07/09/2010

Portfolio construction consists of the following steps

• Decide personal risk profile which determines the target allocation in risk assets.
• Decide asset allocation method: strategic or tactical or both (strategic does not change target asset allocations while tactical can alter allocations more actively)
• Decide target allocation for each asset in a strategic asset allocation
• Periodically rebalancing portfolios

For a portfolio using strategic asset allocation, with long term target allocation being fixed (and only changed when major events such as approaching to retirement and children college education spending, for example), one can further enhance a portfolio return and reduce the risk by rebalancing and fund selection in an asset class. It is reported that adopting proper timing and way to rebalance a portfolio can improve return and reduce risk (see Daryanani opportunitstic rebalancing article).  In this article, we focus on fund selection.

In a well designed portfolio for retirement plans (401K or IRA), it is a popular practice to have funds with various style exposures. In a stock/equity asset, a fund style is defined as value style (growth/blend/value) and size style (large/mid/small cap). The Morningstar 9 boxes of styles are essentially the combinations of the 3 value and 3 size styles. In a fixed income asset, a fund style is a combination of credit risk (junk/investment grade) and interest rate risk (short/intermediate/long) for corporate bonds or a just interest rate risk for treasury bonds.  In an actively managed portfolio, it is a well recognized and widely practiced method to select funds based on style rotation to improve a portfolio alpha or return. For example, in an article published in Journal of Asset Management (May, 2007), B. Arshanapalli , L. Switzer and K. Panju concluded that active multi-style rotation strategies can be devised to outperform the best performing buy-and-hold portfolio.

MyPlanIQ maintains an index fund based plan or an ETF based plan using candidate funds based on those in a lazy portfolio proposed by Fund Advice Paul Merriman and maintained by MarketWatch.com (called Fund Advice Ultimate Buy and Hold Portfolio) (see here for the independently tracked portfolio on MyPlanIQ.com). The candidate funds and the original allocation are as follows

The funds cover five asset classes: U.S. Equity, International Equity, Emerging Mkt Equity, U.S. REIT and Fixed Income. They have various style exposures for U.S. stock market (equity), International Stocks and Fixed income.

MyPlanIQ Strategic Asset Allocation (SAA) selects funds with the best risk adjusted returns for each asset class when rebalancing.  The following table compares the Strategic Asset Allocation (SAA) moderate portfolios in both index fund and ETF plans as well as the original portfolio (both MyPlanIQ SAA moderate portfolios have 40% allocation in fixed income). We also include the strategic asset allocation moderate portfolio in MyPlanIQ Five Core Asset ETF Plan that consists one fund for each asset class.

As of 7/2/2010

From the above table, we can observe:

• Diversification over styles improves return (FundAdvice Buy and Hold vs. Five Core SAA Moderate).

• Style rotation adds 1.3-1.7% returns over buy and hold (SAA Moderate ETF or Index Funds vs. FundAdvice Buy and Hold).

The above observations are consistent across thousands of plans MyPlanIQ maintains. We should also point out that better fund/style selection does not alter the overall portfolio risk allocation, which is a major advantage over an actively managed tactical asset allocation portfolio.

At the moment, for U.S. stocks, MyPlanIQ SAA favors small cap (IWM), small cap value (IWN). For fixed income, it favors Inflation-protected treasury (TIP).

labels:investments,IRA,401K,

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06/27/2010

There is an easy to understand strategy that can lead to high returns with low risk. If you have a portfolio with the correct asset classes represented, over the long term, you will get better results at a lower risk than picking the latest and greatest fund or stock. This is not the bleeding edge of new ideas. This is proven and widely used – being the basis of most money manager’s strategies.

MyPlanIQ created SIB portfolios (Simpler Is Better) – market index funds from key asset classes that can be used to measure historical returns to show the impact of asset class selection rather than fund or stock selection. SIB portfolios for different numbers of asset classes are built and used to benchmark returns. From this, conclusions can be drawn as to what is an effective investment strategy for today.

