Personal Finance: Another Perspective - PowerPoint PPT Presentation

Loading...

PPT – Personal Finance: Another Perspective PowerPoint presentation | free to download - id: 734943-ZDgyY



Loading


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation
Title:

Personal Finance: Another Perspective

Description:

Personal Finance: Another Perspective Investments 9: Portfolio Rebalancing and Reporting * * Portfolio Attribution (continued) 4. Compare your portfolio returns in ... – PowerPoint PPT presentation

Number of Views:95
Avg rating:3.0/5.0
Slides: 50
Provided by: Bryan186
Category:

less

Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: Personal Finance: Another Perspective


1
Personal Finance Another Perspective
  • Investments 9 Portfolio Rebalancing and
    Reporting

2
Objectives
  • A. Understand portfolio rebalancing
  • B. Understand the importance of portfolio
    management and performance evaluation
  • C. Understand risk-adjusted performance measures
  • D. Understand how to perform attribution analysis

3
Investment Plan Assignments
  • Investments 9 Portfolio Rebalancing and
    Reporting
  • 1. Determine the type of rebalancing you will
    likely use and how often you will rebalance, and
    include it in your investment plan under section
    IV.B.2 of your Investment Plan.
  • 2. Think through the new money/donations
    addendum, and how you will utilize it to minimize
    taxes and transactions costs in rebalancing
  • 3. Determine how often you will monitor and
    report on your portfolio, and include it in
    IV.A.1.
  • 4. Determine how you will communicate portfolio
    results and include it in section IV.C.

4
Investment Plan Assignments
  • Investments 10 Behavioral Finance
  • 1. There are no assignments for your Investment
    Plan from this section. Listen and try to
    determine ways Behavioral Finance can help you to
    be a better investor.

5
A. Understand Portfolio Rebalancing
  • What is portfolio rebalancing?
  • The process of bringing portfolios back into
    given target asset allocation ratios
  • What causes the need to rebalance?
  • Changes occur due to
  • Changes in asset class performance
  • Changes in investor objectives or risk
  • Introduction of new capital
  • Introduction of new asset classes

6
Portfolio Rebalancing (continued)
  • Why is this rebalancing so critical?
  • There are competing principles
  • Minimize transactions costs and taxes
  • Minimize tracking error at your risk tolerance
    level
  • What is tracking error?
  • It is the return that is lost from your portfolio
    being different from your target weight
  • What are the different ways of rebalancing?
  • Periodic-based (or calendar-based)
  • Percent-range-based (or volatility-based)

7
Portfolio Rebalancing (continued)
  • Periodic-based rebalancing
  • Specify a time period, i.e. bi-annually,
    annually, etc. After each time period, rebalance
    the portfolio back to your original asset
    allocation targets
  • Advantages
  • Most simple of the methods
  • Longer periods have lower transactions and tax
    costs (but higher tracking error costs)
  • Disadvantages
  • Independent of market performance
  • Performance will depend on relative timing of
    large market moves and rebalancing

8
Portfolio Rebalancing (continued)
  • Percent-range-based rebalancing
  • Rebalance the portfolio every time actual
    holdings are /-5 (or /-10) from target
    ratios. Rebalance whenever you are outside this
    range
  • Advantages
  • Easy to implement
  • Wider ranges will reduce transactions costs (at
    the expense of higher tracking error)
  • Asset performance will trigger rebalancing
  • Disadvantages
  • Setting an effective range is difficult
  • Assets with higher target ranges and volatility
    will generate most rebalances

9
Portfolio Rebalancing (continued)
  • NMD (New Money / Donations) Addendum
  • Since you pay yourself monthly and are very
    careful in your selection of assets, you can
    combine the previous strategies with a New Money
    / Donation strategy
  • Rebalance as determined previously. But use new
    money to purchase the underweight assets, so
    you do not have to sell and incur transactions
    costs or taxable events
  • This way you are not selling assets
  • In addition, this strategy helps you to buy
    low, as you are generally purchasing
    underperforming asset classes

10
Portfolio Rebalancing (continued)
  • NMD Addendum (continued)
  • Rebalance using appreciated assets for your
    charitable contributions (see Learning Tool 8)
  • Use the money you would have spent for
    contributions to purchase underweight assets
  • This way you eliminate your capital gains taxes
    for the contributed assets, and you get the full
    benefit of the deduction for your taxes, i.e.,
    you sell without tax consequences

