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AGENDA

FMUTM
UTC Seminar, KL, 12 Feb 2009

Session 1: Risk & return


Session 2: Diversification
Session 3: Diversifying: asset classes, sectors,
region/countries, and style
Session 4: Asset allocation strategies
Q&A

Chris Gan, Feb 2009

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For educational purpose only – Chris Gan 2009

Building blocks in unit trusts

To be “complete”, you need:

Knowledge
• Market, economy,
finance, etc.

• Products

• Selling & people skill

Action

Lots of Action & No Knowledge vs. No Action & Lots of Knowledge

Where is the balance?

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Allocating Assets & Managing Portfolios

Objective: This seminar will introduce you to


the basics involved in: allocating your wealth,
managing a portfolio, and also, how you can
diversify your portfolio risk.

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For educational purpose only – Chris Gan 2009

“Gentlemen, this is a football” – Vince Lombardi

z Why do investors invest in UT? The basic answer: to


make more money.
z More complex answer: Investors invest in unit trust
funds to generate a return that commensurate with the
risks.
z Investors’ returns come in two form: also known as
total return.
z Capital gains: buy at low price & sell high.
z Dividend distribution: money paid out by fund periodically
(either in cash or extra units).
z We know: The higher the risk of the fund, the higher
the potential return.

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For educational purpose only – Chris Gan 2009

But, what retail investors actually do:


Buy Low, Sell High? Not!
HLG Global Resources Income Fund (03/05/07 to 19/10/07)

Redemptions are generally high, when NAV is lowest


12,000,000.00 0.7000
NAV 0.5842 on 18/10/07

A B
0.6000
10,000,000.00

0.5000
1. Redeemed: 18/6/07 -- 2. Redeemed: on
8,000,000.00 NAV 0.5327 19/9/07 -- NAV 0.5514 RM
0.4000
-RM5.7m Redemption
RM

6,000,000.00
NAV
-RM4.87m 0.3000

4,000,000.00
0.2000

2,000,000.00
0.1000

- 0.0000
5/17/2007

5/31/2007

6/14/2007

6/28/2007

7/12/2007

7/26/2007

8/10/2007

8/27/2007

9/11/2007

9/25/2007

10/9/2007
5/3/2007

Date

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For educational purpose only – Chris Gan 2009

When should you sell?

z At inception on 03/05/07, NAV/unit = 0.50


z If sold on 18/06/07, NAV/unit of 0.5327, gain is
6.54% (in more than 1 month)
z If sold on 19/09/07, NAV/unit of 0.5514, gain is
10.28% (in roughly 4 months)
z If sold on 18/10/07, NAV/unit of 0.5842, gain is
16.84% (in roughly 5 months);
z The Fund’s NAV/unit is now: 0.3824
z When to sell? Would depend on your risk &
return profile.
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For educational purpose only – Chris Gan 2009

What fund managers should do

90 180
170
80 Equity exposure 160
Increased 150

RHBIslamic Index/KL Syariah Index


70 140
Equity Exposure (%)

130
60 120
110
50 100
90
40 80
70
30 60
Equity exposure 50
20 decreased 40
30
10 20
2-10-98

5-11-99

28-01-00

14-04-00

30-06-00

15-09-00

1-12-00

16-02-01

4-05-01

20-07-01

5-10-01

21-12-01

8-03-02

24-05-02

9-08-02

25-10-02

10-01-03

28-03-03

13-06-03
Equity Expos ure (Market Value of Equity Inves tm ent/NAV)
RHB Is lam ic Index / KL Syariah Index
KL Syariah Index

v.1.0 7
For educational purpose only – Chris Gan 2009

Calculating total returns to investor

z Returns to customers’ investments come in two forms:

1) From capital gains (e.g.. Buys 10,000 units of Fund


A at RM0.50/ unit on 1 January 2007 & Sells 10,000
units of Fund A on 31 Dec 2007 at RM0.75/unit: Gain:
RM2,500, or 50% in 1 year (ignoring sales charges).
2) From income distribution which may be declared by
the Fund during the year (e.g.. Fund A paid a
distribution of RM0.02/unit during the year, on 30 June
2007:customer gains additional RM200.00 before
selling units.
Tot. return = (RM2500 + 200) / RM5,000 = 54%

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For educational purpose only – Chris Gan 2009

Higher the risk, higher potential return

z It is important to understand the risk-return


profile of your investors before the fund
selection.
z Investors risk profile can generally be
classified as: Low risk
1. Defensive
2. Conservative
3. Balanced
4. Moderately aggressive
5. Aggressive High risk

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For educational purpose only – Chris Gan 2009

Different types of unit trust

There are many different types of unit trusts now,


but in general, they can be categorized into:
z Money market & bond funds
z Balanced funds (mix of equity & bonds)
z Islamic/Shariah funds
z Equity funds – local, offshore, & thematic funds
z Capital guaranteed/ principal protected funds
z Wholesale funds – hedge funds, commodities
futures, etc.

