asset allocation: building successful portfolios docs/teds/2018... · 2018. 5. 16. · asset...

ASSET ALLOCATION: BUILDING SUCCESSFUL PORTFOLIOS

Bob PariseManaging Director, Public Funds & Taft-Hartley

NCPERS TEDS 2018

2northerntrust.com | © 2018 NorthernTrust

TODAY’S AGENDA

Asset allocation: strategic & tactical approaches

1Processes & frameworks for successful investing

3Risk & return: the efficient frontier

2

STRATEGIC ASSETALLOCATION

3northerntrust.com | © 2018 Northern Trust


Avoiding the “chase”

For illustrative purposes only. Source: Northern Trust, Bloomberg. Gross total returns in USD. Year-to-date column through 9/30/17. Indices shown are preferred Investment Policy Committee proxies; 60/40 = 60% MSCI ACWI & 40% Barclays US Agg Bond Index; risk-control assets in shades of green; 10 Year Avg. Return = Compound Annual Growth Rate (trailing 10 years through 9/30/17).Past performance is no guarantee of future results. Periods greater than one year are annualized except where indicated. Returns reflect the reinvestment of dividends and other earnings and are shown before the deduction of investment management fees, unless indicated otherwise. Returns of the indexes also do not typically reflect the deduction of investment management fees, trading costs or other expenses. It is not possible to invest directly in an index. Indexes are the property of their respective owners, all rights reserved