11
Portfolio Rebalancing (continued)
  • Which are the best methods?
  • Generally, for most investors with fewer
    investable assets, the easiest is likely to be
    most useable
  • Generally, a combination of periodic-based or
    percent-range-based rebalancing is most useful
    with the NMD addendum
  • Review the portfolio annually, but only rebalance
    when you are /- 5 to /-10 (or some range)
    beyond your targets. Then rebalance back to your
    targets
  • Remember, the goal is to minimize transactions
    costs, taxes, and tracking error costs

12
Questions
  • Any questions on portfolio rebalancing?

13
B. Understand the Importance of Portfolio
Management and Evaluation
  • What is portfolio management?
  • The development, construction, and management of
    a portfolio of financial assets to attain an
    investors specific goals
  • What is performance evaluation?
  • The process of evaluating a portfolios
    performance with the goal of understanding the
    key sources of return
  • Why are these two topics so important?
  • Both are complicated subjects and both are
    critical to investing

14
Portfolio Management and Evaluation (continued)
  • What is active portfolio management?
  • The process of using publicly available data to
    actively manage a portfolio in an effort to
  • Beat the benchmark after all transactions costs,
    taxes, management, and other fees
  • However, you must do this consistently
    year-after-year, and not just from luck
  • Why is active management such a hot topic?
  • Management fees for mutual funds which can
    consistently outperform their benchmarks are 5-25
    times higher than those on passive management (19
    basis points versus 250 basis points)

15
Portfolio Management and Evaluation (continued)
  • What is passive portfolio management?
  • The process of buying a diversified portfolio
    which represents a broad market index (or
    benchmark) without any attempt to outperform the
    market or pick stocks
  • Why is passive management such a hot topic?
  • Most active managers fail to outperform their
    benchmarks, especially after costs and taxes
  • Investors have realized that if you cant beat
    them, join them, so they buy low-cost passive
    funds which meet their benchmarks consistently
    and minimize taxes

16
Portfolio Management and Evaluation (continued)
  • What factors lead to above-benchmark or excess
    returns?
  • 1. Superior asset allocation
  • Shifting assets between a poor-performing asset
    class and a better performing asset class, i.e.
    between large cap to international or small cap
  • 2. Superior stock selection
  • Picking sectors, industries, or companies within
    a specified benchmark which, as a whole,
    outperform the return on the specified benchmark

17
Portfolio Management and Evaluation (continued)
  • What is superior asset allocation?
  • The process where the investor gains a higher
    return than the benchmark from adjusting the
    investment portfolio for movements in the market
  • The investor shifts among stocks, bonds and other
    asset classes based on their expectations for
    returns from each of the asset classes
  • What are the results?
  • Done well, superior asset allocation yields
    higher returns with lower risk.
  • Done poorly, it yields lower returns, higher
    transactions costs, and higher taxes

18
Portfolio Management and Evaluation (continued)
  • What is superior stock selection?
  • The process where the investor builds an
    investment portfolio which earns returns in
    excess of the benchmark through buying or selling
    undervalued stocks, sectors or industries
  • The investor shifts among the various securities
    of the index in an attempt to buy the securities
    with the highest growth potential
  • What are the results?
  • Done well, superior selection yields higher
    returns with lower risk.
  • Done poorly, it yields lower returns, high
    transactions costs, and high taxes

19
Portfolio Management and Evaluation (continued)
  • What is portfolio evaluation?
  • The process of monitoring financial asset
    performance, comparing asset performance to the
    relevant benchmarks, and determining how well the
    fund is meeting its objectives.
  • If the assets are underperforming benchmarks, the
    investor may sell underperforming assets and
    purchase other assets which would more closely
    align asset performance with benchmarks

20
Portfolio Management and Evaluation (continued)
  • Why monitor performance?
  • Unless you monitor performance, you will not know
    how you are doing in working toward accomplishing
    your objectives
  • You need to know how every asset you own is
    performing, and performing versus its benchmark,
    so you can determine how well you are moving
    toward your goals