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For educational purpose only – Chris Gan 2009

Risk rating system for funds

z The risk rating system provides a scale of 1 – 5 for the


classification of Funds.
z A risk rating of “1” reflects the funds with the lowest
risk profile while a risk rating of “5” reflects the funds
with the highest risk profile.
z Can be used with Risk Profiler.

Risk Description /
Rating Fund Categories Description
1 Structured Capital Protected / Guaranteed, close ended / Money Market Instruments
2 Income Minimum 60% bonds; Sub-class: Income, Bonds & Money Market Funds
3 Balanced Maximum 60% and Minimum 40% Equity
4 Growth / Income/ Local Minimum 70% Equity, Growth & Income Strategy with Local Mandate
5 Growth / Enhanced Minimum 70% Equity, Aggressive - Thematic, Sector, Global Mandate

Note: this is a general description of funds & assignment of risk ratings.

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For educational purpose only – Chris Gan 2009

Matching risk profile with funds

^
5
^
^
4 Equity -
H
i ngs
I r at offshore
k
G r is Equity -local
H o r’s 3
e st
In v
E
R
Balanced
R 2 fund
I n ds
Bond fund fu
S
i b le
K Money o ss
P
S 1 Capital
market
^
^ guaranteed
^
>>>>> HIGHER RETURNS POTENTIAL >>>>>

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For educational purpose only – Chris Gan 2009

Risk and return explained

z Risk is the uncertainty of whether an investment that is


made will be able to earn the expected rate of return
z Investors invest in unit trust funds to generate a return that
commensurate with the risks.
z The higher the risk of the fund, the higher the expected
returns.
z Common measure of risk is variance or standard deviation
(s.d) which measures the volatility of returns around the
mean; the higher the s.d, the higher the risk of investment.
z Example: S.d of Fund X = 2, & s.d of Fund Y = 5; hence
Fund X is less risky than Fund Y but it will most likely
generate lower returns compared to Fund Y in favorable
market conditions.

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For educational purpose only – Chris Gan 2009

Risk–return example using std deviation

OSK UOB Resources: 95% NAV Equities


Pheim Income: min 70% Bond, max 30% equities

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Let’s talk about Diversification

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For educational purpose only – Chris Gan 2009

What is diversification

z Returns from financial assets display random volatility;


and with risk being one of the main factor affecting
returns on investments, it is important that portfolio
risks be reduced through diversification.
z MPT*: it is possible to reduce portfolio risk without
giving up returns,
z By broadly diversifying into different asset classes,
which are less than perfectly correlated
z Hence, diversify across: Asset Classes, Sectors,
Regions/Countries, and Styles

* Modern Portfolio Theory: Markowitz, Modigliani & Miller, etc

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For educational purpose only – Chris Gan 2009

Diversification- across asset classes,


regions & style
Markets move in CYCLES

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Example of Diversification (Asset Class)

A Diversified
Portfolio Offers:

Portfolio with
z Lower Volatility
lower volatility &
relatively high
returns z Better
Performance in
downturn

z Minimizes risk

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For educational purpose only – Chris Gan 2009

Example of diversifying portfolio

z Objective: to provide investors who wish


to save for their children tertiary
education needs
z Focus: consistent return, with long term
capital appreciation, inflation-adjusted.
z Maturity: 15 – 20 years

Internal Distribution Only 19


For educational purpose only – Chris Gan 2009

Portfolio – expected returns & risk

z Features of funds:
z Established track record of performance
z Expected return (between 8-10% pa)
z Moderate volatility (risk)
z Capital preservation – moderate.
z Target group for this fund: 28- 40 yrs
z Suggested portfolio: HLG Bond (50%), HLG
Penny Stock (30%), HLG Dividend (20%)

Internal Distribution Only 20


For educational purpose only – Chris Gan 2009

Performance vs. Custom benchmark


KLIBOR/KLCI 50 (MP) Bond/Div/Penny_New (MP)

Percentage Growth Total Return, Tax Default, In LC


32.5

30.0

27.5

25.0

22.5

31.3
20.0
Percentage Growth

17.5

15.0

12.5

10.0
28.2

7.5

5.0

2.5

0.0

-2.5
07/2005 10/2005 01/2006 04/2006 07/2006 10/2006 01/2007 04/2007

2 Years From 31/05/2005 To 31/05/2007


User may have modif ied the original chart and axis titles provided by Lipper.

