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The Future of Asset Management

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    The Future of Asset Management The Future of Asset Management Document Transcript

    • The Future of Asset Management FUNDAMENTAL ASSET ALLOCATION  The new global economy and rapid advancements in technology are changing the fundamentals of investing at a rate the industry has never seen before, rendering many mainstream asset management strategies obsolete.  Pensions and institutions need to change their traditional processes to ensure their portfolios remain relevant to their plan members and to identify the next asset managers and asset management methodologies that will thrive in this new era.  Asset management strategies that are not relevant to plan members represent an avoidable liability for pensions and institutions, especially during volatile markets. The banking industry fell first. Are pensions next?  Consumption-Based Fundamental Asset Allocation introduces a new generation of asset management methodologies which utilize the fundamental attributes of the Investor, not the investment.  These consumption and GDP-based asset allocation methodologies create the most relevant portfolios for institutions, pensions and plan members. A Willis Group White Paper © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net
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    • The Next Asset Managers Consumption-based Fundamental Asset Allocation The purpose of this white paper is to show institutional asset managers how to recognize and respond to rapid transformation so they can stay relevant to their plan members and thrive in the new global economy. We believe that institutional asset managers stand at a historic crossroad where they must embrace transformation to stay relevant to their plan members or risk being completely bypassed by the next generation of Investors and asset management methodologies. Pensions and institutions need to change their traditional processes to ensure their portfolios remain relevant to their plan members and to identify the next asset managers and asset management methodologies that will thrive in this new era. Institutions that ignore this transformation and stay with their traditional screening processes will continue to hire traditional asset managers, and their portfolios will rapidly lose relevance during this transformation. Asset management strategies that are not relevant to plan members represent an avoidable liability for pensions and institutions. The focus has been on the fall of the banking industry; however, many pensions and institutions have been hit as hard and will receive increased scrutiny in the years that follow. During periods of large negative returns, plan members will begin to ask how these portfolios were relevant to them. The institutional asset managers who can show their plan members how their investment processes are Investor-Driven will have the advantage, in our opinion. We believe that Emerging Managers will be the primary source of the next generation of asset managers to lead Investors out of the global financial crisis because their lean, efficient models are best positioned to adapt to transformation and create new value for Investors. Many established industry leaders are too entrenched in traditional (Industrial Age) processes to adequately recognize and respond to this transformation. Consumption-based Fundamental Asset Allocation introduces a new generation of asset management methodologies that utilize the fundamental attributes of the Investor, not the investment. We believe that these consumption and GDP-based asset allocation methodologies create the most relevant portfolios for institutions, pensions and plan members. Michael Willis President The Willis Group Giant 5 Funds
    • TABLE OF CONTENTS LETTER FROM THE PRESIDENT CHAPTER I. THE AGE OF THE BROKER.................................................................................. 1 A. Origin of Wall Street E. Infrastructure is Expendable B. The Brokers Club F. The Perfect Storm C. Conflicts of Interest D. Back to the Buttonwood CHAPTER II. THE AGE OF THE INVESTOR............................................................................. 5 A. The Next Big Idea E. Full Liquidity B. Investors First—Brokers Last F. Full Transparency C. No Leverage G. Transformation D. No Shorting H. New Leadership CHAPTER III. ASSET ALLOCATION........................................................................................... 8 A. Fundamental Asset Allocation E. The Evolution B. Trading is Rocket Science F. Investing in the Box C. The First Big Idea G. Box Strategies Are Obsolete D. The New Rocket Science H. The Bottom Line is Relevance CHAPTER IV. CONSUMPTION-BASED FUNDAMENTAL ASSET ALLOCATION................ 12 A. Consumption-Based Fundamental Asset Allocation (CFAA) B. Investor Fundamentals G. The Holy Grail C. Invest Where You Spend H. Prices Rise Over Time D. GDP Diversification I. Freedom E. Risk Management J. Performance F. Temptation and Deception K. Differentiation | Alpha CHAPTER V. THE FUTURE OF ASSET MANAGEMENT....................................................... 20 A. The Future of Asset Management D. New Indexes B. ETFs and Indexes E. Emerging Managers C. Fund of Funds CONCLUSION.................................................................................................................................. 24 A. Opportunity © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 1
    • FUNDAMENTAL ASSET ALLOCATION The Future of Asset Management Michael G. Willis President and Lead Portfolio Manager May 2009 The Willis Group Volume 1.0 TABLE OF CONTENTS Investor, not the investment, as the primary determinant for all asset allocation decisions. This methodology is built OVERVIEW ........................................................................... 1 for the Age of the Investor and offers asset managers and their Investors clear advantages over mainstream CHAPTER I. THE AGE OF THE BROKER ....................... 1 strategies. CHAPTER II. THE AGE OF THE INVESTOR .................. 5 CHAPTER III. ASSET ALLOCATION ……......................... 8 Chapter Five gives examples of new industry transformers who have determined to be the next industry leaders by CHAPTER IV. FUNDAMENTAL ASSET ALLOCATION... 12 creating new value for Investors and asset managers. CHAPTER V. FUTURE OF ASSET MANAGEMENT….. 20 CONCLUSION ……………………………………………………... 24 The new global economy and rapid advancements in technology are changing the fundamentals of investing at a rate the industry has never seen before. This transformation presents Investors with a rare opportunity “Consumption-based Fundamental Asset to reinvent Wall Street on their own terms while Wall Allocation introduces a new generation of asset Street has a once-in-a-lifetime opportunity to earn back the management methodologies that utilize trust of Investors and lead them out of this crisis. Investors fundamental attributes of the Investor, not the will be the cornerstone of the next Wall Street. The asset investment, as the primary determinant for all management companies that effectively respond first will asset allocation decisions.” be the next global leaders and will reap the benefits of the biggest asset-gathering opportunity in 100 years. Overview The purpose of this white paper is to show institutional CHAPTER I asset managers how to recognize and respond to rapid transformation so they can stay relevant to their plan THE AGE OF THE BROKER members and thrive in the new global economy. Chapter One looks at the origin of Wall Street, why the Age of the Broker failed, and how its transformation places the entire industry at a critical crossroad where it must respond or be bypassed by its customers—Investors. Chapter Two covers how the Age of the Investor and the new global economy have ushered in a new set of rules and values that has changed the fundamentals of investing and asset management. Chapter Three reviews the historic importance of asset allocation and how traditional asset management strategies do not provide Investors with financial confidence because they are no longer relevant to the primary reason they invest. Chapter Four introduces Consumption-based Fundamental Asset Allocation, a new generation of asset management methodologies that use fundamental attributes of the © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 1
    • A. The Age of the Broker: Origin of Wall Street Rarely has a 200-year-old contract agreement held true to There is a very good reason why Main Street doesn’t trust its original founding intent as completely as this one has. Wall Street. The root of this great divide goes all the way back to The Buttonwood Agreement—the original “Credit has to be given to these Brokers. Rarely has a founding document that established the New York Stock 200-year-old-contract agreement held true to its Exchange and Wall Street [Figure 1.0]. This historic original intent as completely as this one has.” document created an unlevel playing field from the beginning and made it crystal clear that Wall Street was created “by the Broker and for the Broker”—not the Few experiences are less enjoyable than entering into a Investor. rigged negotiation, especially when your life savings are at stake. It is not surprising that Investors often come away On May 17, 1792, twenty-four stockbrokers gathered from the Wall Street experience feeling plundered and left under the buttonwood tree at 68 Wall Street to formalize standing with the bill. When Investors place their future into existence one of the most important financial financial security in the hands of Wall Street, it is a huge act establishments in world history. Though monumental in its of trust. But at some point, given enough abuse, the public financial scope, this document also contained the seeds trust will go away and Investors will come for their money that eventually would rip Wall Street apart. with pitchforks. It is not surprising to see the top Wall Street executives all lined up in front of Congress taking the THE BUTTONWOOD AGREEMENT 1792 grilling of a lifetime these past few months. The bigger question is how all of this lasted 200 years before it blew “We the Subscribers, Brokers for the Purchase and Sale of the up. Public Stock, do hereby solemnly promise and pledge ourselves to each other, B. The Age of the Broker: The Brokers Club that we will not buy or sell For the purposes of this paper, we define “Investors” as from this day for any person both the individual and the whatsoever, any kind of pooled consortium of Investors Public Stock, at least than found in large pension funds, one quarter of one percent foundations and other Commission on the Specie institutional accounts. We also value and that we will give define “Brokers” as the preference to each other in Investment Banking Firms, our Negotiations. In Brokers, Market Makers and Testimony whereof we have Specialists—the infrastructure of set our hands this 17th day Wall Street. These professionals of May at New York, 1792.” have always been considered essential to an efficiently-run financial industry—the “oil” that keeps everything working. Ideally, Investment Shown above in its entirety, the Buttonwood Agreement Banking Firms and their Brokers create, manage and sell made three resolutions. investments that help provide for Investor retirements. ONE: The first resolution created a “Brokers Club” that Market Makers provide the liquidity for everyone to trade effectively was a cast system that put Brokers first (ahead at fair prices and Specialists protect Investors by accurately of “any person whatsoever” they traded for—Investors). pricing securities and by buying when everyone is selling. TWO: The second resolution established price fixing on the commissions the Brokers would charge to Investors (a This ideal was certainly challenged last year when the stock minimum fee no Broker was to go below). market started to freefall and Investor 401k’s were cut in THREE: The final resolution declared that the Brokers half. It was difficult to find any of these professionals would give each other “preference in negotiations,” or less “buying when everyone was selling.” In fact, instead of eloquently put, they rigged their negotiations and created buying to protect their customers (Investors), it appears an unlevel playing field. that they were the ones doing the selling when they were forced to unwind their leveraged positions as the markets This document started the Age of the Broker and created a fell. In fact, this collapse is unique because it appears to Brokers Club culture that has permeated Wall Street for the have been caused by Wall Street itself. past 200 years. Credit has to be given to these Brokers. © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 2