The following funds were used:

Three Asset Class SIB: The three core assets are US and international equities and fixed income. This represents what used to be conventional wisdom: Heavy dependence on the US and the rest of the developed world. With a conservative strategic asset allocation strategy, the portfolio would consist of 60% fixed income and 20% each for US and international equities. With a tactical asset allocation strategy, the fixed income would never be less than 60% but the split of the three asset classes would move based on asset price movement.

The SAA (buy and hold) strategy represents what many people may end up with as there is little thought put into which asset classes are represented but these are the most likely ones to be covered. The TAA strategy gives a little higher long term performance because of the ability to move to other asset classes when one aspect of the economy is slowing.

It’s clear that world economics has changed becoming smaller, more interlinked and complex. It’s no longer possible to ignore the impact of emerging markets and we are very aware that real estate has an impact on the economy.

If you are just using three asset classes, you should look to upgrade your portfolio immediately.

Four Asset Class SIB: There are two variants for the four asset class SIB. Either add emerging markets or real estate trusts to the three asset class SIB. Note that the international asset class means established nations such as those in Europe and emerging asset classes are represented by developing nations. With a conservative strategic asset allocation strategy, the portfolio would consist of 60% fixed income and 13.33% each for US, international and REIT or emerging market equities. With a tactical asset allocation strategy, the fixed income would never be less than 60% but the split of the three asset classes would move based on asset price movement.

Adding another asset class improves the performance as it balances risk. TAA is also able to increase its long term benefit over SAA as there are more asset classes to move into when one of the asset classes is not performing properly. Choosing between REIT and emerging markets is hard and further diversification is of long term value.

If you are using a four asset class portfolio, you could be doing better and making the choice between emerging markets and real estate is a tough one.

Five Asset Class SIB: Has been covered in a previous article and the results are included for completeness. The five class SIB takes both REIT and Emerging markets so is a fusion of the two four asset class SIBs.

The five asset class SIB is a strong platform for portfolio creation. It has broad diversification and, with tactical asset allocation, good returns.

If you are using a five asset class portfolio, you are in good shape – but take a look at the six asset class portfolio because it will be increasingly important in the current macro economic climate.

Six Asset Class SIB: The last asset class adds commodities to the portfolio. This gives another type of asset class and will further help diversification

Adding another asset class does not significantly improve the result within the 5 year timeframe. It may be asked whether the extra effort of building and managing a six asset class portfolio is worth it. Broader diversification is good, but is it really necessary? In our view, the addition of commodities will be increasingly important as commodities will protect against inflation as the recovery slowly continues and there is increasing inflationary pressure.

labels:investment,ETFs,401K,IRA,

Symbols:vti,spy,veu,efa,vwo,eem,iyr,icf,vnq,dbc,gsg,bnd,agg,tlt,lqd,VTSMX,VGTSX,VEIEX,VGSIX,VBMFX,

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12/03/2010

This report reviews Allegheny Ludlum Corporation Personal Retirement and 401(k) Savings Account Plan plan. We will discuss the investment choices and present the plan rating by MyPlanIQ. Current economic and market conditions are discussed in the context of the investment portfolios in the plan. We will then show how participants in Allegheny Ludlum Corporation Personal Retirement and 401(k) Savings Account Plan can achieve reasonable investment results using asset allocation strategies.

Plan Review and Rating

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Allegheny Ludlum Corporation Personal Retirement and 401(k) Savings Account Plan's 401K plan consists of 55 funds. These funds enable participants to gain exposure to 5 major assets: US Equity, Foreign Equity, Commodity, Emerging Market Equity, Fixed Income. The list of minor asset classes covered:

