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Building Portfolios

with Stocks, Bonds, and Mutual


Funds
Financial & Retirement Planning

Jay Taparia, CFA


Managing Director, Sanskar Investments, Inc.
Lecturer of Finance, University of Illinois @ Chicago

1
The Client Is A Human Being
& Is Capable Of Having…
 Emotion attached to wealth…
 Goals (if…) that are ST, MT or LT
 A limited life span…
 Uncertainty about the future…
 Irrationality associated with decision-making…
 A gambling attitude toward the markets… over-
confidence
 Dreams that could be impossible to reach…
 Dreams that are very possible to reach…
 An aversion toward risk… whatever that may be
 Annoying you at times…
 And don’t forget that… Life Happens

2
Because Of This…
 Building portfolios is not only a science, but it is
an art

 Having a nice irrelevant conversation with the


client is necessary to build a relationship, but
also to discover new “needs” and “objectives”

 Client needs & objectives change over time


(years even days)

 Portfolios are managed with continuously changing


objectives

3
Individual Investor Life Cycle
Spending Phase
Accumulation
Gifting Phase
Consolidation
Long-term:
Retirement, Long-term:
Children’s Retirement Long-term:
college Estate Planning
Short-term:
Short-term: Vacations, Short-term:
House, Car Children’s College Lifestyle Needs,
Gifts

25 35 Phases
45 are Shifting
55 65 75
Age

4
Portfolio Management Process
 State the Objective – Mission statement of the portfolio,
who and what it serves and why: income, and/or capital
appreciation.
 Identify the Constraints – there are always going to be
constraints: taxes, legal, emotions, etc.
 Formulate the Investment Policy – develop the
“business plan” of the portfolio listing out return, risk and
all the other issues associated with the portfolio
 Study Market and Economic Conditions to forecast
future trends – This is everything that you learned in
Economic, Industry, Financial Statements, etc.
 Monitor Performance – keep in touch with what is going
on in the portfolio, and…
 Reevaluate & Modify the Portfolio – rebalance and/or
reconfigure according to the policy and markets

5
Role of the Portfolio Manager
 Bottom Line? You need someone to manage the whole
process of investing –
 Minimizing individual security risk (company, industry, or
unsystematic risk)
 Making sure that the portfolio is well-diversified among
industry, country and company
 Managing the tax consequences of the portfolio – esp. for
expensive people
 Most importantly, making sure the portfolio caters to the
client needs via an Investment Policy Statement –
 Return – capital gain vs.income
 Risk Tolerance – varies typically according to age
 Tax Issues – maximizing after-tax returns
 Time – retirement, college payments
 Liquidity – usually driven by time needs
 Legal Issues – trust and pensions have special legal issues
 Other Unique Needs of the client

6
Realistic Investor Goals
 Current income
 generate spendable funds

 Capital preservation
 minimize risk of real loss

 strongly risk-averse or cash needs are soon

 Capital appreciation
 capital gains for real growth for future needs

 growth strategy with accepted risk

 Total Return
 Capital Gains & Income

 Desire to have “medium” risk exposure

7
What Is Asset Allocation?

Asset allocation is the process of


combining asset classes such
as stocks, bonds, and cash in a Stocks Bonds
portfolio in order to meet
your goals.

Cash
The Need For Asset Allocation
 An investment strategy is based on four decisions
 What asset classes to consider for investment

 What normal or policy weights to assign to each eligible class

 The allowable allocation ranges based on policy weights

 What specific securities to purchase for the portfolio to satisfy

the strategy

 90+% of the overall investment return is due to the first


two decisions, not the selection of individual investments
(BHB 1991)
 70% of the overall investment return is due to style
(Sharpe 1992)

9
Is Asset Allocation Important?
Contributing Factors of Portfolio Performance

Asset Allocation Policy


91.5%

Asset Allocation Policy +


93.3% Market Timing

Asset Allocation Policy +


97.9% Market Timing + Security
Selection

Asset Allocation Policy +


100% Market Timing + Security
Selection + Other

0 20 40 60 80 100
Percent
Returns & Risk Of Different Asset
Classes
 Higher returns should compensate for risk