    • C. The Age of the Broker: Conflicts of Interest with “Investor” and you are already halfway there. Next, Historically, Investors have been given no reason to believe eliminate the price fixing on fees and give preference to that their interests were ever placed first. The exclusive Investors in all negotiations. Now you have a founding nature of the Buttonwood Agreement naturally created a document that might begin to restore trust and bring structure that layered conflicts of interest across every Investors back to the table. Our rewrite of the Buttonwood level of Wall Street. Investment Banking Firms received would go quite a bit further, however. Two hundred years underwriting fees for investment products and then of infrastructure built around a Brokers Club system may became the same companies to evaluate, rate and require a complete dismantling to build something that will recommend these products to Investors. Brokers thrive during the Information Age. recommended higher-paying proprietary products first and were paid regardless of how the Investor fared in the “It really wouldn’t take too much work to fix the recommended investment. original Buttonwood Agreement. Delete “Broker” and replace it with “Investor” and you are already “The bottom line is that the Buttonwood Agreement halfway there. Our rewrite of the Buttonwood would was a “Brokers First—Investors Last” document that go quite a bit further, however.” ultimately set in motion many of the events that are now unfolding across Wall Street.” E. The Age of the Broker: Infrastructure is Expendable For those who grew up seeing telephone poles their whole As for liquidity, Market Makers have a huge conflict of lives, it would be easy to conclude that telephone lines interest not to give Investors the best fill. The worse the fill were the essential component to an efficiently run phone for the Investor, the more they get to take home. Every industry. How else are the voices going to communicate portfolio manager worth his salt knows to put on his full with each other? [Figure 1.2] It turns out that the battle gear and prepare for bloody hell every time a infrastructure was disposable, and it was the decision has been made to purchase or liquidate a holding. communication that was the essential component. Many If you don’t, you are just giving away money. In our parts of Asia will never see a telephone line because cell experience, instead of a “sure glad you came to trade with phones and web phones have made the hard line us today let me see how I can help you” service, Market infrastructure obsolete and unnecessary. Makers take as much as they possibly can from you just short of drawing attention from the regulators. Finally, what purpose was served by giving Specialists monopoly power to price a stock for the public while simultaneously having the ability to purchase or short shares of the same stock in their own personal trading accounts (in addition to their corporate accounts)? The fact that the largest investment banking firms on Wall Street have historically been placing their interests ahead of “any person whatsoever” should not surprise anyone. This is exactly what they agreed to do right from the beginning in the Buttonwood Agreement. The bottom line is that the Buttonwood Agreement was a “Brokers First—Investors Last” document that ultimately set in motion many of the events that are now unfolding This is not an isolated example. One by one industries are across Wall Street. To be clear, Wall Street can be saved shedding infrastructure in order to thrive in the but it will require a return to the Buttonwood to rewrite Information Age. EBay did. Amazon did. Google did. And Investors back into their rightful place (first) in the new the companies that don’t transform will quickly get passed founding document of the next Wall Street. by. For example, look at how the music industry is being bypassed by its next generation of customers who would D. The Age of the Broker: Back to the Buttonwood much rather download one song via MP3 than purchase an It really wouldn’t take too much work to fix the original entire album on a CD. And how many times in the past Buttonwood Agreement. Delete “Broker” and replace it © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 3
    • week did you use Google over the Yellow Pages? Or the their customers (The Emerging Industry). This value Internet over Encyclopedia Britannica? creation is recognized and rewarded by customers, spurring a Growth Industry. As the Growth Industry slows Wall Street should heed these warning signs or it will be down, intellectual capital is protected more than it is 2 completely bypassed by its next generation of customers. created, and innovation is discouraged as disruptive. This Rapidly changing technology has become the great creates a Status Industry where the main players are equalizer as the Information Age is rendering large content to rest on past accomplishments. Eventually infrastructures obsolete all over the world. Investors now customers see the industry for what it has become and have immediate access to unlimited information and the they leave, sending it into the Depleted Stage of the technology needed to bypass Wall Street altogether. Not Industry Lifecycle. There are only two ways out of a only is Wall Street not exempt from becoming obsolete, Depleted Industry—transform or be bypassed. but recent events have made it ripe for becoming obsolete. 2) The Age of the Broker is transforming to the Age of the Investor. Not only is capitalism woven into the fabric of this country, but so are core concepts from America’s founding document—The Declaration of Independence. “That whenever any form of government becomes destructive to these ends, it is the right of the people to alter or to abolish it, and to institute new government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their safety and happiness…But when a long train of abuses and usurpations, pursuing invariably the same object evinces a design to reduce them under absolute despotism, it is their right, it is their duty, to throw off such government, and to 3 provide new guards for their future security.” We think that Investors have reached the tipping point where now they no longer believe in Wall Street, at least not in its present form. Just as the Declaration of Independence shed hundreds of years of British infrastructure and tradition, we believe that Investors are finished with the Age of the Broker [Figure 1.4] and are F. The Age of the Broker: The Perfect Storm moving into the Age of the Investor where they will wield Three powerful events have converged on Wall Street to much more of the control. form the perfect storm, powerful enough to send Wall Street right to the brink of extinction. 1) Creative Destruction. Joseph Schumpeter states that creative destruction is the “essential fact” about capitalism because capitalism “incessantly revolutionizes the economic structure from within, incessantly destroying the 1 old one, incessantly creating a new one.” We believe creative destruction accurately describes what is unfolding before us on Wall Street. The financial services industry finds itself in the Depleted Stage of the Industry Lifecycle. [Figure 1.3] The most visible players are collapsing from the inside and are able to create little new value in the marketplace because their stock of intellectual capital is depleted or covered by layers of bureaucracy. Depleted Industries ignore transformation because they do not see it or they do not understand how to respond to it. As a result, “industry transformers” emerge as leaders, clearly seeing the transformation and are able to create great value for © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 4
    • 3) The Information Age. At the same time all of this is but we believe Investors would flock to a fully transparent, happening, information became ubiquitous, technology fully liquid, long only, cash-based global stock exchange if it exploded and the Internet has given the world the ability to was available. speak with one mind and one language. No small feat, We touch briefly on each of these four principles next considering that the last time that happened was about 4 because we believe they are representative of what five or ten thousand years ago at the Tower of Babel. The Investors want to see in new investment structures and result is that change just went supersonic. It is occurring at asset management strategies going forward. Investors in a velocity never seen before in our history. Large financial the Information Age will prefer and reward portfolios that bureaucracies for the most part are in a state of denial and are relevant to their specific needs. They will focus on only a few of those who see it actually have the capability investments that offer total transparency, immediate to respond to this change in time to save themselves. diversification and full liquidity. They will trust unbiased independent platforms that level the playing field and CHAPTER II minimize conflicts of interest. Lastly, long-term Investors will avoid asset management strategies that focus on THE AGE OF THE INVESTOR leverage or shorting. B. Age of the Investor: Investors First—Brokers Last A. Age of the Investor: The Next Big Idea The true center of the financial universe is the Investor. Underscored throughout this transformation is that Wall Therefore, the New Global Stock Exchange should reverse Street is not the essential element of investing—it never the order of priority given to Brokers and Investors by the has been. It has always been the Investor. The fall of Wall founding documents of Wall Street so that Investors are Street poses an interesting choice for Investors. If Wall placed first, “ahead of any person whatsoever.” As for the Street fails to transform itself, industry transformers will Brokers, the shortest path between any two objects is a likely bypass this Brokers Club and build a new global straight line. At no other time has minimizing the number investment exchange “of the Investor, by the Investor, of middlemen between the product and the customer and for the Investor”. been so important to staying in front of the competition. And when the middlemen have conflicts of interest, it is akin to letting foxes into the henhouse. Until the advent of the internet, it was simply impossible to introduce the customer directly to another customer or product without the use of middlemen. The technology just wasn’t there. Now for the first time in history, this model is feasible on a global scale. Through the lens of the Industrial Age it would be virtually impossible to visualize Wall Street without its current infrastructure. Through the lens of the Information Age, however, we may see this happen overnight. In our opinion, the New Global Stock Exchange (NGSE), or whatever emerges next, should contain four founding principles to avoid repeating the mistakes of the past [Figure 1.2 logo example]: 1. Investors First—Preference Given To Investors 2. Cash-Based Investing—No Leverage | No Shorting 3. Immediate Liquidity & Pricing—No Illiquid Securities 4. Total Transparency & Full Disclosure—Level Field Envision a New Global Stock Exchange that requires sellers to sell only what they own and buyers to purchase only what they can afford with cash. Sounds logical, even elementary; however, this is a radical and controversial concept to most investment banking firms. Wall Street insiders can scoff at the idea of no leverage and shorting, © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 5
    • C. Age of the Investor: No Leverage Sure, some strategies benefit from the use of leverage, but Ultimately, using leverage to increase returns is a wealth leverage used to increase returns is like unstable rocket killer. There are no shortcuts on the long road to fuel and has a way of eventually blowing up in the face of financial independence. Leverage on Wall Street takes on everyone who plays with it—even Wall Street’s best and many faces, but at its core, it is the act of purchasing brightest. Once the nation’s most powerful bank, Citigroup something with nothing in an attempt to increase returns. traded under $1 per share for the first time in March. After Try to take a second look at that definition as if you are becoming the largest bank by both assets and market 5 learning what leverage is for the first time. Is this investing capitalization, Citigroup now ranks near the bottom. Just or a product created by Brokers to speed up (or destroy) 18 months ago the following companies were named the slow and steady creation of wealth? among the greatest companies in the world (we could have listed another 10 pages of top-tier companies with Fast money is tempting because it promises to shortcut the identical looking charts). What could have erased 30 years long road to financial independence, but it’s a much better of wealth this quickly? Leverage. fit for Las Vegas than the New Global Stock Exchange. We were conditioned during the Age of the Broker to believe that leverage is necessary to run efficient financial markets. But this message is pure propaganda by a selling machine that understands all too well what greed can do for sales. Now, the carnage left behind by the use of leverage can be seen strewn all over Wall Street and Main Street today. It has quite literally brought Wall Street and this country to its knees for the second time in 80 years. The Crash of ‘29 and the Great Depression (Figures 1.6 and 1.7) that followed should have been the only wakeup call this country ever needed regarding leverage. Instead, we can now chalk up two of the largest losses of wealth in history to this “important” financial tool. Leverage also muddies the water when it comes to transparency. It is difficult to value a portfolio or holding when leverage is a factor because the value can literally go to zero overnight (Figures 1.8-a,b,c,d). When you don’t know exactly what you own, financial confidence is lost and Investors stay away. If the New Global Stock Exchange was cash based, it would bring immediate stability and legitimacy to the entire trading system. © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 6