21
Portfolio Management and Evaluation (continued)
  • How do you evaluate performance?
  • Calculate
  • 1. The period return on each owned asset
  • 2. The period index return for each benchmark
  • 3. The difference between the asset return and
    benchmark return
  • 4. The weight of each asset or portfolio in the
    overall portfolio
  • 5. The overall portfolio return
  • With this information, you can know how each
    asset is performing versus its benchmark, and how
    well the portfolio is moving toward its objectives

22
Portfolio Management and Evaluation (continued)
  • What is portfolio reporting?
  • The process of reviewing portfolio performance
    with the necessary participants, i.e. your spouse
  • If you are managing your portfolio, you should
    report performance to your spouse at least
    monthly or quarterly
  • If others are helping you manage your portfolio,
    they should report performance to you and your
    spouse at least quarterly as well.
  • Be careful not to do too much buying and selling,
    as these incur transactions costs and taxes

23
Questions
  • Any questions on the importance of portfolio
    management and evaluation?

24
C. Calculate Risk-adjusted Performance
  • How do you determine whether a portfolio manager
    is generating excess returns (i.e., returns above
    the managers benchmark)?
  • Is it only returns?
  • Should you also be concerned about risk?
  • It is not just returns that mattersthey must be
    adjusted for risk.
  • There are a number of recognized performance
    measures available
  • Sharp Index
  • Treynor Measure
  • Jensens Measure

25
Risk Adjusted Performance Sharpe
  • Sharpe Index
  • A ratio of your excess return divided by your
    portfolio standard deviation
  • rp rf
  • sp
  • rp Average return on the portfolio
  • sp Standard deviation of portfolio return
  • The Sharpe Index is the portfolio risk premium
    divided by portfolio risk as measured by standard
    deviation

26
Risk Adjusted Performance Treynor
  • Treynor Measure
  • This is similar to Sharpe but it uses the
    portfolio beta instead of the portfolio standard
    deviation
  • rp rf
  • ßp
  • rp Average return on the portfolio
  • rf Average risk free rate
  • ßp Weighted average b for portfolio
  • It is the portfolio risk premium divided by
    portfolio risk as measured by beta

27
Risk Adjusted Performance Jensen
  • Jensens Measure
  • This is the ratio of your portfolio return less
    CAPM determined portfolio return
  • ap rp - rf ßp (rm rf)
  • ap Alpha for the portfolio
  • rp Average return on the portfolio
  • ßp Weighted average Beta
  • rf Average risk free rate
  • rm Average return on market index port.
  • It is portfolio performance less expected
    portfolio performance from CAPM

28
Risk Adjusted Performance (continued)
  • Which measure is most appropriate? Are there
    some general guidelines?
  • Generally, if the portfolio represents the entire
    investment for an individual, the Sharpe Index
    compared to the Sharpe Index for the market is
    best
  • If many alternatives are possible, or if this is
    only part of the overall portfolio, use the
    Treynor measure versus the Treynor measure for
    the market, or the Jensens a alpha
  • Of these two, the Treynor measure is more
    complete because it adjusts for risk

29
Risk Adjusted Performance (continued)
  • Are their limitations of risk adjustment
    measures?
  • Yes, very much so. The assumptions underlying
    measures limit their usefulness
  • Know the key assumptions and be careful!
  • When the portfolio is being actively managed,
    basic stability requirements are not met
  • Be careful when portfolios are actively managed
  • Practitioners often use benchmark portfolio
    comparisons and comparisons to other managers to
    measure performance
  • This is largely because they are easier

30
Risk Adjusted Performance (continued)
  • What about style analysis?
  • Another way of obtaining abnormal returns is
    chasing style
  • Growth versus valuewhats hot?
  • You can decompose returns by attributing
    allocation to style
  • Style tilts and rotation are important active
    portfolio strategies
  • Style analysis has become increasingly popular in
    the industry

31
Questions
  • Any questions on risk-adjusted performance
    measures?

32
D. Understand How to Perform Portfolio
Attribution (this is optional)
  • What is portfolio attribution?
  • The process of separating out portfolio returns
    into their related components, generally
    attributable to asset allocation and securities
    selection
  • What is the importance of these components?
  • These components are related to elements of
    portfolio performance, to see what you do well
  • What are examples of some of these components?
  • Broad asset allocation Security Choice
  • Industry Currency