 Policy statements must provide risk guidelines


 Measuring risk by standard deviation of returns over

time indicates stocks are more risky than T-bills


 Measuring risk by probability of not meeting your

investment return objective indicates risk of equities is


small and risk of T-bills is large because of different
expected returns
 Focusing only on return variability ignores

reinvestment risk and many other types of risk

11
Historical
Asset Performances: A Guide

12
Asset Class Returns
Highs and Lows: 1926 - 1999
Highest Annual Return
150% 142.9%
Lowest Annual Return
Average Return
100%

54.0%
50% 40.4%
29.1%
14.7%
0% 12.6% 11.3% 5.1% 5.2% 3.8%
-5.1% 0.0%
-9.2%
-50%
-43.3%
-58.0%
-100% Small Large Long-Term Int.-Term Treasury
Company Company Government Government Bills
Stocks Stocks Bonds Bonds

Each bar shows the range of annual total returns for each asset class over the period 1926-1999.
Diversify
To Reduce Risk Or Increase Return
Fixed Income Portfolio

Cash 1970 - 1999


10%

Lower Risk Portfolio Higher Return Portfolio

Bonds
Stocks 90% Cash
12% 20% Stocks
Cash
35% 39%
Return 9.0%
Risk 8.5% Bonds
Bonds
53% 41%

Return 9.0% Return 10.9%


Risk 6.1% Risk 8.5%

Risk is measured by standard deviation. Risk and return are based on annual data over the
period 1970-1999. Portfolios presented are based on Modern Portfolio Theory.
Return Before & After Inflation
15%

1926 - 1999
Compound Annual Return

11.3%

10%
8.0%

5.1%
5%
3.8%
2.0%
0.7%
0%
Stocks Stocks Bonds Bonds Cash Cash
after after after
Inflation Inflation Inflation
Assumes reinvestment of income and no transaction costs or taxes.
Monitor Performance
 Revise IPS as needed

 Modify investment strategy accordingly

 Evaluate portfolio performance not only


with market return or benchmark portfolio

 Consider that relative performance will


mean little when relative progress is on
track

16
Reevaluate & Modify Portfolio
 Asset Allocation – has fixed income/equity balance
changed from the design
 Style Under/Over-weights – is the portfolio tilted in
style?
 Industry Selection – based on the economic environment
what might the best sectors be, or is the portfolio weighted
too much in any 1 sector (i.e. 25%)?
 Security Concentrations – usually anything greater than
10% of the portfolio must be reduced in size
 Security Selection – sell stocks that have poor
fundamental issues in the future – and buy those that have
positive changes ahead.
 Key point – LT focus – not ST turnarounds. Why? Tax
constraints.  

17
Understanding How Stocks
Work

18
What is a Stock?
 Legal ownership in a company through
“shares” – purchase of stock implies you
own a “slice” or “share” of the company

 Stockholders have 1st right to purchase new


shares issued by the company – gives them
right to maintain % share of ownership

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4 Characteristics of Stocks
 Voting Power - Ownership implies “control”
having the right to appoint Board of Directors, who
in turn, elect management

 Residual Claim – you are last on the food chain to


collect your investment if the company goes
bankrupt

 Limited Liability – can only lose the investment


you make into the company – not more than that

 Stock Market Listing – stocks are traded


between buyers and sellers in stock exchange

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Return & Risk of Stocks
 Two Ways to Earn a Return on a Stock
 Appreciation in Stock Price – if the investors
perceive strong growth in the company’s sales
& earnings, then investors will demand to buy
more of the stock. As demand increases, the
price of the stock increases.
 Dividend Payment – if the company pays
dividends

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Caveats of Stock Ownership
 No Guarantee of Return – you can lose your investment

 % Ownership Can Be Small – you are just 1 of many


owners – you have some, but not a whole lot of influence

 Mergers & Acquisitions – other companies can offer to


“buy your share out” and replace your shares with theirs

 Voting Proxy Statements - investors should take an active


role in voting for directors and management – they are
“owners”

22
Conceptualizing Financial
Statements
 Financial statements are guided by a set of
accounting rules, called GAAP (Generally
Accepted Accounting Principles).

 Because of flexibility, financial statements


can be manipulated to give a “better-than-
expected” view of earnings.

