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  • 1. Failing conventionally and succeedingunconventionally in asset allocationR. Scott Hixon, CFAPortfolio Manager,Head of Investment ResearchInvesco Global Asset AllocationThis presentation is for Professional Clients only and is not for consumer use.The CFA® designation is globally recognized and attests to a charterholder’s success in a rigorous andcomprehensive study program in the field of investment management and research analysis.
  • 2. Source: Content licensed from The Official Dilbert Store.1
  • 3. Asset Allocation UNDERSTANDING RISK CONTRIBUTION Weight Risk Contribution 100% Bonds 80% Bonds Weight % Traditional 60% Weights drive Portfolio risk allocation 40% Stocks (The Bicycle Seat) 20% Stocks 0% Weight Risk Contribution 100% 80% New Weight % Balanced 60% Weights drive 40% risk allocation (The Dorky Pants) 20% 0% Investment Grade Bonds High Yield Emerging Market Bonds Developed Market Equities REITs Commodities Inflation Linked Securities Managed Futures Hedge Funds Emerging Market Equities Cash *Alternatives Sources: Invesco analysis and DataStream. Stocks are represented by the MSCI World Index. Bonds are represented by the FTSE All Government Stocks Bond Index. For illustrative purposes only. *Alternatives within the risk contribution chart above are represented by a combination of hedge funds, commodities and managed futures.2
  • 4. Portfolio ConstructionRISK, RETURN & CORRELATION ASSUMPTIONS Hedge Inflation- Asset Private Developed Emerging G7 Long Emerging High Yield Funds Commodities Linked Risk Equity Equity Equity Bonds Debt Debt (HFRI) BondsPrivate Equity 17.3% 1.000 0.659 0.530 0.344 0.183 0.031 -0.168 0.402 0.435Developed Equity 30.5% 1.000 0.720 0.081 0.125 -0.006 -0.061 0.490 0.631Emerging Equity 47.4% 1.000 0.028 0.125 -0.072 -0.188 0.608 0.630Hedge Funds (HFRI) 12.9% 1.000 0.268 -0.028 -0.031 -0.085 0.055Commodities 41.6% 1.000 0.111 -0.197 0.178 0.158Inflation-Linked Bonds 6.2% 1.000 0.562 0.236 0.152G7 Long Bonds 16.5% 1.000 0.048 -0.014Emerging Debt 23.2% 1.000 0.516High Yield Debt 16.9% 1.000 • Private Equity: Cambridge U.S. Private Equity Index • Developed Equity: MSCI World Index • Emerging Equity: MSCI Emerging Equity Index • Hedge Funds: HFRI Fund of Funds Composite Index • Commodities: S&P GSCI Index • Inflation-Linked Bonds: Barclay’s Global Real Bond Index • G7 Long Bonds: Barclay’s G7 Long Treasury Index • Emerging Debt: JP Morgan EMBIG Index • High Yield Debt: Merrill Lynch High Yield Master II IndexSource: Invesco Analysis. Based upon data covering the period 31 March 1986 through 30 June 2012. For illustrativepurposes only.3
  • 5. Portfolio ConstructionRISK, RETURN & CORRELATION ASSUMPTIONS Risk is multi-dimensional. Our goal is to construct practically optimal portfolio structures that consider both Sharpe Ratio and risk concentration. Risk, Return & Correlation Assumptions Equal-Weighted Balanced-Risk Optimized Solutions Solutions Solutions Known Unknown Known Unknown Known Unknown Risk Risk Risk Return Return Return Correlation Correlation CorrelationFor illustrative purposes only.4
  • 6. Portfolio ConstructionDIVERSIFICATION FRAMEWORK Inflationary Growth Non-Inflationary Growth • Commodities • Developed Equities • Inflation-Linked Bonds • Emerging Equities Growth Assets • Private Equity Inflation Hedges • High Yield • Emerging Debt • Hedge Funds Deflation Hedges Recession • Long-Term Government Bonds (hedged)Source: Invesco analysis. For illustrative purposes only.55
  • 7. Hedge Funds, Private Equity & Equity BetaRETURNS BY EQUITY MARKET ENVIRONMENT 30 • Skill is defined by both a high Hedge Funds Private Equity 25 Information Ratio as well as independence from market 20 returns (Beta) Annualized Return 15 10 • Though often considered “Alpha” strategies, both hedge 5 funds and private equity have a 0 high Beta component -5 -10 • Hedge funds and private equity, on average, struggle during -15 equity market turmoil Lowest 60th to 40th to 20th to Highest 20% 80% 60th 40th 20% S&P 500 Return by QuintileSources: Invesco analysis. Performance returns shown are from 1/31/90 through 12/31/11. Hedge fund returns are representedby HFRI Fund of Funds Composite Index. Private equity returns are represented by The Cambridge Associates LLC U.S. PrivateEquity Index. Past performance does not guarantee comparable future performance; an investment cannot be made directly intoan index.6
  • 8. Credit Spread & Equity BetaRETURNS BY EQUITY MARKET ENVIRONMENT 50 High Yield Debt Emerging Debt 40 • Credit risk is Annualized Excess Return equity risk that (vs. Barclays US Treasury Index) 30 masquerades as 20 fixed income risk. 10 0 • Credit asset classes, on -10 average, struggle -20 during periods of equity market -30 turmoil. -40 Lowest 60th to 40th to 20th to Highest 20% 80% 60th 40th 20% S&P 500 Return by QuintileSources: Invesco analysis. Performance returns shown are from 1/31/90 through 12/31/11. High yield returns are representedby Bank of America Merrill Lynch High Yield Master II Index. Emerging debt returns are represented by the J.P. Morgan EMBIGlobal Composite Index. Annualized returns are excess returns versus the Barclays US Treasury Index. Past performance doesnot guarantee comparable future performance; an investment cannot be made directly into an index.7