    • “Leverage has quite literally brought Wall Street and this country to its knees for the second time in 80 years. The Crash of ‘29 and the Great Depression that followed should have been the only wakeup call this country ever needed regarding leverage.” E. Age of the Investor: Full Liquidity Illiquid investments have their place, but they do not belong on a public stock exchange where daily pricing and full transparency is required. Illiquid investments require an extra layer of due diligence, middlemen and trust relationships in order for the Investor to be successful. For the New Global Stock Exchange, Investors need immediate D. Age of the Investor: No Shorting access to their money and full visibility of their investments Shorting has nothing to do with the original intent of at all times. Illiquid securities offer neither. investing and introduces a competing force that is wrought with conflicts of interest. Simply put, shorting is selling F. Age of the Investor: Full Transparency something you do NOT own, or “the practice of selling a Lastly, Investors want their financial world to be clear and financial instrument that the seller does not own at the logical. They are tired of the smoke and mirrors and the 6 time of the sale.” This definition is worth a second look. If culture of complexity that Wall Street created and hid someone had not been “refined” or callused by decades of behind. This complexity was the nature of Wall Street, not Wall Street influence, would they more likely identify this investing. The best ideas are clear and logical, and at its practice as investing or fraud? core, so is investing. Creating a new culture of transparency to replace the old culture of complexity will go a long way At first glance, selling something you do not own may toward cleaning this up. Even during the days of the wild- sound like a legal way to sell the Brooklyn Bridge, but the and-woolly West you were required to play cards with both consequences are actually much worse than that. When hands above the table for everyone to see. Those who you short a company, there are at least four potential didn’t were often shot. No one likes an uneven playing victims: the company, the company employees, the field. Investors and asset managers need full disclosure and company customers and the company shareholders (i.e. visibility to make prudent decisions. Therefore, the New the Investors). Global Stock Exchange should be founded on total transparency. No matter how many times we’ve heard the positive aspects of shorting explained, it has never sounded like “Investors want their financial world to be clear and something that belonged in the same sentence with logical. They are tired of the culture of complexity investing. In fact, it would be much better named “anti- that Wall Street created and hid behind.” investing.” Not only does it have no relevance to investing in the future growth of a company, but it introduces huge G. Age of the Investor: Transformation conflicts of interests for parties betting against the same So, why does any of this belong in a White Paper? company that Investors have placed their life savings into. Everything just went liquid. Many of the old rules and Investing in the right companies is already difficult enough constructs of Wall Street and investing are simply gone. We for Investors to figure out, let alone having to worry about all just experienced the DOW freefall from 14,000 to 6,500. the creation of a competing group set on bidding down Trillions of dollars were lost in America’s 401k’s. Every their shares and seeing the company fail. Through the eyes week we read about another giant on Wall Street failing or of a Broker selling product, shorting may look like a good being swallowed up by another entity. And the largest way to boost commissions. But through the eyes of the banks did the unthinkable. They lost everyone’s money. Investor, it has no relevance to the original intent of Without outside help and government intervention, you investing. Shorting does not belong in the New Global likely would have seen a run on the entire banking system Stock Exchange. with pitchforks to follow [Figure 2.0]. © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 7
    • Remember, during the Industrial Age the grid of telephone poles that crisscrossed the entire country appeared to everyone to be essential infrastructure for a successful telephone industry. However, the Information Age showed everyone in record time that it was communication between people that was the essential element, not the huge entrenched infrastructure of telephone poles. Likewise, the global investment industry is about Investors communicating with other Investors, and the Industrial Age infrastructure is being dismantled before our eyes. If the Information Age has shown us one thing, it has the ability to ruthlessly cut through the complexity of an entire industry and single out the essential element before any of the industry leaders have time to think. In our case, everything points to the Investor as the essential element that will survive and come through this transformation, not All of this turmoil is the result of something much bigger the Industrial Age infrastructure that has become than a real estate bubble or a corruption scandal. What synonymous with our industry. you are now seeing is clear evidence of global transformation at a rate the world has never seen before. “The next generation of asset allocation The Information Age just destroyed whatever was left of methodologies will be built around Investor the Industrial Age on Wall Street. Some of the best fundamentals. This, we believe, is the future of asset companies in the world did not see this transformation management in the Information Age.” coming, and the ones that did certainly underestimated the speed of its onslaught. The signs were staring us all in the face as we watched China and India accomplish in 20 years what it took past civilizations as long as 100 times CHAPTER III that to accomplish. And the pace is quickening, not ASSET ALLOCATION slowing. The wake of devastation this transformation is rendering to anything standing in its way (anyone holding onto an Industrial Age mindset or strategies) is widening A. Consumption-based Fundamental Asset Allocation daily. The purpose of this white paper is to show Asset Managers and Investors how to recognize and respond to rapid “The events now unfolding on Wall Street are the transformation so they can stay relevant and thrive in the result of something much bigger than a real estate new global economy. Since the Investor is the essential bubble or a corruption scandal. What you are now element in the financial universe, the Investor is the key to seeing is clear evidence of global transformation at a unlocking the future of the industry. Consumption-based rate the world has never seen before.” Fundamental Asset Allocation (CFAA) introduces a new generation of asset management methodologies that use fundamental attributes of the Investor, not the investment, H. Age of the Investor: New Leadership as the primary determinant for all asset allocation The main point is that the Information Age is not only decisions. You wouldn’t think putting the Investor at the transforming the infrastructure of Wall Street, but it is also center of the asset allocation process would be such a changing the face of investing and asset management at a radical concept; however, most prevailing strategies use rate the world has never seen before. Investment banking the attributes of the investment to determine how the firms and asset managers that fail to recognize and asset allocation of the portfolio breaks out (i.e. market respond to this change will fail and fall as the others have. capitalization, growth, value, etc.). Many prevailing asset management strategies have lost their relevance to Investors and therefore have become obsolete. As with Wall Street, if it is not relevant to the individual Investor, it will have a difficult time surviving this period of global transformation. © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 8
    • William Sharpe added to Markowitz’s research exploring the “efficient frontier” of portfolios by formalizing the 8 Capital Asset Pricing Model (CAPM) in 1964. Their collective research in this area eventually earned each of them a Nobel Prize. What was so significant about their findings? Their research showed that asset allocation—not market timing or security selection—is the primary determinant of the risk and return, or performance, of a portfolio. “Knowing what individual company to buy and when to sell it has never been the primary contributor to the long-term risk and return, or performance, of a Before we take a closer look at this new asset allocation portfolio.” methodology, let’s look at how history led us here. D. Asset Allocation 1.0: The New Rocket Science B. Asset Allocation 1.0: Trading is Rocket Science Since then, major studies have set out to identify what Since the days of the Buttonwood, the traders and stock percent each factor contributes to overall performance. jockeys always got the glory. That was the rocket science— 9 Two separate studies by Gary P. Brinson and Roger G. the real game. Even today, asset managers rise and fall on 10 Ibbotson appear to place asset allocation’s contribution Wall Street based on their ability to select individual above 90 percent. (Figure 2.3) Although the exact companies at the right time. The financial media almost percentage will always be in debate, we believe that most exclusively focuses on what to buy or sell today and what asset managers would agree that asset allocation is the will be the best performing asset tomorrow. But knowing primary determinant of the long-term, or average, risk and what individual company to buy and when to sell it has return of a portfolio. never been the primary contributor to the long-term performance of a portfolio. That honor goes to a well known concept called asset allocation, or the diversification of a portfolio among different asset classes, categories and sectors. C. Asset Allocation 1.0: The First Big Idea In 1952 Harry Markowitz introduced Modern Portfolio 7 Theory (MPT). His work was one of the first to show that assessing the risks and rewards of individual securities when constructing a portfolio was not the primary determinant of the overall performance of the portfolio. The significance of this fact cannot be overstated. The irony is Wall Street culture showcases the stock jockeys who potentially only contribute to a small percentage of the overall performance while most of the work is quietly being handled by the asset allocation team. For us, this focus on trading is backward and only helps to benefit the billion-dollar industries that have emerged to feed off individual Investors as they jump from one investment to the next hoping to land on this year’s best performer. © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 9