 Ratio Analysis & Footnotes is one of the key


tools to understanding a company.

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Conceptualizing Companies
 Companies are dynamic, financial statements are static
 One date of release: summary of 3, 6, 9 or 12-month activity

 Lagged: released approximately one month after quarter- or

year-end
 Past-tense: information possibly already incorporated into the

stock price (barring any major surprises)

 Dynamic forces on companies are qualitative


 The economic cycle

 Industry analysis

 Management strategy

24
Conceptualizing the 3 Financial
Statements
 Think of analyzing your own finances…

 Financial analysis of companies is similar to


personal financial planning
 Your balance sheet = a loan application

 Income statement = your tax return

 Cash & cash flow statement = Your checking

account and salary


 Footnotes to financial statements =how

you would explain what the numbers really


mean to an IRS auditor or loan agent

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Balance Sheet Income Statement Statement of Cash Flows
(or ... what have you got?) (or ... what do you tell the Government you made?) (or ... what REALLY happened this year)

Assets
Current assets Cash flows from operations
Cash and temporary investments Sales
Income from operations
Accounts receivable - Cost of sales (including depreciation Net income (Profits)
Inventory expense)
+ Depreciation
Prepaid expenses
+ Restructuring charge not spent
Total current assets = Gross profit on sales - or + Gains or losses
Long-term assets + or - Deferred income taxes
- Selling and administrative expenses
Property, plant and equipment - Restructuring expense Cash provided by (used for) working capital
Less: Depreciation + or - Accounts receivable
+/-Gains or losses
Net property, plant, and equipment + or - Inventory
Deferred tax assets = Net Operating Income + or - Accounts Payable
Intangible assets and goodwill = Net cash provided by operating
+ Other revenues
Total long-term assets activities (Cash Flows From
- Other expenses Operations)(CFFO or CFO)
Total assets
= Earnings before tax
- Income tax expense Cash from investing activities
Liabilities + Owners' Equity + Sale of assets
= Net income (Profits)
- Purchase of assets
Current liabilities
Accounts payable
Taxes Payable = Net cash provided by investing
Short-term notes payable activities
Current portion of long term debt - Dividends on preferred stock
Total current liabilities = Net income available to
Cash from financing activities
Long-term liabilities common stock
Long-term debt less current portion - Dividends on common stock + Issue of debt
Deferred tax liability - Retirement of debt
Total long-term liabilities = Net income transferred to + Sale of common stock
surplus or retained earnings
Owners' equity - Dividends paid
Common stock par
Capital surplus = Net cash provided by financing
Retained earnings activities
Less treasury stock at cost
Total owners' equity
The sum of the last line in each box
Total liabilities + Owners' equity above = the change in cash balances
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Public Filings You Need to
Know
 Form 10-K (due 90 days after fiscal year
close)
 Income statement (aka Statement of

Operations)
 Balance Sheet

 Cash Flow Statement

 Footnotes to the Financial Statements

 Management Discussion and Analysis

 Auditor’s Report

 Liquidity Position and Capital Expenditures

27
Stock Market Indices (i.e.,
Indexes)
 Price-Weighted Index - each company represented by 1
share in index. Gives higher-priced shares more weight in
determining performance of the index (e.g., Dow Jones
Industrial Average)

 Market Value-Weighted Index - weight of companies in


index based on its market capitalization (stock price x #
shares outstanding) – the higher the market value, the
higher the weight in the index (e.g., S&P 500, NASDAQ)

 Comparing your portfolio’s performance to the


“market” depends on which index you are using and
whether you are really comparing “apples to apples”
or “ apples to oranges”

28
Costs of Investing
 Commissions – Costs from the broker to
implement trades one-way – must remember that
you incur the cost when selling also

 Bid-Ask Spread – brokers who “make a market”


in the stock make the spread as their profit (or
your cost)

 Market Impact Costs - if you are institutional


(mutual or pension fund), your purchases/sales
are large enough to move the stock price against
you while buying or selling

29
Buying Stock on Margin
 Definition - Borrowing Funds to Buy Stock - initially up to 50% of
the equity purchase – called the Initial Margin Requirement

 After the Purchase - must maintain at least 30% equity of the


total account value – called the Maintenance Margin Requirement –
to guard against default