Annualized returns over 2 years (to 31 May 2007): 14.6% p.a, s.d: 1.93 (higher vs.
retirement portfolio)

Internal Distribution Only 21


Correlation between funds in portfolio

z Portfolio Correlation matrix: 2 yrs (Lipper)

allocation: Correlation Bond Dividend Penny

z HLG Bond: 50% Bond - 0.28 0.39


z HLG Dividend: 20%
z HLG Penny Stock: Dividend 0.28 -
30%
Penny Stock 0.39 0.87 -

To increase diversification benefit, aim is to add negatively


correlated assets into the portfolio
An art and a science – how many funds, % allocation etc.

Internal Distribution Only 22


For educational purpose only – Chris Gan 2009

Determining assets to include

z Low correlation between HLG Bond (conservative)


and more aggressive Dividend and Penny Stock
z Dividend and Penny Stock highly correlated 0.87
(expected); both equities, & dividend should be less
volatile. But below 1.
z HLG Bond- provides steady& consistent income
z HLG Dividend: provides some income & cap growth
(secondary).
z HLG Penny stock: aggressive fund, provides capital
growth via small caps stocks – upside “kicker”
z Over 2 yrs, annualized return = 14.6% with s.d of 1.93
(low). Sharpe = 5.64.

Internal Distribution Only 23


For educational purpose only – Chris Gan 2009

Diversification

z Aim to build an efficient portfolio


z Assume normal distribution & using expected
return, s.d, and covariance to develop.
z Combining diff. assets with diff. return/risks
z Shifting the efficient frontier – same risk but
with higher returns.
z Key: Add less than perfectly correlated assets
to portfolio.
z The only “free lunch” in finance. Same price
but more value.

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For educational purpose only – Chris Gan 2009

Efficient Portfolios

A
R •By adding new assets, with
e X B correlations less than perfect,
t the portfolio efficiency
u improves.
r •Portfolios on Curve A is more
n efficient than Curve B.
•Portfolio X = higher returns
for the same level of market
risk (beta)

Beta ß

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The building blocks of an efficient
portfolio

What are the different assets?

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For educational purpose only – Chris Gan 2009

What are stocks?

z Equity = Ownership in company


z Source of long term capital
z Equity = Assets - Liabilities
Balance sheet as at 30 June 2002
ASSETS LIABILITIES
Equity

Equity may be listed on stock exchange – hence,


market value (or price) can be determined.
Entitles to capital gains & dividends, has voting rights. 27
For educational purpose only – Chris Gan 2009

What are bonds

z Borrowings of the company (debt or i.o.u)


z Issued to raise funds:
z Short term = money market (or discount) securities; maturity <
1 year, Instrument issued at a discount to par value.
z Treasury & BNM Bills
z Banker’s Acceptance & NIDs
z Long term = bonds (or fixed income) securities; maturity > 1
year; pledge to repay a fixed amount of money with interest to
lender upon maturity.
z Corporate bonds e.g.. Gamuda, YTL
z Government bonds e.g. MGS, Sukuk

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What about derivatives?

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For educational purpose only – Chris Gan 2009

Risk profiles of bonds & stocks

z Stocks and bonds have different risk


profiles:
z Stocks represent ownership; have residual rights to
the assets of co.
z Bonds are financial obligations – like a loan, and as
such, have certain contractual rights (e.g..
Interests)
z Risk spectrum:
Risk: High Risk: Low

Stocks Warrants Bonds Cash

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What’s a Portfolio?

z A portfolio consist of more than one financial


asset; example, more than one stock or one
bond.
z Portfolios are created for diversification i.e. to
achieve the same return but taking on lower
risks.