    • Focusing on the trading is like evaluating a car by its paint investment banking firms that utilize and promote box job, or watching the warm-up act and missing the main methodologies, one could easily mistake the box as the event. The accessories are important, but never let them Holy Grail of Wall Street. distract you from the actual product. F. Asset Allocation 1.0: Investing In The Box Because individual security selection and timing are This “Box” theory states that minority contributors to the overall performance of the each box has unique character portfolio, these factors should never be the backbone of an traits that allow asset asset management strategy. This is a misallocation of managers to control risk and resources that eventually leads to inconsistent return by using specific performance as the manager cycles through hot and cold combinations of the boxes streaks. Since asset allocation factors are the primary when constructing the overall contributors to overall performance, the best asset portfolio. In theory, this management strategies are built from this foundation. control allows asset managers Therefore, this is where we have determined to focus our to match the Investor’s time, brain power and energy. Though it may be too boring desired risk and return. The to draw the attention of the mainstream financial media, general idea is that the largest asset allocation is the true Rocket Science of Wall Street! companies are the safest in terms of risk while the smallest companies carry the most amount of risk to the portfolio. “Markowtiz and Sharpe received the Nobel Prize for Growth managers buy the fastest-growing companies at their research which showed that asset allocation, any price while value managers find quality companies not market timing or individual security selection, is whose stock price has fallen below their “real” value. the primary determinant of the risk and return, or International securities are considered a higher risk across performance, of a portfolio.” the board and are usually saved for more aggressive portfolios. But these rules are changing, and even though most portfolio managers and investment banking firms E. Asset Allocation 1.0: The Evolution recognize that the asset management landscape is in a Behind the scene, asset allocation has quietly evolved over constant state of steady change, the industry as a whole the past 50 years. Originally focusing on just two general seems to be in denial as to the extent of transformation it asset classes (stocks and bonds), asset allocation now is currently experiencing. We believe that “box theory” is comes in many forms: Strategic, Dynamic, Tactical, dead, killed by the micro-chip and the Internet. Momentum and a host of others. G. Asset Allocation 1.0: Box Strategies Are Obsolete Are large companies now safer for Investors to own than smaller companies? Is a company based in the United States now safer for Investors to own than a company in Europe or Asia? If you cannot answer with a resounding “Yes!” to these two questions, then why are the primary determinants of asset allocation still the size, style and location of the investment? Better yet, what is the new standard? “We believe that “box theory” is dead, killed by the micro-chip and the Internet.” Although the implementation varies among these We believe that box investing is one of the first asset strategies, the majority have been heavily influenced by management casualties of the Information Age. Asset “box” methodologies. These methodologies divide allocation strategies that are box driven are no longer individual stocks, funds and indexes into at least nine relevant to the Investor and are therefore obsolete. Why? boxes: Large Cap Growth, Large Cap Value, Large Cap Core, Technology has flattened the playing field for all companies Mid Cap Growth, Mid Cap Value, Mid Cap Core, Small Cap no matter their size or location. Is the company large-cap Growth, Small Cap Value, and Small Cap Core (Domestic or mid-cap? What does this matter in the Information and International of each category). In fact, based on the overwhelming percentage of asset managers and © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 10
    • Age? Is it domestic or international? What does this matter in a new global economy? If the boxes all become correlated and lose their unique character traits, they are no longer useful for risk During the Industrial Age, the larger a company was, the management. If they cannot predict risk levels for better chance it had to survive, and thus it was considered Investors, they have lost their relevance and should not be lower risk to the Investor. Now, the large size of a a primary determinant of asset allocation. Even asset company can be a liability for responding to the rapid managers have begun to grumble that being “boxed in” changes presented by the Information Age. Large limits their performance by restricting them to arbitrary 13 bureaucracies cannot adequately maneuver and are boundaries . Our guess is that Investors won’t miss the unable to utilize the latest technologies in order to meet or box methodology very much either as it never fell into the understand the changing needs of their customers “this makes perfect sense” column for them. Our feedback [General Motors (GM), newspapers, Kmart, etc...]. Instead from Investors is that they understood this methodology of higher risk, small and mid-size companies may have a diversified their portfolios; however, it was often unclear to more flexible model that can adjust and adapt to quickly them how the boxes were relevant to them. changing markets. Craigslist only has 25 employees and yet 11 has been repeatedly valued in the billions . Google The purpose of this white paper is not to lay out all of the 12 purchased tiny YouTube.com for $1.65 billion . And the necessary evidence that would be required to convince list grows daily. Wall Street to throw out its primary methodology of asset allocation. Rather, we would like the world to consider a During the Industrial Age, companies located in the United much more relevant methodology. States were viewed as having less risk than their foreign counterparts due to many factors such as currency risk and “Our research has shown that the primary reason political risk. Now, because of technology, rapidly rising people save money is to gain the capability to meet debt levels in America and the threat of terrorism, the risk their future spending needs.” premium associated with domestic equities is beginning to “revert to the mean” of this new global economy. H. Asset Allocation 2.0: The Bottom Line is Relevance The lower-risk companies of the Information Age are those You can do two things with money. You can spend it or that can best adapt and utilize rapidly changing you can save it. What is the reason that people don’t information and technology to enable them to identify and spend every last penny they earn? Our research has respond to changing consumer needs and wants. Size and shown that the primary reason people save money is to location are no longer relevant. If our hypothesis is correct, gain the capability to spend their money later to meet boxes, indexes and “asset classes” that are distinguished future needs, wants and emergencies that will provide for only by size and location will move sharply together in their future quality of life. correlation as we move further into the Information Age. We are already seeing evidence of this change today Since the Investor is the center of the financial universe (Figure 2.6). (investing cannot exist without Investors) and the primary reason Investors invest is to gain the capability to meet their future spending needs and desired quality of life, then the asset allocation of their investment portfolio should be tied as closely as possible to their actual spending habits. This is how you design a portfolio that is truly relevant to the Investor. It is the fundamentals of the Investor, not the investment, that should determine the asset allocation of the portfolio and this is why we named this methodology Consumption-based Fundamental Asset Allocation. “When we talk about Consumption-based Fundamental Asset Allocation, we are focusing on the fundamentals of the Investor, not the investment. Remarkably, this is a major shift from how things are currently done.” © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 11
    • Because their portfolios were built around the attributes of CHAPTER IV the investment rather than the Investor. To simplify this point, let’s say that a traditional asset manager’s research FUNDAMENTAL ASSET ALLOCATION showed that a portfolio of ABC stock was the best fit for the Investor’s stated risk/return goals. At the end of the A. The Next Big Idea: first year, ABC stock surged +30 percent while prices for Consumption-based Fundamental Asset Allocation (CFAA) Investor Spending increased by only +10 percent. At the The purpose of this white paper is to show Asset Managers end of Year 2, ABC stock grew by only +5 percent while and Investors how to recognize and respond to rapid prices for Investor Spending surged by +15 percent. In Year transformation so they can stay relevant and thrive in the One, Investors have the capability to meet the increase in new global economy. Since the Investor is the essential their spending needs; however, they lose that capability in element in the financial universe, the Investor is the key to Year Two. It is important to understand that no matter how unlocking the future of the industry. Our solution for fixing good the annual returns of ABC stock, it is pure chance that Wall Street is radically similar to the next step we believe the growth or decline of the ABC portfolio will give the asset allocation is making: Start over with the Investor at Investors the capability of meeting their future spending the center and build from there. When we talk about needs. This is because the performance of ABC stock is Consumption-based Fundamental Asset Allocation, we most likely only relevant to a small portion of the Investors’ are focusing on the fundamentals of the Investor, not the overall spending needs. Our thesis is that portfolios must investment. Remarkably, this is a major shift from how be directly correlated to Investor spending to be relevant. things are currently done. The standard process on Wall Street is for Investors to pick a risk level they are comfortable with. “Conservative,” “moderate” or “aggressive” are the most common preferences (“I am conservative.” is a popular choice today). Next, the asset manager goes off to his/her laboratory to analyze the attributes and risks associated with selected investments in order to build this “conservative” portfolio. The goal is to match the risk of the Investor with the risk of the portfolio while maximizing returns. This process sounds logical because it is what we have been taught for the past 50 years. But how is it relevant to the Investor? How does this process give Investors the capability to meet their future spending needs and desired quality of life? For example, if most of what Investors buy during the year goes up in price only slightly and yet their investment portfolio rises significantly, they are happy because they have gained the capability to meet their future spending needs. If, however, most of what Investors buy during the year goes up significantly in price and their investment portfolios rise only slightly or fall, they lose financial confidence because they may not have the capability to meet their future spending needs and desired quality of life. “The goal of Consumption-based Fundamental Asset Allocation is to give Investors the capability to meet B. Fundamental Asset Allocation: Investor Fundamentals their future spending needs and desired quality of Consumption-based Fundamental Asset Allocation is built life.” around the Investor from the ground up because nothing else is more relevant to the asset allocation process. The goal of Consumption-based Fundamental Asset Allocation Further, in both cases it was pure chance that their is to give Investors the capability to meet their future portfolios were going to meet their primary need. Why? © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 12