 Primary Objective - Usually done to make higher returns on your


equity via “using someone else’s funds” – but can also lose more than if
you did not borrow the funds

 High Risk Strategy – only meant in cases where client has high
amounts of liquidity (cash reserves) or has the risk tolerance (i.e., loves
risk and has nerves of steel)

30
Buying Stock on Margin
 Example of Margin Trading
 $10,000 of GE desired to be purchased with

$5,000 personal funds and a $5,000 Margin


Loan from broker
 GE’s stock price is $50 per share = # of shares

= 200
Ending Ending Loan Net Maint. Rate of % Chg
 Interest Rate on Loan is 10%
Price Value Value Equity Margin Return Price
$80 16,000 5,000 11,000 68.75% 110% 60%
$50 10,000 5,000 5,000 50.00% -10% 0%
$30 6,000 5,000 1,000 16.67% -90% -40%

Bottom Line?
Margin increases gain and loss returns substantially!
31
Short Selling
 Definition – Instead of “Buying Low 1st, And Selling
High 2nd,” you are doing this in reverse (Selling High,
Buying Low) - You do this, when you think the stock
price is overvalued and you decided to “short” or sell
first, in expectation that the stock is going to fall

 High Risk Strategy – only meant in cases where


client has high amounts of liquidity (cash reserves) or
has the risk tolerance (i.e., loves risk and has nerves
of steel)

32
Procedure to Short Selling
 Borrow the Stock from Broker – as if you were
taking a loan
 Sell the Stock in the Market – collecting the
proceeds
 When Stock Price Declines – buy the stock back at
lower price
 Return the Stock to the Broker – keep leftover
funds as profit
 Similar Margin Requirements – as in Margin
Trading

33
Basics on Portfolio
Management
 Always make sure that your portfolio is
diversified – not just 8-10 securities, but 20-30
minimum – across industries and countries

 Caveat emptor – there are 7,000 stocks and 10,000


mutual funds at a minimum to choose from in the USA
– should you be picky about what you buy? YES!!

 Be “street smart” – make sure that what you are


buying makes sense and you know the reasons why
you are buying it – not just a “hot stock tip” – in other
words, squeeze the tomatoes

34
Basics on Portfolio
Management
 Make sure your portfolio does not become too
concentrated in 1 name or 1 sector. Be receptive
to sell if any 1 stock becomes greater than 10% of the
portfolio – it may drive future performance, including
downward

 Just because you made good money on 1 stock


or sector, please be aware that you might get
“emotionally attached” to it – but keep in mind,
stocks and money never were born with a “heart”

35
Understanding How Bonds
Work

36
Definition of a Bond
 Contractual loan that pays interest over a fixed term
 Upon its maturity, the principal or the investment
amount is returned to the lender of the bond
 Interest rate (called Coupon Rate) is typically fixed –
hence, the alternative name for bonds as “fixed income”
securities
 An Income-Based Investment – focus on generating
income and less so on capital appreciation <> stocks
 Bond Contract is called an Indenture Agreement – which
has all of the structure details about the bond and
disclosures about the company issuing the bonds
 Usually denominated in $1,000 units – $50,000 in Bonds
= 50 Bonds

37
Bond Classifications
 Registered vs. Bearer Forms
 Security
 Collateral – secured by financial securities

 Mortgage – secured by real property, normally

land or buildings
 Debentures – unsecured

 Notes – unsecured debt with original maturity

less than 10 years


 Seniority

38
Major Classes of Bonds
 U.S. Treasury Bonds – issued by the U.S.
Government and considered the safest type of bond

 Corporate Bonds – issued by corporations to fund


their projects and assets – carry higher risk than the
U.S. Treasury bonds due to high risk of default (or non-
payment of interest and/or principal)

 Municipal Bonds – issued by cities, counties, quasi-


government agencies (like the Illinois State Tollway)
and states to fund projects and general municipal
funding.

