Challenging Asset Allocation Promises W. A. Ruch, III, CIMA Chief Executive Officer Sterne Agee...

Challenging Asset Allocation Promises

W. A. Ruch, III, CIMAChief Executive Officer

Sterne Agee Asset Management, Inc.Sterne Agee Investment Advisors, Inc.

Trust Company of Sterne Agee

FIRMA-Orlando, FLApril 9, 2008

Universal Investment Quest

Managing Risk for Client

Risk Management = Asset Allocation Modeling

Strategic Asset Allocation

An investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance and investment horizon.

At the inception of the portfolio, a "base policy mix" is determined based upon expected returns.

Because the value of assets can change given market conditions, the portfolio constantly needs to be rebalanced to meet the policy.

Diversification Ingredients

Major Classes- stocks, bonds, cash

Style Categories- LCG, MCV, GL, INT, MCG, MCV, SCG, SCV,ITM, LTM, TB, ITF-T, LTF-T, MMF, etc…

Alternative Investments- real estate, energy, basic commodities, currency

Alternative Strategies- equity hedge, event driven, macro, relative value

Investment Program Packaging

SMA – Separately Managed Accounts

UMA – Unified Managed Accounts

MSA – Multi-style Accounts

MSP – Multiple-style Portfolios (Models)

OMS-Overlay Management Strategies

Steps in Asset Allocation Process

Selection Funds & Managers

Rebalancing

Risk Profiling

Model Selection

Investment Proposal Path Risk Tolerance Questionnaire

Investment Proposal Path Alternative to the Questionnaire

Steps in Asset Allocation Process

Risk Profiling

Model Selection

Selection Funds & Managers

Rebalancing

Asset Allocation – Mean Variance Optimizer

Asset Allocation – Model Portfolios (Expected Returns)

Active Manager/Fund Recommendations

Proposed Product Allocation

Active Management vs. Indexed Returns (Back-testing)

Portfolio Analysis Portfolio Index

Total Return Over 5 Years 122.09% 92.37%

Annual Return, Last 5 Years 17.30% 13.98%

Annual Return, Last 3 Years 16.28% 12.99%

Annual Return, Last 1 Year 21.66% 15.88%

Alpha 2.69 0

Beta 1.03 100

Up Market Ratio 117.79 100

Down Market Ratio 7.31 1

Standard Deviation 7.28% 6.73%

Sharpe Ratio 1.95 1.62

Steps in Asset Allocation Process

Risk Profiling

Rebalancing

Selection Funds & Managers

Model Selection

Approved Funds & Managers (Historical Data Judgements)

Due Diligence Process - Schematic

Premier Managers

Traditional Due Diligence

Screening Universe Monitoring

Comprehensive Analysis Committee

Advanced Analytics

Qualitative People

Process

Firm

Operations

Quantitative Performance

Portfolio Stats

Risk Statistics

Peer Groups

Skill Persistency

Due Diligence Committee

Usually comprised of all senior staff and analysts Consider inter-disciplinary group of professionals (sales, admin,

& investments?)

Reviews all new and updated due diligence information including any findings and research updates

Approves all additions and deletions to the Approved List Monitors the “watch lists”

New & problem managers

Base Criteria

Criteria Principal Requirements

Assets Under Management $500 million if in business less than 10 years; $1 billion if in business more than 10 years. Positive asset flow

Years In Business 5 Years

Actual Track Record Must be real assets; simulated results are not acceptable

AIMR Compliant Must be compliant; prefer to also see a CFA on the portfolio management staff

Audited Track Record & Business Financial Statements

Preferred

Investment Professional Turnover for Last Three Years

0% if less than 10 investment professionals; <20% if more than 10 investment professionals

Organization Changes Prefer no changes for the length of the track record; mergers/ acquisitions are evaluated on a case-by-case basis

Registrations/Legal Issues No issues in the last 3 years

Performance 1,3,5, and 10 year Rankings Above median in universe of peers for each period, or able to demonstrate upward trend as a result of new professional staff

Change in investment philosophy or strategy for the term of the track record

No changes during the period measured by the track record

Operational Issues Manager able to participate on platform (availability, fees, minimums)

Timing Strategies or Derivative Investments None

Comprehensive Analysis on Funds & Managers

Traditional analysis addresses Performance relative to the benchmark Performance through market cycles Risk-adjusted performance Performance relative to peers Style consistency

Additional analysis to address Manager skill assessment Propensity to continue to add value

Analysis on new managers results in: Approved Conditionally approved Non-approval

Performance Opportunity Distributions – An Example

Source: PPCA-Inc.

MSCI Barra Performance Analyst – An Example

Acme Management Large Cap Core Strategy – January 2001 to December 2006

ATTRIBUTION REPORT Monthly Cumulative Contr To Total Return

-40

-30

-20

-10

0

10

20

30

40

50

60

70

80

90

AssetSelection

Industries/ Sectors

Market Timing

RiskIndices/ Styles

Total Active

TotalBenchmark

Total Managed

Source: MSCI Barra

DD Committee Manages Information Flow to Financial Institution and Advisors

Firm Level Notification Formal announcement through the Research Update is

made available Depending on the circumstances, the financial institution can

determine the course of action for their particular platform Issues List

Managers reviewed during the quarter Summary of discussions from Due Diligence committee

meetings Actions taken by by the committee during the quarter

Advisor and Firm Level Notification The Research Update is posted online as a bulletin

informing all advisors of the issue and recommended course of action

The bulletin information is also included in future editions of the Manager Profile

Web conferences ?

Findings End Up in Marketing Material

Displayed due diligence information collected by research team

Updated quarterly and posted to the web Last page is for the advisor

Fee schedule, minimums, sales and service policies Important Notes section for relevant information

i.e., Why a manager is on alert or why a manager holds ADRs

Steps in Asset Allocation Process

Risk Profiling

Selection Funds & Managers

Rebalancing

Model Selection

Rebalancing Standards

Manual or systematic process ?

Mandates and constraints ?

Cusips, separate accounts, overlay ?

Frequency ( % or moment in time) ?

Cost ?

Considerations in Setting Up a Cusip Driven Model

The Model or “Rebalancing Target”

From A to B….Transitional Sensitivity

Setting Model Tolerances (% of Holding-Range)

Taxes Matter !!!

Buy/Sell Recommendations Driven by Logical Approach

In Closing…

Questions ?