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Stocks vs. Bonds

z Objective of buying a stock portfolio is usually


for Growth (but sometimes also for dividend
income)
z Stocks provide returns through capital appreciation
(growth) and some dividends.
z Objective of buying a bond portfolio is usually
for Income (yield)
z Bonds provide steady returns from coupon/interest &
gains from trading (buy & sell).
z By adding more stocks and bonds into respective
portfolios, there are diversification benefits.

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For educational purpose only – Chris Gan 2009

Combination of bonds & stocks

z Combining a portfolio of bonds and stocks


together, would depend on the investment
objective, constraints & guidelines.
z Growth and/or income, volatility
z What is the hurdle rate?
z 95% Bond vs. Balanced (50:50) vs.95%
Stocks, vs. Money Market fund
z Or, it can be a dynamic swing (60: 40 & 40:60)
z Or a static index or tracker fund (e.g.. KLCI
Tracker)
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Graphical illustration of risk & return
for funds

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For educational purpose only – Chris Gan 2009

1) Money market fund


PRUcash management (MF)

Percentage Growth Total Return, Tax Default, In LC


15.0

12.5

10.0
Percentage Growth

7.5

14.4
5.0

2.5

0.0

-2.5
07/2003 01/2004 07/2004 01/2005 07/2005 01/2006 07/2006 01/2007 07/2007 01/2008

1827 Days From 30/05/2003 To 30/05/2008


User may have modified the original chart and axis titles provided by Lipper.

95% of NAV invested in short term debt instruments (CPs, etc) – less
than 1 yr maturity

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For educational purpose only – Chris Gan 2009

2) Bond fund
HLG Bond (MF)

Percentage Growth Total Return, Tax Default, In LC


22.5

20.0

17.5

15.0

12.5
Percentage Growth

10.0
21.7
7.5

5.0

2.5

0.0

-2.5

-5.0
07/2003 01/2004 07/2004 01/2005 07/2005 01/2006 07/2006 01/2007 07/2007 01/2008

1827 Days From 30/05/2003 To 30/05/2008


User may have modified the original chart and axis titles provided by Lipper.

95% of NAV invested in long term debt instruments (bonds, MGS,


etc) – more than 1 yr maturity

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For educational purpose only – Chris Gan 2009

3) Balanced fund
HWANGDBS Select Balanced (MF)

Percentage Growth Total Return, Tax Default, In LC


80

70

60

50
Percentage Growth

40
61.1
30

20

10

-10
01/2004 07/2004 01/2005 07/2005 01/2006 07/2006 01/2007 07/2007 01/2008

1768 Days From 28/07/2003 To 30/05/2008


User may have modified the original chart and axis titles provided by Lipper.

Max 60% of NAV to Bonds, allocation to local equities (max 40%).

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For educational purpose only – Chris Gan 2009

4) Equity fund
HLG Penny Stock (MF)

Percentage Growth Total Return, Tax Default, In LC


110

100

90

80

70
Percentage Growth

60

50 80.3

40

30

20

10

-10
07/2003 01/2004 07/2004 01/2005 07/2005 01/2006 07/2006 01/2007 07/2007 01/2008

1827 Days From 30/05/2003 To 30/05/2008


User may have modified the original chart and axis titles provided by Lipper.

Minimum 30% of NAV into equity, smaller cap stocks, disc to NTA.

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For educational purpose only – Chris Gan 2009

Combining 2 portfolios

z We can also combine 2 or more portfolios


z Example: 2 portfolios.
z Portfolio A: consists of different stocks. ER = 12%,
s.d = 7%
z Portfolio B: consists of different bonds. ER = 5%,
s.d.= 3%
z (ER = expected returns, s.d.= std deviation)
z But let’s take a 60: 40, static, balanced portfolio
(Portfolio A: Portfolio B)
z Assume that the risk profile of individual investors are
the same.

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For educational purpose only – Chris Gan 2009

Returns & risk of portfolios

z Portfolio Returns: ERp = (12% x 0.6) + (5% x 0.4) = 7.2


+ 2% = 9.2%
z Portfolio Risk: s.d (stocks) = 7% , & s.d (bonds) = 3%
but the sd (portfolio) is not 5.4% (i.e. (0. 6 x 7%) +
(0.4 x 3%))
z S.dp should be lower than 5.4% due to less than
perfect correlation between bonds and stocks.
z Assume correlation between stocks & bonds = 0.27
z If stocks go up/down by 1%, then bonds should go
up/down by only 0.27%

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For educational purpose only – Chris Gan 2009