39
Major Classes of Bonds
 Foreign Bonds – issued by foreign governments as well as
foreign corporations – can be denominated either in US
Dollars or in foreign currency – considered to have multiple
layers of risk, both in terms of the foreign entities
willingness to pay as well as in currency risk terms

 Securitized Certificates – issued by taking a group of


assets such as mortgages, auto loans or credit cards and
packaging them for issuance as a security. Considered to
have higher quality than a single asset due to
diversification. Cash flow is usually less predictable and
dependent on changing levels of interest rates

40
Key Characteristics of Bonds
 Par Value – stated value of a bond – usually $1000 par value per
bond. $50,000 par is = to 50 bonds to buy.
 Coupon Interest Rate – the amount that is paid each period to a
bondholder by the issuer. Rate is usually quoted as an annual rate,
but payments are made usually semi-annually.
 Coupon Payment = Coupon Interest Rate x Par Value
 Maturity Date – when the bond matures – principal and last coupon
payment paid on this day.
 Price (Market Value) – what the value of the bond is worth. Better
yet, what the market is valuing this Annuity Stream.

41
Bond Value ($)
1,372 kd = 7%.
1,211

kd = 10%. M
1,000

837
775 kd = 13%.

30 25 20 15 10 5 0
Years remaining to Maturity
Bond Risks
 Default Risk – Risk that you are not going to get your original
principal back due to the company going bankrupt.

 Interest Rate Risk – as interest rates rise, the price (and


value) of the bond falls. Capital Loss!!

 Reinvestment Rate Risk – has to do with the reinvestment


of interest and principal payments.
 Interest Payments – what do you do with the interest
payments (beside spend it) – if rates decline, your return is
lower as you reinvest these at a lower rate.
 Principal Payments – what do you do when you get your
money (principal) back – if rates decline, your principal gets
reinvested at a lower rate.
 Keep in mind that Callable Bonds also have
reinvestment rate risk. The company will only call the
bonds when rates decline. You have both interest and
principal payment reinvestment rate risk.

43
What is Interest Rate Risk?
Also, called Price Risk…

Interest rate risk: Rising kd causes bond’s price to


fall. Which bond has more risk? 1-year or 10-
year?

kd 1-year Change 10-year Change


5% $1,048 $1,386
+4.8% +38.6%
10% 1,000 1,000
-4.4% -25.1%
15% 956 749
Prices and Yield / Interest
Rates

Price

Yield

45
Default Risk Premium (Credit
Risk)

Investment Grade Junk Bonds

Moody’s Aaa Aa A Baa Ba B Caa C

S&P AAA AA A BBB BB B CCC D

46
Corporate Bond Spreads – AA
& BB
10

4
4-96

7-96

1-97

4 -97

7-97

1-98

4 -98

7-98

1-99

4-99

7 -99

1-00

4-00

7 -00

1-01
10-9

10-9

10-9

10-9

10-0
7
6

0
10-YR US Treasury AA Corporate Rate BBB Corporate Rate

47
Benefits of Bonds in Portfolios
 Historically Lower Risk

 Diversification Benefits

 Income Generation

 Expand Efficient Opportunities

 Potential Growth

48
Fixed Income Maturity (Interest
Rate) Risk
1970 - 1999 Long-Term
15% Gov’t Bond
Intermediate-Term 9.8%
10% Gov’t Bond
5.9%
Short-Term
5% Gov’t Bond
1.5%

0%

-1.3%
-5%
-4.5%

-10% -8.7%
Average Rise in Price during Declining Interest Rate Periods
Average Decline in Price during Rising Interest Rate Periods
49
Using Bonds to Diversify
1970 - 1999
Original Portfolio Lower Risk Portfolio

Cash
19%
Stocks Stocks
50% 38%
Cash
50% Bonds
43%

Return 10.8% Return 10.8%


Risk 8.0% Risk 7.6%

Risk is measured by standard deviation.