33
Portfolio Attribution (continued)
  • How do you determine portfolio attribution?
  • 1. Set up a weighted benchmark which includes
    all your chosen asset classes
  • Use your chosen benchmark for each asset class,
    and use your target asset allocation weights from
    your Investment Plan
  • 2. Calculate your returns for each of your asset
    classes
  • Calculated returns for each asset class
  • Calculate a weighted return for your overall
    portfolio

34
Portfolio Attribution (continued)
  • 4. Compare your portfolio returns in each asset
    class to the benchmark returns of each index
  • Use Teaching Tool 17 Portfolio Attribution
    Spreadsheet
  • 5. Calculate your attribution and make decisions
    accordingly

35
Portfolio Attribution (continued)
  • Why is it important to attribute performance to
    the portfolios components?
  • It can explain the difference in return based on
    component weights or selection
  • It can summarize the performance differences into
    appropriate categories
  • It can help you know how you are doing
  • What happens if you dont perform portfolio
    attribution?
  • You will not know why you are performing as you
    are
  • You will not know how to improve

36
Portfolio Attribution (continued)
  • What do you do if your actively managed funds
    continue to underperform?
  • Watch them carefully. Underperformance for a
    month or quarter is understandable, but over
    12-36 months it should be positive
  • If not, find another fund or index the asset
    class performance
  • How long does it take to determine whether an
    active manager is good or not?
  • Generally, 12-36 months

37
Questions
  • Any questions on portfolio attribution?

38
Review of Objectives
  • A. Do you understand the different types and
    uses of indexes?
  • B. Do you understand the Importance of Portfolio
    Management and Performance Evaluation?
  • C. Do you understand portfolio rebalancing?
  • D. Do you understand risk-adjusted performance
    measures?
  • E. Do you understand how to perform attribution
    analysis?

39
Case Study 1
  • Data
  • Steve and Suzie, both 45, are aggressive
    investors, and have a portfolio of over 250,000.
    Their target asset allocation is 60 equities and
    40 bonds and cash which they have invested in 10
    mutual funds. Their actual asset class weights
    are different from their targets due to the
    out-performance of the equity part of their
    portfolios.
  • Asset Class Actual Weight Target Weight
    Difference
  • Equity 70 60
    10
  • Bonds 20 30
    -10
  • Cash 10 10
    0
  • Application When should they rebalance their
    portfolio and how should they do it?

40
Case Study 1 Answers
  • The decision of when to rebalance should be part
    of their investment plan. They need to determine
    the best time for them to rebalance, and the most
    cost effective means. The key is to minimize
    transactions costs and turnover, while
    maintaining diversification and return.
  • One thought is the new money donation (NMD)
    strategy where they use new money and donate
    appreciated assets to rebalance. Since this
    change is due to appreciation of equities, if
    they will donate the appreciated equity assets,
    i.e. donations in kind to a charity, they can
    take the money they would have spent on their
    charity donations, and purchase more bonds. (See
    Teaching Tool 8 Tithing Share Transfer Example)

41
Case Study 2
  • Data
  • Steve is reviewing the performance of his largest
    asset, the XYZ mutual fund (which is actively
    managed), for the most recent sample period. The
    T-bill rate during the period was 4.
    Fund XYZ Market
  • Average return 12 10
  • Beta 1.2
    1.0
  • Standard Deviation 26 24
  • Calculations and Application
  • a. Calculate the following performance measures
    for Steve for the fund and the market Sharpe,
    Treynor, and Jensens alpha.
  • b. On a risk-adjusted basis, did Fund XYZ
    outperform the market?
  • c. Which risk-adjusted measure should Steve use?

42
Case Study 2 Answers
  • XYZ Fund Market
  • Average return 12.0 10.0
  • Beta 1.2
    1.0
  • Standard Deviation 26.0 24.0
  • T-Bill rate 4.0
  • a. Performance measures
  • Sharpe (rp rf )/ sd
  • Portfolio (12-4)/26 .31
  • Market (10-4)/24 .25
  • Treynor (rp rf )/ ßp
  • Portfolio (12-4)/1.2 6.7
  • Market (10-4)/1.0 6.0

43
Case Study 2 Answers
  • XYZ Fund Market
  • Average return 12.0 10.0
  • Beta 1.2
    1.0
  • Standard Deviation 26.0 24.0
  • T-Bill rate 4.0
  • Jensen rp rf ßp (rm rf)
  • Portfolio alpha 12 4 1.2 (10-4) 0.8
  • Market alpha 0
  • b. Steves XYZ Fund outperformed the market in
    terms of all three measures the Jensens alpha,
    Treynor measure, and the Sharpe ratio.