  • 9. Risk Parity Implementation – Example “A”CAPITAL & RISK ALLOCATION WITHOUT A DIVERSIFICATION FRAMEWORK Risk Parity Risk Parity Weight MCR Weight MCR %MCR Private Equity 8.41% 0.91% Non-Inflationary Growth 48.35% 5.48% 66.67% Developed Equity 4.59% 0.91% Inflationary Growth 34.94% 1.83% 22.22% Emerging Equity 3.30% 0.91% Recession 16.71% 0.91% 11.11% Hedge Funds 17.52% 0.91% TOTAL 100.00% 8.19% 100.00% Commodities 5.12% 0.91% Inflation-Linked Bonds 29.81% 0.91% G7 Long Treasuries 16.71% 0.91% Emerging Debt 6.25% 0.91% High Yield Debt 8.28% 0.91% TOTAL 100.00% 8.19%Source: Invesco analysis. MCR refers to Marginal Contribution to Risk. For illustrative purposes only.8
  • 10. Risk Parity Implementation – Example “B”CAPITAL & RISK ALLOCATION INCLUDING A DIVERSIFICATION FRAMEWORK Risk Parity Risk Parity Weight MCR Weight MCR %MCR Private Equity 6.07% 0.44% Non-Inflationary Growth 31.84% 2.67% 33.33% Developed Equity 3.13% 0.44% Inflationary Growth 40.33% 2.67% 33.33% Emerging Equity 2.54% 0.44% Recession 27.83% 2.67% 33.33% Hedge Funds 11.05% 0.44% TOTAL 100.00% 8.00% 100.00% Commodities 7.31% 1.33% Inflation-Linked Bonds 33.01% 1.33% G7 Long Treasuries 27.83% 2.67% Emerging Debt 3.75% 0.44% High Yield Debt 5.30% 0.44% TOTAL 100.00% 8.00%Source: Invesco analysis. MCR refers to Marginal Contribution to Risk. For illustrative purposes only.9
  • 11. Risk Parity ImplementationCAPITAL & RISK ALLOCATION Risk Parity Example “A” Risk Parity Example “B” Weight MCR %MCR Weight MCR %MCR Non-Inflationary Growth 48.35% 5.48% 66.67% 31.84% 2.67% 33.33% Inflationary Growth 34.94% 1.83% 22.22% 40.33% 2.67% 33.33% Recession 16.71% 0.91% 11.11% 27.83% 2.67% 33.33% TOTAL 100.00% 8.19% 100.00% 100.00% 8.00% 100.00%Source: Invesco analysis. MCR refers to Marginal Contribution to Risk. For illustrative purposes only.10
  • 12. Strategic Risk Parity ImplementationONLY A STARTING POINT Strategic allocation Tactical allocation Adjust to Prepare Engineer for Return market for risk conditions Design a portfolio of Pair risky assets with Evaluate market risky assets with positive long-term government conditions and long-term return bonds adjust portfolio expectations allocationsSource: Invesco analysis. For illustrative purposes only.11
  • 13. Risk Parity Implementation STRATEGIC VS. TACTICAL ASSET ALLOCATION Composition of Risk Level of Risk • Strategic Allocation Strategic Strategic 33% 10% is calculated 8.0% 8% through volatility 22% 6% Risk (%) Risk (%) and correlation 4% 11% estimates 2% 0% 0% Non-Inflationary Recession Inflationary Growth Strategic Growth • Active positioning 50% Tactical Range Tactical Range 10% allows the asset 40% 8% 8.0% 33% strategic allocation weights to deviate Risk (%) 30% 6% Risk (%) from the long-term 20% 4% strategic allocation 10% 2% 0% 0% Non-Inflationary Recession Inflationary Growth Tactical Growth Source: Invesco analysis. Above figures do not represent specific time periods or actual portfolio results. For illustrative purposes only. Asset classes are subject to change and are not buy/sell recommendations.12
  • 14. Additional Information Any simulation presented here was created to consider possible results of a Risk Parity Strategy (not previously managed by Invesco for any client). These performance results are hypothetical (not real) and were achieved by using a balanced risk optimization model. It may not be possible to replicate these results. The hypothetical results were derived by back-testing using a simulated portfolio. There can be no assurance that the simulated results can be achieved in the future. While the balanced risk optimization model was used to reflect the investment process for a Risk Parity Strategy, this model does not factor in all the economic and market conditions that can impact results.13
  • 15. Important informationThis presentation is for Professional Clients only and is not for consumer use.Where R Scott Hixon has expressed views and opinions, they are based on current market conditions andare subject to change without notice. These opinions may differ from those of other Invesco Perpetualinvestment professionals.Where securities are mentioned in this document they do not necessarily represent a specific portfolioholding and do not constitute a recommendation to purchase or sell.Further information on our products is available using the contact details shown.Invesco Perpetual is a business name of Invesco Asset Management LimitedPerpetual Park, Perpetual Park Drive, Henley-on-Thames, Oxfordshire RG9 1HH, UKAuthorised and regulated by the Financial Services Authority. 14