Risk and return are based on annual data over the period 1970-1999.
Portfolios presented are based on Modern Portfolio Theory.
Bonds Produce Greater Income
1970 - Capital Appreciation
1999 Income
2% Reinvestment of Income

6%
9%
25%

73% 85%

Stocks Bonds
Based on annual data over the period 1970-1999.
Bond Prices & Yields Over Time
When Yields Increase, Bond Prices Decrease
$1.60 Bond Prices ($) 16%
Bond Yields (%)
$1.40 14%

$1.20 12%

$1.00 10%

$.80 8%

$.60 6%

$.40 4%

$.20 2%

$0 0%
1925 1935 1945 1955 1965 1975 1985 1999
52
Understanding
How Mutual Funds Work

53
Definition of an Investment
Company
 Financial intermediaries (i.e., middlemen) that collect funds from
individual investors and invest those funds in a diversified pool of stocks,
bonds, or other assets based on the company’s focus or specialty. (i.e., a
bond fund, an international fund)

 Benefits to the Individual Investor –


 Recordkeeping & Administration – for all holdings in the fund

 Diversification & Divisibility – if the investor has a small amount of

money they can have instant ownership of many stocks, not just one.
They can also easily buy more (in increments of $, not 100 share blocks)
 Professional Management – this is of course relative – you must do

you homework on management – but it does beat doing the research


yourself
 Lower Transaction Costs – due to pooling of funds, commissions, fees,

and market impact costs are lower

54
Types of Investment
Companies
 Managed Investment Companies (mutual funds)
 Open-End – issues shares every time a buyer adds money to the
mutual fund – investor buys shares at NAV.
 Closed-End – trade like stocks on the exchange. Investor buys
at the current stock prices (which could be higher or lower than
the NAV).

 Unit Investment Trust – pool of money invested in a portfolio


whose investments are fixed for the life of the fund. Usually Bonds
given that they have a maturity, but also seen used with stocks for
a 1 year term.

 Commingled Funds (i.e., limited partnerships) – similar to


Open-Ended Funds, but instead of buying shares, you are buying
units at NAV. Usually offered by banks & insurance companies.

 Real Estate Investment Trusts (REITs) – a closed-ended fund


that invests in real estate

55
Net Asset Value and Price
 Used as a basis for valuation of investment
company shares.
 Selling new shares

 Redeeming existing shares

Market Value of Assets - Liabilities


Shares Outstanding

 Open Ended Funds – NAV is Price


 Closed Ended Funds - NAV is compared to Stock Price
of Fund

56
Open-End and Closed-
End Funds: Key Differences
Shares Outstanding
 Closed-end: no change unless new stock is
offered.
 Open-end: changes when new shares are
sold or old shares are redeemed.

Pricing
 Open-end: Net Asset Value (NAV)

 Closed-end: Premium or discount to NAV

57
Investment Policies
 Money Market

 Fixed Income

 Equity

 Balance & Income

 Asset Allocation

 Indexed

 Specialized Sector
58
Costs of Investing in Mutual
Funds
 Fee Structure
 Front-end load

 Back-end load

 Operating expenses

 12 b-1 charges
 distribution costs paid by the fund

 Alternative to a load

 Fees and performance


59
Exchange Traded Funds
 Allow investors to trade funds based on
indexes like stock.

 Examples
 SPDRS

 WEBS

 HOLDERS

 Allow sector specialization

60
A First Look at Fund
Performance
 Benchmark: Wilshire 5000

 Results
 Most funds underperform

 Not fair comparison because of costs

 Adjusted Benchmark: Wilshire 5000 with


passive management costs considered.
 The majority of funds still under-perform.

61
Consistency of Fund
Performance
 Do some mutual funds consistently
outperform?

 Evidence suggests that some funds show


consistent stronger performance.
 Depends on measurement interval

 Depends on time period

 Evidence shows consistent poor


performance.

62
Rate of Return Calculations for
Funds
 Performance – History has shown that 80% of mutual fund
managers do not beat the “market” – so why bother? Main
difference is that they are comparing apples and oranges.

 Mutual fund managers charge fees and hence their


performance will be lower. In other words, you cannot
get around the fees period – even if you bought the index
yourself – you would still have commission charges.

 Past Performance does not completely indicate future


performance, but do remember you are investing in the
mutual fund manager. If his/her performance is poor, then it
is likely that it might remain poor (if he is not fired, that is) –
Money Magazine flaws as an example of this.

63
Information Sources on Mutual
Funds
 Wiesenberger’s Investment Companies

 Morningstar

 Investment Company Institute

 Popular press

 Investment services

64
Measuring Fund Performance –
Category Ranks and Ratings
 You can view all mutual funds as 1 peer group – but
everyone is investing with a different “style”

 Category ratings are used to see who did better within


a “category” of style.