Correlations

z Hence, s.dp = 4.5%* which is lower than 5.4%


z Lower than s.d for stocks alone of 7%,
z The magic is less than perfect correlation,
between bonds & stocks.
z Diversification: the only “free lunch” in
investments.
z Getting higher returns for taking on same level of
risks.
z Basis of Modern portfolio theory (MPT)

* Sd2 = (0.62 x 0.072) + (0.42 x 0.032) +[ 2 x (0.4 x 0.6) x 0.07 x 0.03 x 0.27] 41
For educational purpose only – Chris Gan 2009

These are the formulaes…if you are


interested in the details

42
Diversifying: asset classes, sectors,
regions/countries, & styles

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For educational purpose only – Chris Gan 2009

1- Asset classes

z Traditional assets: Fixed income (bonds),


equity, & cash (FD)
z Alternative assets: Private equity, hedge
funds, real estate investment trusts (REITs),
ETF, ELN, structured products & managed
futures.
z Commodities; Agriculture, metals (softs &
industrial), & energy.
z Others: Currencies, & real property.

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For educational purpose only – Chris Gan 2009

2 - Sectors

z Sector rotation strategy: generally used by


managers to invest in domestic equities.
z Position portfolio to take advantage of next
market movement.
z Over or under-weight (vs. benchmark) certain
sectors/industries in response to next phase of
business cycle.
z Example: HLG Sectorial Fund

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For educational purpose only – Chris Gan 2009

Stock market & economic cycle

Sector Rotation Strategy Peak

Basic industries

Trough Consumer staples


Capital goods

Economic cycle
Position portfolios in
Financial stocks
sectors likely to benefit
Consumer durables from next market
movement & economic
cycle.

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For educational purpose only – Chris Gan 2009

Sector Performance - US

z Performance of US
sectors, represented by
Exchange Traded Funds
(ETFs)
z ETF =Listed funds which
tracks performance of
specific industries
z ETF are traded on
exchange like stocks

As at 23 Dec 2007

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For educational purpose only – Chris Gan 2009

3- Regions/Countries

z Stock markets volatility worldwide – reason for


international investing
z All countries experience economic downturns but not
simultaneously (hence, global recession)

Source; World Bank Dev. Indicators


z Investing in different countries reduces impact of
downturn on portfolio (via diversification).

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For educational purpose only – Chris Gan 2009

Stock market correlations

•Markets are not perfectly correlated with each other,


hence, benefits from diversification.
•DJIA & S&P 500 are closely correlated (0.96) but is
lowly correlated with Emerging Markets (0.16)
•DJIA & Nikkei are slightly negative correlated (-0.08)

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For educational purpose only – Chris Gan 2009

Investing styles

z Style investing:
z Asset allocation decision is guided by the investors investment philosophy
(generally determined by the investor’s belief).
z Active vs. Passive:
z Active investors believe in their ability to outperform the overall market by
picking stocks they believe may perform well.
z Passive investors simply invest in a market index fund that may produce
potentially higher long-term results.
z Large caps vs. Small caps:
z Uses size of the company (market capitalization) as basis for investing.
S&P500 index consists of large cap stocks in the US, while the Russell 2000
is an index for small cap stocks.
z Growth vs. Value:
z Most equity fund managers tend to follow one of two general approaches to
stock selection: growth or value. Core manager combines elements of both
approaches.

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For educational purpose only – Chris Gan 2009

Styles (and methods)

z Growth vs. Value Investing


CORE
Relative value
GARP*

Growth Value

•GROWTH investing: strategy to seek out stocks with higher rate


of return vs. other stocks in market with same risks. Normally
associated with companies with high earnings growth.
•VALUE investing: strategy to invest in undervalued stocks. When to
BUY? When: “Value” > “Price” of stock. When to SELL? When:
“Value” < “Price” of stock. (*Price is what you pay & Value is what you
get). Value is determined through rigorous research & fundamental
valuation process.

