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Investment Presentation
By
Professor David M. Sinow
University of Illinois
September 11, 2007
Investing Overview
What makes a difference when you invest?
Equities vs. Fixed IncomeVolatility Is Your EnemyLonger Term Fixed Income Investments Are Too RiskyThree Factor ModelAsset Allocation: The Real Key to InvestingDave’s Couch Potato Portfolio
Asset Class Performance 1925-1996
Volatility is Your Enemy!!!!
Assume I invest $100.00 for one year & earn 0% at the end of year 1. Assume that the following year I invest the $100.00 and earn 0% again. My average return is 0%.
Now Assume that you invest $100.00 for one year and earn 50% at the end of year 1. Assume the following year you invest $150.00 and your second year rate of return is a –50%.
We each had an average rate of return of 0% over the two year period.
$150
$75
$0
$100
$200
Yr 1 Yr 2
But……….Who has more money at the end of the 2 years????
A) Me
B) You
MORAL OF THE STORY: VOLATILITY KILLS PORTFOLIOS IN DOWN YEARS—BECAUSE YOU LOSE A GREATER PERCENTAGE OF YOUR GAINS FROM PREVIOUS YEARS!!!!
Risk/Reward: Does it Pay to Extend Maturities? 1964-1994
0
2
4
6
8
10
12
14
1 Mo. 6 Mo. 1 Yr. 5 Yrs. 20 Yrs.Maturity
AnnualizedReturn
AnnualizedStandardDeviation
(%)
Annualized Return (%)
6.56 7.43 7.53 7.70 6.89
Annualized Standard Deviation
1.32 1.64 2.16 6.68 11.50
Long maturity instruments are riskier.
Returns for longer maturity instruments are not consistently greater.
Alternative strategies are needed to enhance returns.
Three Elements That Determine the Majority of an Equity Fund’s Expected Return
Size FactorSmall Stocks Minus Large Stocks
Market FactorAll-Equity Universe Minus T-bills
Style Factor“Out-of-Favor Companies
Minus “Glamour” Companies
AverageAnnualReturns1964-1996
5.86%
3.58%
5.13%
Porfolio #1 – A Basic Portfolio Passively Invested
Expected Return Standard Deviation
Portfolio #1 13.6% 10.3
60% S&P 500 Index
40% Lehman Gov/Corp. Index
Porfolio #2 – A Basic Portfolio Substituting Short-Term Fixed Income for Long-Term Fixed Income
Expected Return Standard Deviation
Portfolio #1 13.6% 10.3
Portfolio #2 13.3% 8.6
60% S&P 500 Index
40% 1-yr Fixed Income
Porfolio #3 – A Basic Portfolio Balancing Equities, S & P, and US Small Cap Index
Expected Return Standard Deviation
Portfolio #1 13.6% 10.3
Portfolio #2 13.3% 8.6
Portfolio #3 14.9% 9.9
30% S&P 500 Index
40% 1-yr Fixed Income
30%Small Cap
Porfolio #4 – A Basic Portfolio Balancing US Small Cap Value, US Small Cap, US Large Value, and S&P 500 Index
Expected Return Standard Deviation
Portfolio #1 13.6% 10.3
Portfolio #2 13.3% 8.6
Portfolio #3 14.9% 9.9
Portfolio #4 15.7% 9.8
15% S&P 500 Index
15% US LargeCo. Value
40% 1-yr FixedInc.
15% Small Cap
15%Small Cap Value
Porfolio #5 – A Basic Portfolio Adding International Diversification
Expected Return Standard Deviation
Portfolio #1 13.6% 10.3
Portfolio #2 13.3% 8.6
Portfolio #3 14.9% 9.9
Portfolio #4 15.7% 9.8
Portfolio #5 16.6% 9.1
7.5% S&P 500
40% 1-yr Fixed Inc
15% Int’l Small Value
7.5% US Large Co. Value
7.5% US Small Cap
15% Int’l Large Value
7.5% US Small Cap Value
DAVE’S COUCH POTATO PORTFOLIO
Asset Class Percentage Invested
1 S&P 500 10%
2 US Large Value 16.5%
3 US Small Cap 10%
4 US Small Cap Value 16.5%
5 US Mid-Caps 10%
6 US REIT 7%
7 Total International 25%
8 Emerging Markets 5%
Total 100%
