–3: Explain the decisions, strategies, and principles of portfolio management involved in practicing asset allocation. 9–4: Describe advantages and disadvantages of different asset classes. 9-13

14. Diversification Including two or more unlike investments (i.e., negatively correlated assets) in a portfolio, has been shown to reduce the portfolio’s unsystematic risk: 9-14

15. Practicing Asset Allocation Which asset classes should become part of the client’s portfolio? What weights should be assigned to each asset category? 9-15

16. Three Approaches to Asset Allocation Strategic Tactical Core-satellite 9-16

17. Professionally Managed Funds Target retirement funds Balanced mutual funds Managed (separate) account 9-17

18. Asset Classes Common stocks Fixed-income securities Cash equivalents Real estate 3-18

19. Fixed Income Maturity Credit Rating Yield – Current Yield, Yield-to-Call (YTC) and Yield-to-Maturity (YTM) TIPS Cash Equivalents 9-19

20. Real Estate Rental homes Reverse mortgage Real estate limited partnerships (RELPs) Real estate investment trusts (REITs) 9-20

21. Learning Objectives 9–5: Explain the four steps of the asset allocation process. 9–6: Calculate measurements of risk and return used in portfolio management of retirement investments. 9–7: Calculate the intrinsic value of stock investments and their earnings multiplier used in stock investment strategies pursued before and during retirement. 9–8: Perform basic bond valuation and price volatility calculations as they apply to ladder and barbell strategies used by bond investors. 9-21

22. Steps in the Asset Allocation Process 1. Determine which asset classes should be represented in the portfolio. 2. Determine the percentage that each asset class should represent in the total portfolio. 3. Select the securities. 4. Review the performance and investment climate. 9-22

23. Three Approaches to Asset Allocation Strategic Tactical Core-satellite 9-23

24. Measures of Risk Standard deviation (SD) the dispersion of returns around the security’s average (mean) return. 68% of returns can be expected to range within one SD, 95% within two SDs, and 99% within 3 SDs. Coefficient of variation the security’s standard deviation divided by its mean return 9-24

25. Measures of Risk Beta a measure of the volatility of an asset relative to the volatility of the market Duration a measure of the price sensitivity of a bond to changes in interest rates or, in other words, a measure of interest rate risk. duration times the interest rate change approximately equals the inverse change in the bond price. 9-25 β

26. Systematic & Unsystematic Risk 9-26 Risk associated with the system with which a particular asset is associated and over which it has no control. Systematic risk cannot be diversified away. Market Risk The risk associated with a bear market where almost all stocks fall in price. Adding 20 stocks to a portfolio of 25 stocks will not diversify away market risk Systematic risk The unique risk associated with owning a particular security. Unsystematic risk can be diversified away. Business Risk The risk associated with owning a specific stock. Owning Ford stock involves specific risks such as Ford’s specific product line, marketing strategy, financial condition, and product development expertise. Adding 20 other stocks in different industries can diversify away these specific Ford risks to the overall portfolio. Unsystematic risk

27. Risk-Adjusted Returns Sharpe index: (Rs –Rf) / SD Treynor index: (Rs –Rf) / beta Jensen index: Rp - [Rf + (Rm – Rf)ß] 9-27

28. Risk Control Diversification Acquiring assets with low or negative correlations to each other with the goal of lowering overall risk. Correlation A relative measure of the degree to which the returns of two assets move together. correlations range from +1.0 to –1.0. in practice, negative correlations are rare. the further a correlation is from +1.0, the more diversification. For example, -.30 provides more diversification than.20, which provides more diversification than.60. 9-28

29. Learning Objectives 9–5: Explain the four steps of the asset allocation process. 9–6: Calculate measurements of risk and return used in portfolio management of retirement investments. 9–7: Calculate the intrinsic value of stock investments and their earnings multiplier used in stock investment strategies pursued before and during retirement. 9–8: Perform basic bond valuation and price volatility calculations as they apply to ladder and barbell strategies used by bond investors. 9-29

30. Investment Strategies Buy and hold Timing strategies: Dollar cost averaging and value averaging Economic cycle investing Sector rotation Contrarian strategy Low P/E approach Value investing Growth stock investing Small stock investing 9-30

31. Calculating Intrinsic Value of a Stock Constant growth dividend discount model Stock value = annual dividend/ k–g, where k is the investor’s required rate of return and g is the company’s earnings growth rate Earnings multiplier Determine the earnings growth rate (g) by multiplying ROE times retention ratio (1 minus payout ratio) Determine earnings multiplier by dividing the payout ratio by (k–g) (as defined above) Determine stock value by multiplying the company’s earnings by the multiplier (from Step 2) 9-31

32. Calculating Intrinsic Value of a Stock Earnings multiplier— alternative method Determine the multiplier based on historic discount or premium to its industry’s multiplier Determine either the current or next year’s earnings, depending on the question The multiplier × the earnings equals the stock value Graham formula Price = EPS × (8.5 + 2G) × [4.4/AAA bond yield] 9-32

33. Bond Investment Strategies Ladder owning equal amounts of bonds along with maturities of equal intervals e.g., $50,000 of bonds with $10,000 each in 2-, 4-, 6-, 8-, and 10-year maturities Barbell owning short-term and long-term bonds, each with a ladder e.g., $100,000 of bonds with $10,000 each in 1-, 2-, 3-, 4-, and 5-year bonds and in 16-, 17-, 18-, 19-, and 20-year bonds. 9-33

34. Bond Valuation Calculator example Assume a 6%, $1,000 par value bond with 20 years to maturity and a yield to maturity of 7%. What is the price of this bond? Set calculator to 2 payments per year, clear calculator (gold key, C ALL), set to an ordinary annuity (END mode) -1,000, FV; -30, PMT; 7, I/YR; 40, N: PV = $893.22 (Note that FV and PMT are entered as negatives) 9-34

35. Question 1 An investment policy is developed for all of the following reasons except a. to provide a foundation of goals, time horizons, and constraints. b. to provide a basis for review. c. to select individual securities. d. all of the above. 9-35

36. Question 2 An investor has a 6%, 10,000 par value bond that matures in 15 years. The yield to maturity on similar bonds currently is 5.5%. What is the price of this bond? a. $1,050.62 b. $5,779.16 c. $9,509.99 d. $10,506.23 9-36

37. Question 3 The type of analysis that focuses on economic and financial statement data and earnings projections to determine the intrinsic value of a stock is a. fundamental analysis. b. technical analysis. c. charting. d. none of the above. 9-37

38. Question 4 Growth stocks are characterized by a. high market-to-book ratios. b. low market-to-book ratios. c. low P/E ratios. d. both b and c. 9-38

39. Question 5 Assume a mutual fund has a return of 10%, a beta of 1.1, and a standard deviation of 18%. The risk free rate is 3%. What is the Sharpe index for this fund? a.. 39 b. 6.36 c. 11 d. 15 9-39

40. ©2013, College for Financial Planning, all rights reserved. Module 9 End of Slides Chartered Retirement Planning Counselor SM Professional Designation Program