    • spending needs and desired quality of life. To provide them with this capability fulfills their primary need for investing Consumption-based Fundamental Asset Allocation can be and gives Investors financial confidence. This is the core constructed on an individual, country or global scale. The deliverable for all asset managers and requires that we process for individual Investors would be to match the focus directly on the Investors’ spending behavior. The asset allocation of their investment portfolio with their current spending behavior of an Investor is the single specific spending habits. As their spending changes over greatest insight we have to their future spending needs time, so should their portfolio. It is important to use and desired quality of life. Therefore, the Investors’ current spending data when designing portfolios because spending behavior determines their asset allocation and to forecasting future spending needs will lead to tracking a large extent, the risk of their portfolio. error and portfolios that are not relevant to the target Investors. If Investors buy it, asset managers should own it in their portfolios. How else can they provide Investors with the “If Investors buy it, asset managers should own it capability to meet their future spending needs? This “Invest in their portfolios.” Where You Spend” Consumption-based Fundamental Asset Allocation strategy builds a portfolio around the primary products, services and commodities that the For portfolios with multiple Investors, the asset manager Investor consumes each year. must look at a larger pool of spending data that matches the Investor base. The asset manager then needs to group For example, if a primary budget item for Investors is together the spending data into primary categories that gasoline for transportation, then oil should be purchased in will ultimately comprise the asset allocation of the their portfolio. If gas prices rise at the pumps, their portfolio. Managers with access to very specific spending portfolio should give them the capability of meeting this data on their Investor base can design very specific future increase in their spending needs. In addition, if a portfolios. For portfolios with the largest number of primary budget item for an Investor is property rent or Investors, the asset manager would need to focus on much property taxes, then real estate should be purchased in broader data such as global spending patterns. Since their portfolio. When real estate prices rise, the chances portfolios constructed with Consumption-based are good that their property taxes and property rent will Fundamental Asset Allocation methodologies are unique also rise. Thus, the growth in the real estate portion of their to the spending of their Investor base, they will invariably portfolio is designed to give them the capability to meet look different. As the Investor base grows in size, this future spending need. similarities will begin to emerge with other large portfolios because managers need to use broad spending patterns as their benchmark. This doesn’t mean that the largest “The current spending behavior of Investors is the portfolios will be identical. Consumption-based single greatest insight we have to their future Fundamental Asset Allocation managers have wide spending needs and desired quality of life.” discretion on how to best align their portfolios with Investor spending. Almost every time we have explained this methodology of asset allocation to Investors, they have walked away saying “Mainstream asset management strategies do not “How come no one else is doing this? This is the first time I provide Investors with financial confidence because walked out of an investment banking appointment fully they are no longer relevant to the primary reason understanding how my portfolio is being invested and the they invest.” process behind it. This makes perfect sense!” Providing Investors with this type of direction and capability gives them financial confidence and lays a foundation of trust To illustrate, we decided to represent the transportation with their asset manager. spending needs of our Investors with transportation fuels (energy holdings) instead of with transportation vehicles C. Fundamental Asset Allocation: Invest Where You Spend (automobile industry, airline industry, etc…). Why? To The center of the financial universe is the Investor and so is move any object from Point A to Point B requires some the next step in the evolution of asset allocation. If we are form of energy. We don’t see how purchasing GM or right, the next generation of asset allocation United Airlines stock will give our Investors the capability of methodologies will be built around Investor fundamentals. meeting their future transportation spending needs. To Designing relevant portfolios for Investors is the future of illustrate further, if local commuting costs double, or if the asset management in the Information Age. average plane ticket jumps from $250 to $500, the rise is more likely driven by fuel costs than GM’s ability to © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 13
    • suddenly charge double the price for its cars. Furthermore, if GM or United Airlines were required to double their prices for any reason, it is doubtful that their earnings or stock price would also double as a result of the increase, which would be required to give Investors the capability of meeting this increase in their future transportation costs. Our solution is to own transportation fuels through the energy sector to give them this capability. Similar issues arise in regard to representing healthcare spending in the portfolio that every Consumption-based Fundamental Asset Allocation manager will approach differently. Even if global asset managers agree on the primary asset allocation categories, the similarities of their portfolios will likely end there as managers use their unique processes to determine which individual holdings will comprise each category. “Consumption-based Fundamental Asset Allocation managers have wide discretion on how to best align their portfolios with Investor spending.” D. Fundamental Asset Allocation: GDP Diversification This diversity would benefit Investors because Just as Investor spending should be the primary Consumption-based Fundamental Asset Allocation determinant of asset allocation, Investor spending within managers would compete to show how their unique each country, or Gross Domestic Product (GDP), should be processes will best give Investors the capability of meeting the primary determinant of the geographic diversification their future spending needs and quality of life. Can you of a global portfolio. Thus, Consumption-based picture 500 asset management firms all lining up on one Fundamental Asset Allocation uses spending for asset Internet “Exchange” to show Investors how their CFAA allocation and diversification purposes. For example, if approach best provides for a specific demographic of China’s spending is 9 percent of the world’s GDP, then a Investor? Investors would only have to enter their specific global portfolio should attempt to allocate 9 percent of the spending data and they would be routed to the portfolio to China. This methodology dynamically allocates investments and asset managers that correlate best with the portfolio to the geographic regions with the greatest their spending needs (just one of the new features economic activity. Again, unique processes will produce Investors could add to the NEW GLOBAL STOCK variances as CFAA managers may determine that the EXCHANGE). This is how you provide Investors with liquidity risk or political risk of a certain region could financial capability and confidence to restore an industry override the benefits given to Investors; however, without trust. [Figure 2.8 shows how we designed two of Consumption-based Fundamental Asset Allocation uses our own global Consumption-based Fundamental Asset spending as its benchmark for the asset allocation and the Allocation portfolios] geographic diversification of the portfolio. © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 14
    • E. Fundamental Asset Allocation: Risk Management by, Investor fundamentals. Essentially, a non-relevant With Consumption-based Fundamental Asset Allocation, portfolio becomes relevant if the returns meet the portfolio risk is primarily determined by the volatility of the Investors’ stated risk and return goals. things Investors spend their money on. In a very real sense, a standard risk level assessed on everyone’s current The problem is that this is the same “We will maximize quality of life is dictated by their spending. Unless Investors your returns” message we have heard for the past 50 are independently wealthy and this status is not at risk to years. This financial theology ultimately led Wall Street change, they do not have the luxury of designing a down a slippery path to becoming the largest trading “conservative” portfolio that has nothing to do with how casino in the world. When the focus is the investment they spend. If they want a “conservative” portfolio, then product and not Investor fundamentals, the natural result their spending needs to be “conservative.” is always a full out battle to maximize returns, which usually comes at a very high cost. Investors are equally at Once the primary categories of asset allocation are fault in this regard as they are quick to chase the “hot dot” determined for the portfolio, Consumption-based (best performer) when given the opportunity. Fundamental Asset Allocation managers select the individual positions that best represent each category and “Asset managers cannot see the future. They cannot offer the greatest return for risk (or, lowest risk for return if consistently predict when markets will rise or fall that is the objective). Since asset allocation determines a over long periods of time. They do not know which large part of the overall risk of the portfolio, it is important sector, fund or stock will be the best performer of to note that the Investors’ spending habits have already the year. Asset managers simply guess.” predetermined a certain risk level to the portfolio. A mandate to maximize returns always, inevitably, leads to “Investor spending determines their asset allocation gambling. The temptation to maximize returns has one and, to a large extent, the risk of their portfolio.” fundamental and critical flaw. It is the elephant in the room and the final veil yet to be lifted from Wall Street. Asset Asset managers are limited to work their risk management managers cannot see the future. They cannot accurately processes within the categories predetermined by Investor predict individual prices or market moves over long periods spending. If the resulting asset allocation pushes the of time. They do not know which sector, fund or stock will portfolio into a risk category that does not match the risk be the best performer of the year. Asset managers guess category the Investor has requested, the Investors are and investment banking firms guess. Eventually, no matter faced with a moment of truth. They can accept the level of how “hot” managers get, their streak will end. Statisticians risk their current lifestyle and spending needs have call this reversion to the mean. The biggest deception dictated or they can adjust their spending into lower risk propagated by Wall Street during the Age of the Broker categories. In our experience, Investors rarely change their was that by using the right methodologies and research spending habits though it does happen. More often, processes, asset managers have the capability to accurately Investors accept the level of risk their lifestyle has dictated and consistently predict individual price levels or broad and managers must use their skill to best lower the risk market moves before they happen. within each category during the individual selection process for specific underlying holdings. One other option Predicting market moves is a waste of time, energy and exists. Investors can return to a traditional asset manager resources that could be spent on providing Investors with and have them design a “conservative” portfolio that has capability. No pot of gold is at the end of that rainbow. no relevance to their spending needs and just hope Managers simply guess. They have no control over market everything works out in the end. In our opinion, this is movements. Too many influencing factors exist. If market gambling with your future quality of life and will not lead to fundamentals were the only factors to move markets and financial confidence. the price of a stock or commodity, then this business of managing assets would get very mathematical very quickly. F. Maximum Returns: Temptation and Deception Quantitative Managers would win the game on pure math Traditional Wall Street managers can really only go to one and science. However, there are at least three other place to argue their case against Consumption-based factors that influence markets and how they move. Other Fundamental Asset Allocation. They can argue that their than fundamentals, there are technicals, emotions and portfolios are “relevant” because they have the ability to manipulation to name just a few. If asset managers could design a portfolio that will outpace the growth of the accurately predict the future, Wall Street would not be Investors’ spending even though it is not tied to, or limited going through the crisis it is now facing. © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 15