* Growth at Reasonable Price (GARP), a hybrid strategy


pioneered by Peter Lynch, of Fidelity 51
Let’s talk about Asset Allocation
Strategies & Managing Portfolios

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For educational purpose only – Chris Gan 2009

What’s Asset Allocation?

z Process of deciding how to Asset Allocation

distribute investors’ wealth Market t iming


2% Ot hers

among diff. countries & Securit y select ion


5%
2%

asset classes for


investment purposes.
z Key to long term portfolio
performance.
z Approximately 90% of
success depends on asset
allocation, only 10% on
security selection.
Asset Allocat ion
91%

Reference: Financial Analyst Journal, May-June 1991

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For educational purpose only – Chris Gan 2009

Example: Global Resources Portfolio

Sector
Performance allocation

Asset class:
Country - Global equities,
-- Natural Resources
Allocation stocks,

Stock
selection

HLG Global Resources Income Fund: 50% Newgate Global Resources + 50% local bonds 54
For educational purpose only – Chris Gan 2009

Asset Allocation: Strategies

z Process of deciding how to distribute an


investor’s wealth among different countries
and asset classes for investment purposes.
z A disciplined approach ensures success
z Largest exposure to risky asset gives highest
compounded returns over long term.
z Four (4) strategies: Integrated, Tactical asset
allocation, Strategic asset allocation & Insured.

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For educational purpose only – Chris Gan 2009

Integrated asset allocation

z Separately examines: market conditions &


investor’s objectives and constraints.
z Factors: inputs into optimizer (to derive
efficient frontier); determines portfolio asset
mix that best meets investors needs given
market conditions.
z An iterative process (repeated over & over
again)
z Done by private banks for UHNWI.

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For educational purpose only – Chris Gan 2009

Tactical asset allocation (TAA)

z Portfolio management strategy where manager


attempts to generate active value-added returns
(alpha) solely through allocation decisions.
z Instead of picking superior stocks, TAA managers
adjust asset class exposure based on changes in
relative valuation of asset classes.
z Shifts between Cash, Stocks and Bonds.
z Between large caps and small caps in practice
z Dependent on market timing skills

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For educational purpose only – Chris Gan 2009

Example of TAA

Model portfolio as
recommended by Citi’s
Global Investment
Committee, April 2008.

Conservative
2% cash
73% fixed income / bonds
25% equities

Aggressive
2% cash
0% fixed income / bonds
98% equities

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For educational purpose only – Chris Gan 2009

Strategic asset allocation

z Used to determine long term policy asset


weights in a portfolio
z LT asset average returns, risk & covariance
used to estimate future results.
z Efficient frontiers generated based on
historical data & investor decides which is
appropriate for the planning horizon
z Results in constant mix asset allocation with
periodic rebalancing to adj. portfolio to specific
asset weights

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For educational purpose only – Chris Gan 2009

Example of strategic asset allocation

z Balanced portfolio: 50/50%, Equity: Bond.


z Equity increases 10% while bonds fall 10% in
value, mix now: 55/45%.
z To adjust back to desired level: sell some
equity, and use proceeds to buy bonds.
z In the long term, this should generate superior
returns that can meet investor’s investment
objectives.
z Used by majority of portfolio managers.

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For educational purpose only – Chris Gan 2009

To aid Strategic Asset Allocation

Investment outlook, by Citi’s


Global Investment
Committee.

Global asset class weighting


-Equities – partial overweight
-Fixed income – Partial
underweight
-Cash – neutral
-Hedge funds – neutral

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For educational purpose only – Chris Gan 2009

Insured asset allocation

z Assumes expected market returns & risk are


constant over time; while investors objectives
& constraints changes as wealth changes.
z As wealth increases, investors can take more
risk Æ increase exposure to risky asset & vice
versa.
z Results in continual adjustments in portfolio
allocation.
z Normally allocation between equities & cash.

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For educational purpose only – Chris Gan 2009

Selecting asset allocation strategy

z Depends on perception of variability in


investor’s objectives & constraints. And
on relationship between past & future
market conditions.

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For educational purpose only – Chris Gan 2009

Selecting asset allocation strategy.. cont

z Market conditions z Investor’s objectives &


relatively constant over constraints, risks
time: relatively constant over
z Strategic or time:
z Insured asset z Tactical or
allocation z Strategic asset
allocation

If both market conditions & investor’s objectives, constraints &


risk are variable; must be constantly monitored Æ Integrated
asset allocation

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For educational purpose only – Chris Gan 2009

Strategies to manage portfolios


Once portfolio created, you need a strategy to manage & to rebalance:

z Wing-It
z Most common – no plan or structure
z “A little bit of this” and “A little bit of that”
z Least success: no consistency
z Market Timing
z Ability to get in and out of market/assets at the right time
z Aim to buy low and sell high but in reality, it’s buy high and
sell low
z No one can predict (or market time) consistently.