Commodities Broad Basket: GSG, DBC
Conservative Allocation: AOK
Diversified Emerging Mkts: EEM, GMM, PXH, DEM, SCHE
Diversified Pacific/asia: EPP, VPL, GMF, PAF
Equity Energy: ITE, IXC, IPW, DBE, RYE, DKA
Europe Stock: IEV, VGK, PEF, DEB
Foreign Large Blend: EFA, VEU, GWL, PFA
Foreign Small/mid Growth: IFSM, VSS, SCHC
Health: IYH, IXJ, VHT, XBI, PBE, DBR, RYH
Inflation-protected Bond: TIP
Intermediate-term Bond: AGG, CIU, BIV, BND
Large Blend: IVV, IYY, IWV, VTI, VV, SPY, DLN, RSP, SCHX
Large Growth: IVW, IWZ, JKE, VUG, ELG, QQQQ, RPG, SCHG
Large Value: IVE, IWW, JKF, VTV, ELV, PWV, RPV, SCHV
Latin America Stock: ILF, GML
Long Government: TLT, TLH, IEF, EDV, VGLT, TLO, PLW
Mid-cap Value: IJJ, IWS, JKI, VOE, EMV, PWP, RFV, UVU
Multisector Bond: AGG, GBF, BND, LAG
Natural Resources: IYM, IGE, VAW, XLB, XME, PYZ, DBN, RTM, UYM
Pacific/asia Ex-japan Stk: EPP, AAXJ, GMF, PAF, DND
Short Government: SHY, SHV, VGSH, PLK, USY
Short-term Bond: CSJ, BSV, VCSH
Small Growth: IJT, IWO, JKK, VBK, DSG, PWT, RZG, UKK
Technology: MTK, PTF, DBT, RYT, ROM

As of Dec 2, 2010, this plan investment choice is rated as based on MyPlanIQ Plan Rating methodology that measures the effectiveness of a plan's available investment funds. It has the following detailed ratings:

Diversification -- Rated as (91%)
Fund Quality -- Rated as (48%)
Portfolio Building -- Rated as (84%)
Overall Rating: (75%)

Current Economic and Market Conditions

We have experienced an uncertain 2010: plenty of worries on whether the US economy will climb out of the great recession and recover.

• The Federal Reserve embarked on Quantitative Easing II (QE2) to stimulate the economy.
• The housing market is still at its low but largely stabilized.
• The unemployment rate is stuck at 9%.

Americans continue to face an uncertain future, given (among others) the high unemployment rate, large federal and local government debts and global trade imbalance. With such an economic backdrop, the stock and debt markets are going to be volatile. Despite this, markets have been resilient and appear positioned to rebound.

In this market it is even more critical to properly diversify and respond market changes. MyPlanIQ offers two asset allocation strategies: strategic and tactical asset allocation strategies ( SAA and TAA for participants in Allegheny Ludlum Corporation Personal Retirement and 401(k) Savings Account Plan).

Strategic Asset Allocation is based on well known modern portfolio theory and its key features include: diversification, proper fund selection and periodically re-balancing.

Tactical Asset Allocation works on a diversified array of assets provided by funds in a plan and adjusts asset mixes based on market conditions such as asset price momentum utilized by TAA.

Portfolio Discussions

The chart and table below show the historical performance of moderate model portfolios employing strategic and tactical asset allocation strategies. For comparison purpose, we also include the moderate model portfolios of a typical 4 asset SIB (Simpler Is Better) plan . This SIB plan has the following candidate index funds and their ETFs equivalent:

US Equity: (SPY or VTI)
Foreign Equity: (EFA or VEU)
Emerging Market Equity: (EEM or VWO)
Fixed Income: (AGG or BND)

Performance chart (as of Dec 2, 2010)

Performance table (as of Dec 2, 2010)

Currently, asset classes in Foreign Equity (EFA,VEU), Emerging Market Equity (EEM,VWO) and Fixed Income (AGG,BND) are doing relatively well. These asset classes are available to Allegheny Ludlum Corporation Personal Retirement and 401(k) Savings Account Plan participants.

To summarize, Allegheny Ludlum Corporation Personal Retirement and 401(k) Savings Account Plan plan participants can achieve reasonable investment returns by adopting asset allocation strategies that are tailored to their risk profiles.

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12/03/2010

12/07/2010

06/02/2011