    • In an age of ubiquitous information, Investors need to focus on what they can control and learn to ignore everything else. Spending, saving, inflation, compounding of interest and time can and must be controlled for Investors to be successful in the new global economy. Focusing on what you cannot control is a distraction at best and gambling at worst. Rejecting the temptation to chase the best performers of the day is another moment of truth for Investors. Will they allow the promise of maximum returns to distract them from building a relevant portfolio that gives them the capability to meet their future spending needs and their desired quality of life? We believe that there is no shortcut to the slow and steady creation of wealth that happens over time. A recent example of this was when the price of oil was cut “Almost every time we have explained Consumption- in half during a 3-month period last year and our energy based Fundamental Asset Allocation to Investors, holdings were down sharply as a result. During this same they have walked away saying, period, gasoline prices at the pumps also fell from $4 a ‘How come no one else is doing this?’” gallon to $2 a gallon for consumers [Figure 3.0a]. So, even though our portfolios were down, our Investors were still G. Fundamental Asset Allocation: The Holy Grail provided with the capability to meet their future spending For Brokers, the “box” might be the Holy Grail of Wall needs because their costs fell during the same time period. Street, but for Investors, it is Consumption-based Therefore, using Consumption-based Fundamental Asset Fundamental Asset Allocation. One of the key benefits of Allocation to design portfolios that are relevant to Investor CFAA is that it has the potential to work all the time, spending can increase Investor confidence even during irrespective of market conditions. How? As long as Investor difficult investment periods such as the current recession. portfolios are tied directly to their spending, their portfolios should rise or fall in line with their spending H. Fundamental Asset Allocation: Prices Rise Over Time needs. If prices for their primary spending needs move Prices go up over time and destroy purchasing power, higher, their portfolios should rise as well. If the prices for thereby becoming a primary threat to the Investors’ ability their primary spending needs move lower, their portfolios to meet their future spending needs. Utilizing an inflation- should also move lower. In both scenarios the Investor are beating investment strategy and compounding interest given the capability to meet their future spending needs over time is a straight path to financial confidence. At a and desired quality of life. Therefore, regardless of whether minimum, Consumption-based Fundamental Asset the market goes up or down, the Investors’ primary reason Allocation portfolios are designed to keep up with the for investing is met and can result in financial confidence price inflation of the products, services and commodities for them. Investors buy most. One of the underlying assumptions of this methodology is that prices will go up over time. If you believe that prices will fall over time, then Consumption- based Fundamental Asset Allocation is probably not for you. Why invest in assets that fall in value over time? © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 16
    • But prices do go up over time in general. For the past 100 I. Fundamental Asset Allocation: Freedom years the price of milk, stamps, houses and cars has gone A core principle of Consumption-based Fundamental Asset up, not down. The cost of living is higher today than it was Allocation is that Investors are free to ignore financial 50 or 20 years ago. And despite down stretches such as the noise. The only relevant benchmark to Investors is whether Dark Ages, the Great Depression and this recession, the or not their portfolio keeps up with their spending needs. general trend is that prices rise over time (Figure 3.0b). No other benchmark is relevant—not the Dow Jones Since the early ‘80s, the rate of inflation has fallen, but it is Average, not an individual stock, not a specific sector, not a still a positive number and has had a large compounding broad global index, not their neighbor and not the hot dot effect on Investor spending over time. Keeping up with currently being broadcast by the financial media. Nothing inflation can be as difficult as beating the S&P 500 Index. else. “One of the key benefits of Consumption-based Stop for a moment and think of the freedom this offers Fundamental Asset Allocation is that it works all the Investors. They are the benchmark, not the countless time, irrespective of market conditions.” products sold on Wall Street. There is a very good reason that you likely will not hear this significant lifestyle benefit Although we don’t waste time predicting short-term shouted from the rooftops. A billion-dollar infrastructure market moves, it doesn't take a mathematician to figure lives on its ability to keep the Investors’ attention captive out that government stimulus plans, bank bailouts and every waking minute of the day. The type of freedom that record low interest rates will likely increase, not decrease, Consumption-based Fundamental Asset Allocation offers inflation rates. Furthermore, the developing world is Investors poses a threat to these industries. For Investors, beginning to want what we want and live like we live. We this does not mean that they will never let their financial are no longer the only kids in the candy store. Our guess is confidence be influenced by other benchmarks. It simply that the world simply does not have enough resources to means that Investors now have the ability to shut it all off if supply seven billion people with a quality of life equal to they choose to. Since no other asset is as valuable as time, America’s middle class. This will put pressure on finite this may be the greatest return on assets Consumption- commodities, and prices will rise. (Figure 3.1) Beating based Fundamental Asset Allocation offers to Investors. inflation may not sound sexy, but it is the real deal. And if our suspicions are correct, we are about to go through a J. Fundamental Asset Allocation: Performance new cycle of inflation greater than what we saw during the At a minimum, Consumption-based Fundamental Asset ‘70s. Consumption-based Fundamental Asset Allocation Allocation portfolios are designed to keep up with the portfolios are built to remove this threat for Investors. price inflation of the products, services and commodities Investors buy most. At a maximum, these portfolios have the potential to perform better than the average “market” because these are the areas where people all over the world primarily spend their money. Although outperforming various markets is not relevant to Consumption-based Fundamental Asset Allocation or its Investors, we recognize that if we did not show some form © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 17
    • of comparative study, the truth behind our words may Our reason for adding bonds to this portfolio was to target never reach Main Street. Investor debt, which is always tied to an interest rate expense for the Investor. Because bonds pay out market Therefore we performed a 10-year study [Figure 3.2] based interest rates to their owners, we are able to offer on a portfolio of five broad consumption categories and Investors the capability to meet their future interest rate compared them to the S&P 500 Index over the same time spending needs by owning bonds in their portfolios (debt is period. This is not meant to be an exhaustive study by any a major expense for most American Investors). measure; rather, our point is to show that Consumption- based Fundamental Asset Allocation methodologies can We chose the S&P 500 Index as the benchmark in this 10- be “competitive” as defined by Wall Street. year study because we wanted to show how this methodology would compete against “market” returns. The five consumption categories selected for this study: We are not making a claim that our asset allocation is correlated to the S&P 500 Index. Just as traditional asset Real Estate—Where Investors Live|Work|Play|Shop managers correlate all returns to risk—especially when Energy—Heating|Cooling|Lighting|Transportation Fuels using benchmarks, Consumption-based Fundamental Raw Materials—Food|Metals|Wood|Water|Grains Asset Allocation managers correlate all portfolios to Bonds—Investor Debt|Loans|Mortgages|Credit Cards Investor spending, which is their primary benchmark of risk Capital Markets—Brandname Products and return. Consumption-based Fundamental Asset Allocation, therefore, has no traditional “market” These five consumption categories were chosen by taking benchmark. Nevertheless, to outperform the S&P 500 14 spending data from several government sources and Index over a long period of time would show the grouping each spending category into broad themes. We competitive nature of this methodology because it is used five broad categories to represent a broad spectrum commonly reported that a majority of asset managers fail 16 of Investors’ primary spending habits. We then determined to beat the S&P 500 Index over time. The S&P 500 Index to hold substantially equal portions of each category over is relevant to our study because it is recognized by time by rebalancing the portfolio annually. Because a Investors and professionals as a standard benchmark for global pool of Investors was assumed for this study, we the market. determined not to overweigh any one of these top five spending categories. Additionally, for this specific study, “Prices go up over time and destroy purchasing we chose to utilize stock, bond and REIT indexes to power, thereby becoming a primary threat to 15 represent each category . Investors’ ability to meet their future spending needs. Utilizing an inflation-beating investment “If you rebuild the system around Investors and provide strategy and compounding interest over time is a them with the capability to meet their future spending straight path to financial confidence.” needs and quality of life, you will give them financial confidence. In return, they will give you trust.” © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 18
    • © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 19
    • K. Fundamental Asset Allocation: Differentiation | Alpha This case study illustrates how much discretion a CHAPTER V Consumption-based Fundamental Asset Allocation manager has to best represent their Investor base. Even FUTURE OF ASSET MANAGEMENT after the spending data has been gathered and studied, there is no set mathematical formula for optimizing the A. The Future of Asset Management portfolio to match Investor spending. Quantitative During periods of transformation, the old leaders and managers have the option of matching Investor spending methodologies are replaced by a new group of leaders and to the penny while other managers have the discretion to methodologies that are able to create great value in rapidly use their own assumptions to provide Investors with changing environments. One advantage of living in a world spending capability. This diversity is where Consumption- of ubiquitous information is that the winners and losers are based Fundamental Asset Allocation managers can use much easier to spot. This helps us identify trends and see their unique processes to create positive “alpha” over what really is going on in the economy and the new other CFAA managers who use Investor fundamentals to emerging investment world. make their decisions. One macro-trend we have already identified is the shift Consumption-based Fundamental Asset Allocation toward everything global. The Internet and rapidly managers will each have unique methodologies that will changing technology have leveled the playing field for differentiate their portfolios from other CFAA managers. Investors all around the world and given the planet the Each manager has to determine which markets and opportunity to speak with one language and one mind for holdings best correlate with their Investor spending. This the first time in modern history. This global transformation will result in unique portfolio holdings, asset allocation and has completely changed the rules of investing. geographic diversification. Their buy/sell methodologies will also be unique as well as their rebalancing strategies. A second-trend with far reaching implications for asset management methodologies is the shift from the Age of Our goal is not to defend one Consumption-based the Broker to the Age of the Investor. Fundamental Asset Allocation methodology over another. Rather, it is to create relevant portfolios that will thrive in A third macro-trend in the investment world is the shift the new global economy and provide Investors with toward greater diversification. Instead of focusing solely on spending capability and financial confidence. Ultimately, stocks and bonds, we see Investors adding new asset we would like to see trust restored to an industry that has classes to their portfolios such as real estate, gold, oil and given America so much. We believe that Consumption- other commodities. In this same trend we see a shift away based Fundamental Asset Allocation is one step in that from buying individual securities toward purchasing direction. “baskets” of securities (either managed or unmanaged). These Funds offer investors and asset managers significant In addition to asset allocation, many other components of advantages in this new era. investing are rapidly changing the face of asset management in the emerging global economy. During periods of rapid change, industry transformers recognize these trends first and respond by creating great “One advantage of living in a world of ubiquitous new value for Investors. They see crisis as opportunity and information is that the winners and losers are much become the new leaders. Amidst the turmoil, their ideas easier to spot. This helps us identify trends and see stand out as clear and logical. They tend to have lean, flat, what really is going on in the economy.” efficient models that adapt well to technology. They embrace change and are built for speed. When you look closely, you can already see their tracks as Investors have begun to reward their innovation. How do you distinguish the new leaders from the old leaders? One way is to see who is thriving during transformation and who is not. Our review of the data shows at least three clear winners: ETFs, Fund of Funds and Index Funds. © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 20