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 YTD 10 Year Avg. Return

Natural Res.53.0

Gold5.5

EM Equities79.0

Gold29.7

TIPS13.6

Global RE29.8

U.S. Equities32.6

Global RE14.7

Municipals3.3

Natural Res.31.6

EM Equities28.1

High Yield7.9

EM Equities39.8

Inv. Grade5.2

High Yield58.8

Global RE20.0

Municipals10.7

EM Equities18.6

Dev. ex-U.S.21.6

U.S. Equities13.4

U.S. Equities1.3

High Yield17.1

Dev. ex-U.S.19.7

U.S. Equities7.5

Gold31.3

Global Fixed4.8

Natural Res.53.6

EM Equities19.2

Gold10.2

Dev. ex-U.S.17.0

Infrastructure15.0

Infrastructure13.0

Inv. Grade0.5

Infrastructure12.4

Infrastructure17.9

Gold5.6

Infrastructure23.2

Cash1.8

Global RE41.3

Natural Res.18.6

Inv. Grade7.8

EM Fixed16.8

60/4012.7

Municipals9.1

Cash0.0

U.S. Equities11.6

U.S. Equities14.4

60/404.7

EM Fixed18.1

TIPS-2.4

Dev. ex-U.S.34.4

EM Fixed15.7

Global Fixed5.6

U.S. Equities16.1

High Yield7.4

Inv. Grade6.0

Global RE-0.4

EM Equities11.6

EM Fixed14.3

Municipals4.5

Dev. ex-U.S.12.9

Municipals-2.5

U.S. Equities27.1

U.S. Equities15.4

High Yield5.0

High Yield15.8

Global RE2.2

60/405.3

60/40-0.7

EM Fixed9.9

60/4011.7

Inv. Grade4.3

TIPS11.6

EM Fixed-5.2

Infrastructure25.3

High Yield14.9

U.S. Equities2.0

Infrastructure11.9

Cash0.0

TIPS3.6

TIPS-1.4

Gold8.6

Gold11.3

TIPS3.9

60/4010.2

High Yield-25.9

Gold24.0

60/4011.1

Cash0.1

60/4011.9

Natural Res.-0.3

High Yield2.5

Dev. ex-U.S.-2.6

60/406.3

Global RE10.8

EM Fixed3.8

Global Fixed9.5

60/40-25.5

60/4023.5

Dev. ex-U.S.9.4

Infrastructure-0.4

Natural Res.9.0

Inv. Grade-2.0

Global Fixed0.6

Global Fixed-3.2

TIPS4.7

Natural Res.10.3

Infrastructure3.6

Inv. Grade7.0

U.S. Equities-37.1

EM Fixed22.0

Inv. Grade6.5

60/40-0.8

TIPS7.0

EM Equities-2.3

Cash0.0

High Yield-4.4

Global RE4.6

High Yield7.0

Global Fixed3.3

U.S. Equities6.0

Infrastructure-39.0

Municipals12.9

TIPS6.3

EM Fixed-1.8

Gold7.0

Municipals-2.6

Gold-1.5

Gold-10.5

Dev. ex-U.S.3.3

Global Fixed6.3

Global RE2.4

Cash4.8

Dev. ex-U.S.-43.2

TIPS11.4

Infrastructure5.8

Global RE-8.1

Municipals6.8

Global Fixed-2.6

EM Equities-1.8

Infrastructure-11.5

Inv. Grade2.6

Municipals4.7

Dev. ex-U.S.1.8

Municipals3.4

Natural Res.-45.3

Global Fixed6.9

Global Fixed5.5

Dev. ex-U.S.-11.8

Global Fixed4.3

TIPS-8.6

Dev. ex-U.S.-3.9

EM Equities-14.6

Global Fixed2.1

Inv. Grade3.1

EM Equities1.7

High Yield2.3

Global RE-48.9

Inv. Grade5.9

Municipals2.4

Natural Res.-12.5

Inv. Grade4.2

EM Fixed-9.0

EM Fixed-5.7

EM Fixed-14.9

Cash0.3

TIPS1.7

Natural Res.0.8

Global RE-4.7

EM Equities-53.2

Cash0.1

Cash0.1

EM Equities-18.2

Cash0.1

Gold-28.3

Natural Res.-7.2

Natural Res.-24.0

Municipals0.2

Cash0.6

Cash0.4


What is asset allocation?


Factors to consider

Target rate of return Plan time horizon Risk tolerance Liquidity needs

Strategic asset allocation


Major asset classesASSET CLASS

Bond

sCash

Treasury Inflation Protected Securities (TIPS)

Investment Grade

High Yield

Emerging Market Debt

Stoc

ks

U.S. Equities

Developed Ex-U.S. Equities

Emerging Market Equities

Rea

l Ass

ets Infrastructure

Real Estate

Natural Resources

Gol

d

Gold

RIS

K A

SSET

SR

ISK

C

ON

TRO

L

INVESTMENT RISK



CorrelationSharpe ratio

Standard deviation

Key investment risk terms


Standard deviation is a statistical measurement. When applied to the annual rate of return of an investment, it sheds light on the historical volatility of that investment.

The greater the standard deviation of a security, the greater the variance between each price and the mean,

indicating a larger price range.


Normal distribution graph (bell curve)


1σ-1σ-3σ -2σ 2σ 3σ(μ)

34.1% 34.1%13.6% 13.6%

2.1%2.1% 0.1%0.1%

Average


Example:Applied to financial markets, the standard deviation of returns can gauge how large market movements are likely to be, assuming that returns are normally

distributed.

However, there are events outside of normal distribution in markets. The stock market crash of October 1987 was an event around

30 standard deviations away from the average single-day change in the S&P 500.


Correlation is a statistic that measures the degree to which two securities move in relation to each other,

used in advanced portfolio management.


Correlation example:

SECURITY HISTORIC RETURN STANDARD DEVIATION COVARIANCE (X,Y)

Company X Common Stock 1.0% 0.456% 0.1925

Company YCommon Stock 3.0% 0.522% 0.1925

.. .

.809


Correlation matrices

For illustrative purposes only.


Sharpe ratio is the average return earned in excessof the risk-free rate per unit of volatility or total risk.

In subtracting the risk-free rate from the mean return, the performance associated with risk-taking activities can be isolated.

Generally, the greater the value of the Sharpe ratio, the more attractive the risk-adjusted return.


Sharpe ratio example:

MANAGER AVERAGE (MEAN) RETURN RISK FREE RATE STANDARD DEVIATION

(RISK)

Manager ABC 12.0% 2.4% 10.0%

. % . %. %

0.96


What is the efficient frontier?


Expe

cted

Ret

urns

Risk (Standard Deviation)

The efficient frontier

For illustrative purposes only.

