©2013, College for Financial Planning, all rights reserved. Module 9 Asset Management &...

©2013, College for Financial Planning, all rights reserved.

Module 9Asset Management & Investment Strategy During Retirement

Chartered Retirement Planning CounselorSM Professional Designation Program

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

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.

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Questions to Get Us Warmed Up

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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

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.

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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

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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

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 optimizereturns for any given level of risk.

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Risk & Return 1926-2012

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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.

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Asset Allocation Considerations

• Importance of time horizon• Portfolio mix will change over time • Longevity risk

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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.

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-10

-5

0

5

10

15

20

25

1 3 5 7 9 11 13 15 17 19 21 23

Return

Years

Real EstateForeign Stock

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:

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Practicing Asset Allocation

• Which asset classes should become part of the client’s portfolio?

• What weights should be assigned to each asset category?

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Three Approaches to Asset Allocation

• Strategic• Tactical• Core-satellite

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Professionally Managed Funds

• Target retirement funds• Balanced mutual funds• Managed (separate) account

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Asset Classes

• Common stocks• Fixed-income securities• Cash equivalents• Real estate

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Fixed Income

• Maturity• Credit Rating• Yield – Current Yield, Yield-to-Call (YTC)

and Yield-to-Maturity (YTM)• TIPS• Cash Equivalents

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Real Estate

• Rental homes• Reverse mortgage• Real estate limited partnerships (RELPs)• Real estate investment trusts (REITs)

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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.

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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.

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Three Approaches to Asset Allocation

• Strategic• Tactical• Core-satellite

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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

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risk icunsystemat risk systematic risk Total

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.

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ββ

Systematic & Unsystematic Risk

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Risk-Adjusted Returns

• Sharpe index: (Rs –Rf) / SD• Treynor index: (Rs –Rf) / beta• Jensen index: Rp - [Rf + (Rm – Rf)ß]

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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.

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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.

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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

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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)

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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

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.

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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)

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value.maturity the of value present the

stream income interest the of value present the value bondA

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.

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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. $1,050.62b. $5,779.16c. $9,509.99d. $10,506.23

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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.

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Question 4

Growth stocks are characterized bya. high market-to-book ratios.b. low market-to-book ratios.c. low P/E ratios.d. both b and c.

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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. .39b. 6.36c. 11d. 15

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©2013, College for Financial Planning, all rights reserved.

Module 9End of Slides

Chartered Retirement Planning CounselorSM Professional Designation Program