 Certain investment styles perform better than others


at any point in time – if that is the case, then managers
must be compared to their peers…

 Category Style = Investment Objective of the Fund


 Helps to determine what funds do well even when style is
out of favor
 Points out funds that are just riding on the coat tails of
their group

65
Categories Identify the Real
Competition
 For example: International Equity
 Foreign

 World

 Diversified Emerging Markets

 Regional

 International Hybrid

 This reaffirms that returns do not tell the


whole story –

 10 YR Trailing Return (1/2001)


 Janus Twenty 21.63%
 Weitz Partners Value 21.57%
66
Morningstar Equity Style Box
Value Blend
Growth

Large

Medium

Small

 Classifies a fund based on –


 Style —Value, Blend, Growth

 Size — Small, Medium, Large

67
Style Box Breakpoints
 Market Capitalization
 Large – >= $10 billion
 Medium – < $10.0 billion, >= $1.6 billion
 Small – < $1.6 billion

 Style Types – Relative Valuation Ratios vs.


Market
 Value – rel. P/E + rel. P/B <1.75
 Blend – rel. P/E + rel. P/B = 1.75-
2.25
 Growth – rel. P/E + rel. P/B >2.25

68
Styles <> Objectives
Fund Objective Actual Style
Oakmark Select Growth Mid Value
Pioneer Cap Growth Small Co. Mid Value
Prudential Equity Inc Equity Inc. Mid Value

69
Styles <> Objectives
Fund Objective Actual Style
Vanguard Growth IndexGrowth Large Growth
Sequoia Growth Large Value
Delafield Growth Small Value

70
Current Equity Style Box
Twenty Weitz
Value Blend Growth Value Blend Growth

Large

Medium

Small

Large Cap Growth Mid Cap Value


71
Janus Twenty Top Holdings

72
Weitz Top Holdings

73
Janus Twenty Portfolio
Breakdown

74
Weitz Partners Value Portfolio
Breakdown

75
Janus Twenty Sector Exposure

76
Weitz Partners Value Sector
Exposure

77
Risk Measures
Twenty Weitz
Morningstar Risk (10 YR) 1.32 0.59
Standard Deviation 24.72
14.18

 Morningstar Risk Ratio = Fund SD / Market


SD
 It is a Relative Measure of Risk

78
Five Key Points in Picking
 Funds
How has the fund performed?
 Compare with appropriate index
 Compare with peer group
 Examine after-tax returns, if relevant
 How risky has the fund been?
 Big returns spell risk
 Are you comfortable with the level of volatility?
 Morningstar risk & standard deviation
 What does the fund own?
 Value vs. Growth
 Sectors
 U.S. and Foreign
 Who runs the fund?
 Who earned the fund’s record?
 Where does this manager come from?
 What’s the fund family like?
 What does the fund cost?
 Low expenses are best
 Load funds aren’t bad if performance is justified, but rare
79
Understanding Global
Investing

80
Why Invest Globally?
 Investment Opportunities – roughly 50% of
the global stock market currently Foreign

 Market History

 Growth Potential – faster growing economies

 Diversification Benefits – Expand Efficient


Range
Global Stock Market Returns
Highest and Lowest Historical Annual Returns for Each
Region 1970 - 1999
Pacific
120
% 107.5%
Europe
100
% International
80
79.8%
% 69.9%
60 United States
%
40 37.4%
%
20
% 13.7% 13.2% 13.8% 13.4%
0
%
-
20%
-26.5% -23.2% -22.8%
- -34.3%
40%

Each bar shows the range of annual total returns for each region over the period 1970-1999. Average Return
Domestic Versus Global
1970 - 1999
U.S. Stocks U.S. Bonds International Stocks

Domestic Portfolio Global Portfolio

18%

40% 40%
60%
42%

Average Return 12.0% Average Return 12.0%


Risk 10.8% Risk 10.0%
Risk is measured by standard deviation.
Risk and return are based on annual data over the period 1970-1999.
83
Risks Of Foreign Investing
 Currency Risk

 Economic/Political Risk

 Market Liquidity Risk

 Differences in Accounting Standards

 Costs of Investing Internationally

84
The End!

Thank You!

85

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