Cash U.S. Equity International Equity Real Assets Fixed Income

E(R)Maximum Growth

Growth with Income

Income with Moderate Growth

Growth with Moderate Income

Income

TACTICAL ASSETALLOCATION



Tactical asset allocation is used to develop short-term strategies to exploit changes in market conditions and is

often viewed as a contrarian strategy.

Practical issues include more frequent rebalancing and

constraints on a “swing component”.


The asset allocation process

Target rate of return Plan time horizon Risk tolerance Liquidity needs

Strategic and tactical asset allocation

Review and rebalance portfolio


SUMMARY

Establish policies and objectives1

Monitor investment performance3

Stay focused and make informed decisions2


Accessing our research and insights FIVE-YEAR OUTLOOK

FACTOR RESEARCH Articles & Webinars

MARKETSCAPE Meaningful Insights in Less Than 3 minutes

BLOGTimely market perspectives

Investor Intelligence Network

www.capitalmarketassumptions.comwww.pointofview.northerntrust.com

@NTInvest

QUESTIONS


THE RISK IS RIGHT

With your host… Game Show Bob

ASSET ALLOCATION

GAME


Round 1THE RISK IS RIGHT


Round 1

Scenario: Shelbyville PERS sponsors an open, 80% funded DB plan with $250M in assets. The plan has a return and risk target of 7.5% and 9.5%, respectively.

Objective: Using the “asset classes” below, determine the optimal asset allocation.

ASSET CLASS 10-YEARRETURN

10-YEARSTANDARD DEVIATION

Cash 0.3% 0.2%Investment 1 3.1% 5.8%Investment 2 8.0% 10.6%Investment 3 3.8% 4.9%Investment 4 8.5% 15.1%Investment 5 2.4% 18.4%Investment 6 2.0% 22.8%Investment 7 8.7% 10.1%Investment 8 3.8% 5.5%


Round 2


Objective: Using the “asset classes” below, determine the optimal 5-year asset allocation.

ASSET CLASSPROJECTED

5-YEARRETURN

PROJECTED5-YEAR

STANDARD DEVIATIONCash 1.7% 0.4%Investment 1 3.3% 3.3%Investment 2 5.4% 10.8%Investment 3 6.2% 13.2%Investment 4 7.2% 15.8%Investment 5 8.5% 18.7%Investment 6 11.2% 23.6%Investment 7 10.0% 18.0%Investment 8 4.6% 6.2%


Round 3


Objective: Using the traditional asset classes below, determine the optimal 5-year asset allocation.

ASSET CLASSPROJECTED

5-YEARRETURN

PROJECTED5-YEAR

STANDARD DEVIATIONCash 1.7% 0.4%U.S. Inv. Gr. Bonds 3.3% 3.3%U.S. High Yield Bonds 5.4% 10.8%Emerging Markets Debt 6.2% 13.2%U.S. Equity 7.2% 15.8%Developed ex-U.S. Equity 8.5% 18.7%Emerging Market Equity 11.2% 23.6%Private Equity 10.0% 18.0%Hedge Funds 4.6% 6.2%

THANK YOU

ASSET ALLOCATION

GAME


Intra-round winners


Grand prize winners


IMPORTANT INFORMATIONThis material is directed to eligible counterparties and professional clients only and should not be relied upon by retail investors. The information contained herein is intended for use with current or prospective clients of Northern Trust Investments, Inc. and Northern Trust Global Investments . The information is not intended for distribution or use by any person in any jurisdiction where such distribution would be contrary to local law or regulation. Northern Trust and its affiliates may have positions in and may effect transactions in the markets, contracts and related investments different than described in this information. This information is obtained from sources believed to be reliable, and its accuracy and completeness are not guaranteed. Information does not constitute a recommendation of any investment strategy, is not intended as investment advice and does not take into account all the circumstances of each investor. Opinions and forecasts discussed are those of the author, do not necessarily reflect the views of Northern Trust and are subject to change without notice.

This report is provided for informational purposes only and is not intended to be, and should not be construed as, an offer, solicitation or recommendation with respect to any transaction and should not be treated as legal advice, investment advice or tax advice. Recipients should not rely upon this information as a substitute for obtaining specific legal or tax advice from their own professional legal or tax advisors. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. Indices and trademarks are the property of their respective owners. Information is subject to change based on market or other conditions.