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For educational purpose only – Chris Gan 2009

Strategies to manage portfolios -2

z Buy & Hold


z Most commonly advocated
z Statistically: markets up 75% & down 25% of time
z Make money 75% of the time?
z Easy to employ (not necessary better or worse)
z Rebalancing
z In between market timing and Buy & Hold
z Make adjustments to mix from time to time

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For educational purpose only – Chris Gan 2009

Rebalancing…

z Is counter intuitive
z Sell some funds that have performed well & buy some of
funds underperformed.
z In investing, everything goes in cycles.
z Example:
z Initial allocation: Invest RM25k into each Fund A, B, C & D
(25% each)
z After 1 year, the weighting changes as some funds performed
better than others.

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For educational purpose only – Chris Gan 2009

Rebalancing .. cont

Returns after 1 year

Fund Return (%) End Bal, Allocation (%)


1-year RM
A 13.6 28,400 26.28

B 6.8 26,700 24.71

C 8.5 27,125 25.10

D 3.4 25,850 23.92

108,075 100

Initial allocation is 25% each

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For educational purpose only – Chris Gan 2009

Rebalancing…Returns

z Although, portfolio return is 8% after 1 year, inclined to


sell Fund D.
z Underperformed - 1-yr return 3.4%
z Buy more of Fund A?
z 1-yr return of 13.60%
z Buy low, sell high? – sell A, and buy D
z Rebalance fund every year
z Key is discipline. And, have a Plan.

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For educational purpose only – Chris Gan 2009

Rebalancing .. Risk Adjusted Returns

Adding risks to the return equation

Fund Return (%) Risk (s.d) Risk Adj.


1 year % Return (RAR)
A 13.6 14.0 0.97 (4)

B 6.8 5.0 1.36 (1)

C 8.5 7.0 1.21 (2)

D 3.4 3.0 1.13 (3)

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For educational purpose only – Chris Gan 2009

Risk Adjusted Returns

z Amount of risk taken per dollar of returns


generated
z Risk Adj. Return (RAR)= Returns / s.d
z S.d = measure of risk (also called volatility of
returns)
z RAR is a relative measure (not absolute); rank
the RAR relative to each other.
z On a returns basis: Fund D underperformed
Fund A ( 3.4% vs. 13.6%)

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For educational purpose only – Chris Gan 2009

Risk Adjusted Returns - 2

z But, on a Risk adjusted basis: Fund D


performed better vs. Fund A ( RAR of 1.13 vs.
0.97) -- relative
z Important to take Risk into account when
evaluating portfolio returns (not just returns)
z Buy Fund D and sell Fund A,
z Fund B – buy some, Fund C – Hold.

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Working example

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For educational purpose only – Chris Gan 2009

Portfolio rebalancing

z You have allocated, RM20k to each of the 5 selected


funds.
z After one year, you are planning to rebalance your
portfolio.
z Given the expected returns (on next slide), calculate
the risk adjusted returns.
z S.d. for the funds are as follows: fund A(15%), B (7%),
C (5%), D (7%) & E (15%)
z Finally decide on which funds to sell, buy & hold. And
give reasons why.

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For educational purpose only – Chris Gan 2009

Expected returns & risk

Fund Return (%) End Bal, Allocation (%) s.d (%)


1-year RM
A 15 23,000 20.3 15
B 10 22,000 19.4 7
C 8.5 21,700 19.1 5
D 4.3 20,860 18.4 7
E 29.0 25,800 22.8 15
113,360

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For educational purpose only – Chris Gan 2009

Suggested approach

Initial RM20,000

Fund Return RM % Risk RADR Rank Remarks

A 15.0% $ 23,000.00 20.3% 15% 1.00 4

B 10.0% $ 22,000.00 19.4% 7% 1.43 3

C 8.5% $ 21,700.00 19.1% 5% 1.70 2

D 4.3% $ 20,860.00 18.4% 7% 0.61 5

E 29.0% $ 25,800.00 22.8% 15% 1.93 1

$113,360.00

•Decide which fund to buy & which to sell. Buy E and Sell D.
•No right or wrong answer. Subjective.
•Based on the above results & on RAR, this is the approach to take,
•More importantly: whether the fund performance is consistent with
mandate of fund.
•Depends on the overall objective of the portfolio & investors.
•Or you can rebalance based on target weights. To get back to 20%
each.

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End

Q&A

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