44
Case Study 2 Answers
  • c. Which measure is most appropriate?
  • Generally, if the portfolio represents the entire
    investment for an individual, the Sharpe Index
    compared to the Sharpe Index for the market is
    best. This is not the case here.
  • If many alternatives are possible, or if this is
    only part of the overall portfolio, use the
    Treynor measure versus the Treynor measure for
    the market, or the Jensens a alpha
  • Of these two, the Treynor measure is more
    complete because it adjusts better for risk

45
Case Study 3 (optional)
  • Data
  • Steve and Suzie are 45 years old, married, and
    have a portfolio with three asset classes. Last
    quarter they had the following performance. The
    equity benchmark is the SP 500, bonds the SB
    Intermediate, and cash is the Lehman Cash Index.
    Benchmark weights are their target asset
    allocation, and actual weights are different from
    their target get since they have not rebalanced
    lately. They like their current asset class
    weights.
  • Asset Class Actual Actual Benchmark
    Benchmark
  • Return Weight
    Weight Return
  • Equity 2.0 70 60
    2.5
  • Bonds 1.0 20 30
    1.2
  • Cash 0.5 10 10
    0.5
  • Calculations and Application
  • What was their over or underperformance? What
    was their contribution to security selection and
    to asset allocation? How did they do for the
    quarter?

46
Case Study 3 Answers
  • Asset Class Actual Actual Benchmark
    Benchmark
  • Return Weight Weight
    Return
  • Equity 2.0 .70 .60
    2.5
  • Bonds 1.0 .20 .30
    1.2
  • Cash 0.5 .10 .10
    0.5
  • a. Steve and Suzies quarterly return was
    (2.0.7) (1.0.2) (.5.1) or 1.65. The
    index return was (2.5.6) (1.2.3) (.5.1) or
    1.91. The difference between these two returns
    is their performance. In this case they
    underperformed their benchmark by -.26 for the
    quarter.

47
Case Study 3 Answers (continued)
  • b. Their contribution of security selection to
    relative performance was -.39. This is
    calculated as
  • (1) (2)
    (12)
  • Market Diff. Ret. Man. Port. Wgt. Contribution
  • Equity -0.5 .70
    -0.35
  • Bonds -0.2 .20
    -0.04
  • Cash 0.0 .10
    0.00
  • Contribution of Security Selection -0.39
  • (1) Managed fund return less index return
    (2.0-2.5)
  • (2) Actual weight of the managed portfolio
  • (12) Contribution of asset class security
    selection to the portfolio

48
Case Study 3 Answers (continued)
  • c. Their contribution from asset allocation was
    .13. This is calculated as
  • (3) (4) (34)
  • Market Excess Weight Index-BM Contribution
  • Equity 10 .59 0.059
  • Bonds -10 -.71 0.071
  • Cash 0 -1.41 0.000
  • Contribution of Asset Allocation 0.130
  • (3) Weight of actively managed fund less
    benchmark weight (- is underweight)
  • (4) Asset class return less total portfolio
    return (equity is 2.50-1.91 or .59, bond is
    1.20-1.91-.71)
  • (34) Contribution of the asset class to the
    total portfolio

49
Case Study 3 Answers (continued)
  • Overall comments
  • Steve and Suzies actively managed portfolio
    under performed the benchmark by .26 or 26 basis
    points (1.65-1.91). This underperformance was
    a combination of a -.39 contribution to security
    selection and a .13 contribution from asset
    allocation. While they did well overweighting
    (versus their asset allocation targets) the asset
    classes that performed well, they didnt do as
    well picking the assets in those asset classes.
  • If this performance continued for 24-36 months,
    they should consider indexing the stock selection
    decision, i.e. buy index funds, and keep doing
    what they are doing with the asset class decision.
About PowerShow.com