All securities investing and trading activities risk the loss of capital. Each portfolio is subject to substantial risks including market risks, strategy risks, adviser risk and risks with respect to its investment in other structures. There can be no assurance that any portfolio investment objectives will be achieved, or that any investment will achieve profits or avoid incurring substantial losses. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Risk controls and models do not promise any level of performance or guarantee against loss of principal. Any discussion of risk management is intended to describe Northern Trust’s efforts to monitor and manage risk but does not imply low risk.

Past performance is no guarantee of future results. Performance returns and the principal value of an investment will fluctuate. Performance returns contained herein are subject to revision by Northern Trust. Comparative indices shown are provided as an indication of the performance of a particular segment of the capital markets and/or alternative strategies in general. Index performance returns do not reflect any advisory fees, transaction costs or expenses. It is not possible to invest directly in any index. Performance returns are reduced by investment management fees and other expenses relating to the management of the account. Performance returns contained herein include reinvestment of dividends and other earnings, transaction costs, and all fees and expenses other than investment management fees, unless indicated otherwise. Gross performance returns do not reflect the deduction of investment advisory fees and returns will therefore be reduced by these and any other expenses occurred in the management of the account. For additional information on fees, please refer to Part 2a of the Form ADV or consult a Northern Trust representative.

Forward-looking statements and assumptions are Northern Trust’s current estimates or expectations of future events or future results based upon proprietary research and should not be construed as an estimate or promise of results that a portfolio may achieve. Actual results could differ materially from the results indicated by this information.


If presented, hypothetical portfolio information provided does not represent results of an actual investment portfolio but reflects representative historical performance of the strategies, funds or accounts listed herein, which were selected with the benefit of hindsight. Hypothetical performance results do not reflect actual trading. No representation is being made that any portfolio will achieve a performance record similar to that shown. A hypothetical investment does not necessarily take into account the fees, risks, economic or market factors/conditions an investor might experience in actual trading. Hypothetical results may have under- or over-compensation for the impact, if any, of certain market factors such as lack of liquidity, economic or market factors/conditions. The investment returns of other clients may differ materially from the portfolio portrayed. There are numerous other factors related to the markets in general or to the implementation of any specific program that cannot be fully accounted for in the preparation of hypothetical performance results. The information is confidential and may not be duplicated in any form or disseminated without the prior consent of Northern Trust.

This information is intended for purposes of Northern Trust marketing of itself as a provider of the products and services described herein and not to provide any investment recommendations or advice within the meaning of the Department of Labor’s Final Fiduciary Rule (29 CFR §2510.3-21). Northern Trust is not undertaking to provide impartial investment advice or give advice in a fiduciary capacity to the recipient of these materials. To the extent that the recipient of these materials has authority to act on behalf of a benefit plan that is subject to Title I of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), Northern Trust provides information with the understanding that the recipient: (1) is a fiduciary under ERISA with respect to any plan transaction(s) contemplated herein and is responsible for exercising independent judgment in evaluating any such transaction(s); (2) is independent of Northern Trust; (3) is a bank or similarly regulated financial institution, insurance carrier, registered investment adviser, registered broker-dealer, or a plan fiduciary that holds, or has under management or control, total assets of at least $50 million; (4) is capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies. Please advise Northern Trust immediately if any of the foregoing understandings is incorrect. Further, Northern Trust and its affiliates receive fees and other compensation in connection with the products and services described herein as well as for custody, fund administration, transfer agent, investment operations outsourcing and other services rendered to various proprietary and third party investment products and firms that may be the subject of or become associated with the services described herein.

Northern Trust Asset Management is composed of Northern Trust Investments, Inc. Northern Trust Global Investments Limited, Northern Trust Global Investments Japan, K.K, NT Global Advisors Inc., 50 South Capital Advisors, LLC and investment personnel of The Northern Trust Company of Hong Kong Limited and The Northern Trust Company.

© 2018 Northern Trust Corporation. Head Office: 50 South La Salle Street, Chicago, Illinois 60603 U.S.A.

IMPORTANT INFORMATION

asset allocation: building successful portfolios docs/teds/2018... · 2018. 5. 16. · asset...

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