Building Better Portfolios

Building Better Portfolios Can you beat the markets? Our goal at CFA is not to beat markets, but to receive more intelligent returns per unit of risk. The below graph shows the returns of 192 corporate pension funds (1988 to 2005). Despite all of the investment options available to pensions, only a few beat a simple mix of a large company stock and diversified bond index, and fewer beat it by a meaningful margin. On the flipside we use this basic portfolio (Portfolio #1) as the starting point to determine portfolio weights that may result in higher returns without added risk. 16 Companies (in alphabetical order) 14Annual Average Returns (%) Anheuser-Busch Cos., Inc. 12 Avista Corp. Cooper Industries, Inc. 10 Delta Air Lines, Inc. Edison International 8 FirstEnergy Corp. Goodyear Tire & Rubber Co. Ingersoll-Rand Co. Ltd. 6 IBM Corporation Jefferson-Pilot Corp. 4 Lincoln National Corp. Sherwin-Williams Co. 2 Sunoco, Inc. SunTrust Banks, Inc. 0 UAL Corp. Union Pacific Corp. Basic 60/40 Company 1 Company 10 Company 20 Company 30 Company 40 Company 50 Company 60 Company 70 Company 80 Company 90 Company 100 Company 110 Company 120 Company 130 Company 140 Company 150 Company 160 Company 170 Company 180 Company 190 Company 192 Verizon Communications, Inc. VF Corp. West Pharmaceutical Svcs., Inc. Williams Cos., Inc. Wolverine World Wide, Inc. Basic 60/40 Balanced Strategy vs. Company Plans. Results of 192 Corporate Pension Funds. Annual: 1988–2005. Basic 60/40 is 60% S&P 500 Index, 40% Lehman Brothers US Government/Credit Bond Index Intermediate, rebalanced monthly. Source: FutureMetrics (December 2006); all companies with fiscal year ending December, with complete return data from 1988-2005. The S&P data are provided by Standard & Poor’s Index Services Group. Barclays Capital data, formerly Lehman Brothers, provided by Barclays Bank PLC.

Diversification Beyond Traditional Portfolios Traditional Stock and Bond portfolio diversified for more intelligent risk taking Quarterly: 1973–2010 Merrill Lynch One-Year US Treasury Note Index Annualized Annualized Compound Standard S&P 500 Index Return Deviation US Small Cap Index US Large Value Index Model Portfolio 1 9.47% 11.16% Targeted Value Index Model Portfolio 2 8.83% 10.23% International Large Index Model Portfolio 3 9.74% 11.88% International Small Index Model Portfolio 4 10.68% 11.81% International Large Value Index Model Portfolio 5 11.65% 11.26% International Small Value Index Emerging Markets Blended Index BofA Barclays US Merrill Lynch US US Intl. Intl. Emerging Govt./Credit S&P One-Year US Small Large Targeted Intl. Intl. Large Small Markets Bond 500 Treasury Cap Value Value Large Small Value Value Blended Index Index Note Index Index Index Index Index Index Index Index Index Model Portfolio 1 40% 60% Model Portfolio 2 60% 40% Model Portfolio 3 30% 40% 30% Model Portfolio 4 15% 40% 15% 15% 15% Model Portfolio 5 7.5% 40% 7.5% 7.5% 7.5% 6% 6% 6% 6% 6%Rebalanced annually. Barclays Capital data, formerly Lehman Brothers, provided by Barclays Bank PLC. The S&P data are provided by Standard &Poor’s Index Services Group. The Merrill Lynch Indices are used with permission; copyright 2011 Merrill Lynch, Pierce, Fenner & Smith Incorporated; allrights reserved. Dimensional Index data compiled by Dimensional. Emerging Markets Blended Index consists of 50% Fama/French Emerging MarketsIndex, 25% Fama/French Emerging Markets Small Cap Index, and 25% Fama/French Emerging Markets Value Index. Fama/French Emerging Markets,Fama/French Emerging Markets Value and Fama/French Emerging Markets Small Cap Index weightings allocated evenly between DimensionalInternational Small Cap Index and Fama/French International Value Index prior to January 1989 data inception. Dimensional International Small CapValue Index weighting allocated to International Small Cap Index prior to July 1981 data inception. International Value weighting allocated evenlybetween International Small Cap and MSCI World ex USA Index prior to January 1975 data inception. Indexes are not available for direct investment.Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of futureresults. Not to be construed as investment advice. Returns of model portfolios are based on back-tested model allocation mixes designed with thebenefit of hindsight and do not represent actual investment performance.

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Building Better Portfolios

by Robert Schmansky on Dec 29, 2011

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