    • viewed as taboo by active managers, we believe that ETFs are a hybrid that will eventually find their way into most actively managed pension plans. The advantages ETFs offer asset managers will offset the internal fees, and the performance of the overall portfolio will dispel any perception that managers are not earning their keep. Keep in mind, asset allocation is the primary driver of performance. B. The Future of Asset Management: ETFs and Indexes There is a good reason why Exchange-Traded Funds (ETFs) have grown at a rate of 35 percent annually since 1999, making them the fastest growing global fund management 17 products to surface in the last 10 years. ETFs are built for the Information Age [Figure 3.3]. Initially created for institutions in the early ‘90s to trade big blocks quickly, these “Super Shares” have experienced a meteoric rise in popularity over the past five years. They allow Investors and asset managers to target specific By using ETFs in their portfolios, new asset managers can sectors or entire countries. The efficient structure of an ETF focus their skills and resources on the area of the portfolio keeps its fees low and tax efficiency high. They offer full where they can add the greatest “alpha” over traditional liquidity and full transparency, and Investors do not have to managers who focus their time and resources on individual worry about sales loads. company selection. ETFs shift the focus of asset management onto relevant design and asset allocation, which is another step in the right direction. The unprecedented growth of the ETF industry during Wall Street’s turbulent transition into the Information Age demonstrates its relevance to institutional portfolios. Exchange-Traded Funds (ETFs) experienced record inflows in 2008 despite facing one of the most challenging investment periods in over a half century. Investors poured more than $177 billion in net new money into ETFs 18 for the year while long-term mutual funds saw outflows of $226 billion, according to the Investment Company 19 Institute . Investors and asset managers alike are rewarding clear and logical investments that offer them control, diversification, liquidity and transparency. (See Figures 3.4 and 3.5) As with any new technology, the early adopters are the Just last month Goldman Sachs, Merrill Lynch and Morgan ones with the most flexible models and are positioned to Stanley launched a unique open-architecture ETF platform benefit the most as a result. At this time, ETFs remain in Europe that could revolutionize Europe’s $140 billion 20 suspiciously absent from many of the largest institutional exchange-traded fund industry. pension funds, but we suspect this is a result of entrenched Industrial Age processes more than anything else. Although the use of indexes in a portfolio has traditionally been © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 21
    • group of their own family of funds. (The Investor gets multiple funds of the same fund family). During periods of rapid change, simplifying the investment process by creating a one-step investment structure that offers immediate diversification across multiple asset classes and strategies creates great value for Investors. Investors also want to know they have the best managers or indexes in their portfolios, irrespective of the investment management company that offers the investment. Because Independent fund of funds are not limited to the interests of one investment firm as are most mutual funds, Investors gain great value and confidence that their portfolios are invested in a level playing field. “ETFs and Fund of Funds investments enable asset managers to focus their skills and resources on the area of the portfolio where they can add the greatest contribution to performance—asset allocation and relevance to Investors.” B. The Future of Asset Management: Fund of Funds Another area showing strong growth is Fund of Funds. Despite one of the most challenging years in Wall Street’s history, Fund of Funds quietly added $63 billion in net new 21 cash flow last year. The primary criticism of the fund of funds structure is the second layer of fees. We don’t see this as a deal-killer because the second layer of fees is paid for the asset allocation and relevance of the overall portfolio, which has already been determined to be the primary contributor to We believe that Independent Fund of Funds make a lot of overall performance for the Investor. Therefore, good fund sense to Investors and will thrive in the Information Age, of funds managers have plenty of bandwidth to more than especially the “40 Act” variety which offer full cover their fees. Ultimately, this is a moot point as the transparency. Independent fund of funds have access to overall relevance and performance of the portfolio net of the entire fund universe and manage a portfolio of fees will determine its market value. Poorly managed, non- underlying funds that have no legal or monetary relevant fund of funds will be avoided by Investors while relationship with the fund manager (the Investor gets the best ones will thrive. Traditional mutual fund multiple funds from multiple-fund families managed under companies will remain at a disadvantage because they can one strategy). Proprietary fund of funds are limited to one only offer Investors a very limited pool of asset managers family of funds and simply offer a convenient way to buy a to choose from—their own. © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 22
    • An industry transformer in this space, Grail Advisors, makes sense. Investors seem to like that clear and logical recently released an actively managed fund of funds inside stuff. 22 of an ETF, which is an industry first. Expect to see more transformation here as Investors reward and spur D. The Future of Asset Management: Emerging Managers innovation in fund of funds investments. In the institutional separate account space, the industry transformers are the asset managers that recognize the C. The Future of Asset Management: New Indexes global transformation of the financial industry and how this When John C. Bogle introduced the first index mutual fund, change is impacting asset management methodologies. the industry scoffed and said Investors would never be These asset managers are designing relevant portfolios 23 content with “average” returns. Thirty-four years later that will thrive in this new era. Emerging Managers are the Wall Street’s best have found it difficult to beat this index new class of asset managers that are emerging on Wall fund and The Vanguard Group ranks as one of the largest Street, typically smaller in size with lower assets and mutual fund companies in the world. John Bogle is a great shorter track records than their established counterparts. example of an industry transformer who was able to We believe a large portion of the next leaders will come recognize change and respond to it by adding great value from this new demographic because they are not to Investors. He and Charles Schwab are two of the earliest entrenched in layers of traditional Industrial Age processes and most visible industry transformers; however, as and methodologies. Large pension funds and asset transformation speeds-up so will the visibility of other management firms will have difficulty shedding these industry transformers. layers of bureaucracy in time to help them or their Investors. Pensions and institutions need to take proactive steps to ensure their portfolios remain relevant and perform well in the new global economy. New screening processes will be required to identify the new leaders and relevant asset allocation methodologies. Institutions that ignore this transformation and stay with their traditional screening processes will continue to hire traditional asset managers, and their portfolios will rapidly lose relevance. Our advice to the Chief Investment Officers (CIOs) of these pension funds and investment banking firms is to get Board approval to allocate a percentage of the portfolio into a “new opportunities” fund that allows the CIO to specifically target the next leaders and new asset allocation methodologies that will thrive in the Information Age. Index Funds added $34 billion in net new assets in 2008 Emerging Managers cannot be taken through the normal 24 while most of the industry suffered outflows. Why are mandate process as most traditional screening processes they popular with Investors and asset managers? Their would automatically eliminate them because they are not clear, logical and efficient structures resonate with one of the large established managers and would not meet portfolio managers of all types. Index Funds offer control, minimum requirements. During periods of rapid change, diversification and transparency to their buyers. They are new screening processes are required. built for the new global economy. Therefore, we expect to see more of them and many new innovative Because they are largely unknown, Emerging Managers methodologies. For decades Wall Street almost exclusively should be kept on a very short performance “leash.” CIOs used indexes that were benchmarked to market should have full discretion to hire and fire these managers capitalization (price x shares). In 2005, however, Rob as required. This discretionary power will enable CIOs to Arnott introduced “Fundamental Indexing,” which used the take the necessary proactive steps to ensure their fundamental attributes of a company such as revenue and portfolios remain relevant and perform well in the new 25 dividends to build the index. It was an innovative concept global economy. that met with the normal posse of “resistors;” however, during the past four years the idea has gained momentum. Our guess is that it is an idea that will stick. Why? It just © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 23
    • “Investors will be the cornerstone of the next Wall During periods of large negative returns, plan members will Street and the next generation of asset management begin to ask how these portfolios were relevant to them. strategies. The asset management companies that The institutional asset managers that can show their plan effectively respond first will be the next global members how their investment processes are Investor- leaders and will reap the benefits of the biggest Driven will have the advantage, in our opinion. asset gathering opportunity in 100 years.” The key to every financial system is trust. When you provide Investors with the capability to meet their future spending needs and desired quality of life, you will give CHAPTER VI them financial confidence. In return, they will give you CONCLUSION trust. We believe that Consumption-based Fundamental Asset Allocation is the most relevant asset management strategy in the world because it is designed to give A. The Opportunity Investors this capability. Where do we go from here? Our purpose was to show institutional asset managers how to recognize and respond Every once in a while something genuinely new alters the to rapid transformation so they can stay relevant to their trajectory of an industry. Consumption-based plan members and thrive in the new global economy. We Fundamental Asset Allocation is a new asset allocation believe that institutional asset managers stand at a historic methodology that will overthrow decades of perceived crossroad where they must embrace transformation to wisdom. If accepted, this way of thinking has the potential stay relevant to their plan members or risk being to do violent harm to established investment companies. completely bypassed by the next generation of Investors We challenge the norms and accepted practices of this and asset management methodologies. industry. Much of the investment process is backward. It favors the brokers over the Investors. It glorifies trading Pensions and institutions need to change their traditional instead of asset allocation. And it focuses on investment processes to ensure their portfolios remain relevant to fundamentals in place of Investor fundamentals. their plan members and to identify the next asset managers and asset management methodologies that will Consumption-based Fundamental Asset Allocation will thrive in this new era. Institutions that ignore this unleash a set of ideas that will shape this industry and transformation and stay with their traditional screening reshape the sense of what’s possible for individual processes will continue to hire traditional asset managers, Investors. The most and their portfolios will rapidly lose relevance during this powerful ideas are the transformation. ones that set forth an agenda for reform and Asset management strategies that are not relevant to plan renewal, the ones that members represent an avoidable liability for pensions and turn a company into a institutions. The focus has been on the fall of the banking cause. We have re- industry; however, many pensions and institutions have imagined what it been hit as hard and will receive increased scrutiny in the means to be an asset years that follow. manager. © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 24
    • MESSAGE FROM THE AUTHOR: For the past century, Wall Bio: Michael G. Willis Street has been the center of the financial universe. All Michael G. Willis is president and lead portfolio manager financial paths led through this hallowed street. Until of THE WILLIS GROUP and GIANT 5 FUNDS. Mr. Willis is the recently, I believe that most Americans viewed Wall Street author and creator of Consumption-Based Fundamental with immense patriotic pride. I certainly did. For me, Wall Asset Allocation, a new generation of asset allocation Street represented the greatest financial achievement in methodologies built around Investor fundamentals. Mr. world history and I Willis believes that people save money for one primary wanted to be a part of purpose—to gain the capability to meet their future it. So, I became one of spending needs and desired quality of life. Michael Willis the “Boys” and joined has a born ability to see through clutter to the heart of the Smith Barney after matter. His clear vision gives him the ability to capture two years of day- opportunities and provide direction to the people he trading on my own. leads. He uses his ability to innovate logical and simple My entire career has solutions to complex problems. Michael’s passion for truth been given to Wall and freedom drives him to create innovative systems that Street so when I talk have the potential to simplify and transform lives. about its shortcomings it is not the typical Master of Business Administration, California Polytechnic bashing from an University 1991 outsider or a journalist First Vice President - Investments, Smith Barney 1994-1999 trying to fill a column. Senior Vice President - Investments, Paine Webber 1999-2003 Senior Vice President - Investments, UBS Financial Services I hung the Buttonwood Agreement on the wall in my office 2003-2004 right next to the Declaration of Independence and the President, The Willis Group 2004-Current Constitution of the United States. As a student of Wall President, Giant 5 Funds 2005-Current Street and its history, I used to look at this agreement with Lead Portfolio Manager, Giant 5 Funds 2006-Current pride as it represented to me the beginning of it all. However, when I actually took the time to understand the provisions of this agreement, I took it down. The Buttonwood Agreement summarized for me everything that was wrong with Wall Street. It showed the dark side of it and represented for me a ticking countdown to a day when these principles would ultimately cause its own demise. That day is here. My blunt appraisal of the industry is given in hopes that enough industry transformers read this and respond to create something much better. There is a huge amount of talent on Wall Street and many of the smartest people in the world work there. This white paper is a call to those individuals to stand up and lead Investors out of this crisis. I’ve always believed that America was special because it was founded on God, truth and the rights of the individual over governments (infrastructure). There is no difference THE WILLIS GROUP for me when I look at Investors (the individuals) and Wall THE WILLIS GROUP, Street (the governing infrastructure). Sixteen years ago I Inc. is a Registered moved to Colorado to build my company because I found Investment Advisor myself more comfortable around the traditional values (RIA) with the often found in the heartland of America over a culture that Securities and placed its own interests ahead of its customers’. However, I Exchange see great hope in this transformation and I keep a “best-is- Commission (SEC) yet-to-come” attitude when I view the vast potential the and is an Emerging Manager for institutional clients. THE Age of the Investor can bring to the new global economy. WILLIS GROUP utilizes Consumption-Based Fundamental Asset Allocation to design relevant portfolios that are © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 25
    • 17 based on Investor fundamentals. THE WILLIS GROUP is “Major Issuer Corrals Substantial ETF Assets in 2008” Investment Advisor to the Giant 5 Total Index System <www.etf.com > 02 February, 2009 18 (INDEX NASDAQ Ticker) and the Giant 5 Total Investment *IndexUniverse.” ETFs Defy Stereotypes In 2008. 13 January, 2009 http://www.indexuniverse.com/sections/features... System (FIVEX NASDAQ Ticker), each a registered 1940 Act 19 Investment Company Institute, Statistics & Research, Long-Term Mutual Fund. Mutual Fund Flows Historical Data, 15 April, 2009, <http://www.ici.org/stats/mf/flows_data_2009.pdf> For more information visit www.TheWillisGroup.net, 20 Thao Hua. “An American ETF Revolution in Europe”, Pensions & www.Giant5.com, or email info@TheWillisGroup.net. Investments, 04 May, 2009 21 th “2009 Investment Company Fact Book” 49 Edition Our Culture Washington D.C. 2009 Figure 2.11 22 We live in the heartland of America—the Rocky Mountains. “An Active ETF’s Debut Draws the WSJ’s Notice”, MutualFundWire.com. 04 May, 2009 We value common sense and believe that the best ideas <http://www.MFWIRE.com/story.asp?s=21462> are often logical and simple. We think people matter more 23 Bogle, John. “The First Index Mutual Fund: A History of than things, and we’d rather value people by their word Vanguard Index Trust and the Vanguard Index Strategy” than by their bank statement. We appreciate that money 24 th “2009 Investment Company Fact Book” 49 Edition has value but understand that it cannot buy happiness. We Washington D.C. 2009 Figure 2.12 think it’s important to know who you are and why you are http://www.icifactbook.org/fb_sec2.html#developments 25 here. We recognize time as our most valuable asset and Arnott, Hsu, and John M. West. The Fundamental Index. believe that when you do something right, people will Hoboken, New Jersey: Bohn Wiley & Sons, Inc. 2008 eventually notice. OTHER REFERENCES Israelson, Craig. “Don’t Box Me In.” Financial Planning WORK CITED 1 September 2005: 167-170. Schumpeter, Joseph A. "Creative Destruction" Capitalism, Socialism and Democracy (New York: Harper, 1975) [orig. pub. Grinold, Richard C. “The fundamental law of active 1942], pp. 82-85 management.” Journal of Portfolio Management Spring 2 Sullivan, Dan. “Creative Destruction” (Canada: The Strategic 1989: 30-37. Coach 2003) pp 9-11 Brown, Rob. “At Odds With Style Boxes.” OnWall- 3 United States Declaration of Independence, 04 July, 1776 Street November 2006: 76. 4 The Holy Bible, Gen. 11.1-9 Au and Tony Foley. “The Ideal Blend of Growth and Value.” The 5 “Citigroup Stock Falls Below $1 a Share.” Journal of Investing Winter 2006: 68-77. www.baltimoresun.com Associate Press. 06 March, 2009 6 Young, Laren. “Active Mutual Fund Managers Still Can’t Beat “Short Sale” Investopedia ULC. <www.investopedia.com> 7 Indexes”, April 20, 2009, BusinessWeek.com Markowitz, Harry. “Portfolio Selection” The Journal of Finance, Vol. 7 (1). March 1952. pp 77-91 Fox, Justin . “Mutual Fund Managers Keep Failing to Beat the 8 Sharpe, William F. “Capital asset prices: A theory of market Market”, The Curious Capitalist. April 20, 2009, equilibrium under conditions of risk” Journal of Finance, Vol. 19 Marquardt, Katy. “More Reasons to Invest in Index Funds”, U.S. (3). 1965. pp 425-442 News & World Report, April 2009 9 “Brinson, Gary. CFA” CFA Institute www.cfainstitute.org Standard & Poor’s Indices Versus Active Scorecard Year-End 2008, 10 “Ibbotson, Roger G.” Yale School of Management April 2009, <StandardandPoors.com> <www.mba.yale.edu> Ranson, David. Inflation May Be Worse Than We Think, Wall 11 Blodget, Henry. “Craigslist Valuation: $80 Million in 2008 Street Journal, February 28, 2008 Revenue, worth $5 Billion” The Business Insider. McGowan, Lee. “Index Funds vs. Actively-Managed Funds, <www.businessinsider.com> 03 April, 2008 12 <http://mutualfunds.about.com/od/activevspassivefunds/a/index “Google buys YouTube for $1.65 billion” vsactive.htm> <www.msnbc.msn.com> Associate Press. 10 October, 2006 13 Howard, and Craig T. Callahan. “The Problematic ‘Style’ Grid.” Leckey, Andrew. “Index vs. Managed Funds Debate Rages On”, Icon Advisers, Inc. working paper. July 2005. <TwinCities.com> April 10, 2009, 14 “OECD.” Organisation for Economic Co-operation and Loomis, Carol. “Buffet’s Big Bet”, 09 June, 2008, Development http://www.oecd.org/statsportal <CNNMoney.com> 14 ”BEA.” Bureau of Economic Analysis < http://www.bea.gov/> Wingfield, Nick. Wall Street Journal, “Ebay Buys Stake in 15 Hypothetical study with invested monies equally into the Craigslist”, 13 August, 2004 following 5 indexes and rebalanced annually with no fees: S&P Ravikant, Naval. “Craigslist is Worth More than Ebay”, 06 Global Energy Index, Russell 3000 Index, Dow Jones Basic February, 2006 <Startupboy.com>, Materials Index, Dow Jones Wilshire REIT Index, Barclay Capital US Aggregate Bond Index. Brinson, Singer and Gilbert L. Beebower, "Determinants of 16 Dash, Pane and Dave Guarino. “Standard & Poor’s Indices Portfolio Performance II: An Update," Financial Analysts Journal, Versus Active Fund Scorecard”. <www.standardandpoors.com> May/June 1991. Year End 2008. 20 April, 2009 © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 26
    • Ibbotson and Paul D. Kaplan. “Does Asset Allocation Policy Explain have any liability for any special, punitive, indirect, or 40%, 90%, or 100% of Performance?” consequential damages (including lost profits), even if Murray Coleman, “ETFs Defy Stereotypes In 2008”, 07 January, notified of the possibility of such damages. 2009, <IndexUniverse.com> Financial Research Corporation, Company Press Release, April 13, *** 2009, <TheMutualFundWire.com> “The Crash of 1929.” American Experience. PBS, 15 April, 2009, <http://www.ici.org/stats/mf/flows_data_2009.pdf> Disclosures This material is for your own personal information, and we are not soliciting any action based upon it. The material is based upon information we consider reliable, but we do not represent that it is accurate or complete and it should not be relied upon as such. Opinions included in this material are as of May, 2009, and are subject to change without prior notice. Past performance is not indicative of future results. As with any investment vehicle, there is always a potential for profit as well as the possibility of loss. Actual results may differ from composite returns, depending on account size, investment guidelines and/or restrictions, inception date and other factors. Nothing contained in this presentation should be construed as a recommendation to buy or sell a security or economic sector. These materials have been prepared solely for informational purposes based upon information generally available to the public from sources believed to be reliable. The Willis Group makes no representation with respect to the accuracy or completeness of these materials as content may change without notice. The Willis Group disclaims any and all liability relating to these materials, and makes no express or implied representations or warranties concerning the statements made in, or omissions from, these materials. No portion of this publication may be reproduced in any format or by any means including electronically or mechanically, by photocopying, recording or by any information storage or retrieval system, or by any other form or manner whatsoever, without the prior written consent of The Willis Group. The Willis Group does not guarantee the accuracy and/or completeness of any Index, any data included therein, or any data from which it is based, and The Willis Group shall have no liability for any errors, omissions, or interruptions therein. The Willis Group makes no warranty, express or implied, as to results to be obtained from the use of Consumption-Based Fundamental Asset Allocation. The Willis Group makes no express or implied warranties, and expressly disclaims all warranties of merchantability or fitness for a particular purpose or use with respect to this white paper or any data included therein. Without limiting any of the foregoing, in no event shall The Willis Group © 2009 THE WILLIS GROUP | The Future of Asset Management All Rights Reserved. www.thewillisgroup.net Page 27