260 502 621
260 505 384
260 550 353
260 531 031
2015 THE FOUR PROFITEERS
Table of Content
2015 THE FOUR PROFITEERS
As members of the Four Profiteers, we understand that planning for retirement is an essential aspect to
ensuring your future well-being. It is our goal to relieve any finance-related stress that you may have when
planning your retirement. In the following report we have constructed a portfolio plan that meets your
return criteria without putting your future finances at risk. This portfolio requires little management on your
part, however, we recommend rebalancing the portfolio on a yearly basis in order to maintain the optimal
asset allocation. Along with this portfolio, we have made suggestions to improve upon your current
investments. This information should enable you to fully enjoy your retirement without the stress of
To construct your retirement portfolio we have taken your financial information and applied it to a passive
management strategy. We began by identifying your financial knowledge, risk tolerance and portfolio
return based upon your expected future income and expenses. We then analyzed your current assets and
liabilities to identify any potential risks that you are overly exposed to as well as any risks that you are not
sensitive to. Following this identification we researched assets that would allow the portfolio to take
advantage of return premiums from factors that do not affect you, while not increasing your exposure to
your current risk factors. From these concepts, along with our understanding of macroeconomic principles,
we created a portfolio that is fully tailored to your needs.
First, using various Exchange Traded Funds (ETFs) we regressed the monthly returns of several
representative industries and firm characteristics to the monthly returns of four risk factors we deemed
relevant to your situation. The four factors we identified are:
• Recession risk: as modeled by changes in employment, industrial output, retail sales less autos,
and manufacturing and trade sales1
• Interest risk: modeled upon the 1 month Canadian bond2
• Inflation risk: modeled upon the changes in the Canadian CPI3
• Market risk: based upon the S&P 500 index4
We then measure the sensitivity of our chosen assets to changes in each of the four underlying factors.
For example, an asset with a positive inflation factor sensitivity of 2 would mean that as inflation averages
1%, this asset would have an expected return of 2%.
Then, we performed a statistical analysis (second-pass regression) for all our chosen ETFs by regressing
the monthly returns of the ETFs to the four individual risk factors. The output of this regression yielded the
aggregate risk premium of each of the four factors. We were able to understand which risk factors were
priced in the market and this helped us determine how you could earn a risk premium. Implementing these
findings enabled us to create a portfolio with the appropriate weights of assets to maximize your return,
while maintaining your portfolio risk to a minimum.
Through our discussions it was clear that you have a fundamental understanding of finance and are
slightly more risk averse compared to the average investor. According to your desires, we have
constructed a financial plan that allows you to retire without placing any burdens upon your children as
well as offer you the possibility to travel, donate to worthy charities, and engage in other activities of
2015 THE FOUR PROFITEERS
Contrary to the average Canadian, you possess
zero liabilities, mortgages or debt. We also noticed
that a large portion of your current assets consist of
reliable, low-risk instruments such as your pension
income, rental property income, and fixed income
included in your TFSA and RRSP funds. Due to the
safe nature of these assets, we have decided to
focus the majority of our asset selection on equity
instruments to rebalance your overall financial
profile and to earn higher returns.
Based upon your goal to retire after the age of 60
we have constructed a financial cash flow diagram
that offers insightful information upon your needs at
retirement. This diagram reveals that your pension,
along with your rental income will sufficiently cover
your day-to-day living expenses. This alleviates
substantial risk, as you will not need to rely upon
your investments to maintain your current lifestyle.
This allows us to create a portfolio that does not
need to take on excess risk to earn extra return.
Therefore, the goal of these investments is to
increase your wealth without risking losses in order
to expand the range of possible activities in which
you can engage.
Total Inflows Total Outflows Net Cash Flow (Savings)
2015 THE FOUR PROFITEERS
Following the cash flow analysis, we compared your financial position to the average investor for each of
the four risk factors.
The inflation factor is priced in the market, with a
negative risk premium5
. This means that assets
that are negatively correlated to inflation are likely
to perform better in times of low inflation, because
the demand is lower. Average investors usually
demand assets that are positively correlated to
inflation, to compensate for the decrease in their
purchasing power when inflation increases.
Because both your pension and rental income are
adjusted for inflation, you are able to earn a risk
premium by investing in assets that negatively
correlates with inflation.
The interest rates factor is priced in the market,
with a negative risk premium6
. Average investors
usually demand assets that are positively
correlated to interest rates, as the amount to be
repaid on liabilities, such as mortgages, increases
when interest rates rise. Since you have already
paid off your mortgages, you are able to invest in
assets that are negatively correlated to interest
rates, earning you a premium. It is our belief that
this premium is caused by lower demand for these
The recession factor is priced in the
market, with a positive risk premium7
. We assume
that this premium is due to the average investors’
risk of losing their job during times of recessions.
Therefore, the average investor would not want
assets that perform poorly during recessions.
Because your current job is secure and your
pension is guaranteed, we believe that you should
increase your holding of assets that may perform
badly during recession and thus earn higher
returns in better economic environments.
The market factor is priced with a positive
. The majority of the assets we
selected have a positive correlation to the market,
which will allow you to earn an additional premium.
Note on ETFs
After choosing to tilt this portfolio towards equity instruments, we have decided to invest more specifically
in ETFs. There are three main reasons why this seemed a more appropriate option for you9
• Diversification: ETFs comprise of vast holdings of assets including equity, bonds, and
commodities. Risks that affect single assets are thus minimized, leading to a lower overall
• Lower Management Fees: The management expense ratios for ETFs are some of the lowest in
the index fund industry, averaging 0.44%. This is important as lower management fees lead to
higher growth in your portfolio.
Note on Mutual Funds
Currently, your financial portfolio is heavily weighted in mutual funds. More specifically, your 70%
allocation into one specific mutual fund (CIG686) that is low to moderately risky poses a potential concern.
One option to further diversify your wealth would be to reduce the proportion invested in this asset and
use those proceeds to invest in our portfolio.
Since this option involves transaction fees, an alternative measure would be to cease investment in this
particular mutual fund and instead divert those funds to another mutual fund or ETF.
2015 THE FOUR PROFITEERS
We have chosen to build a portfolio based on ETFs in order to achieve low cost diversification across
assets, industries, and countries. Taking all of this into consideration, we have chosen to add twelve ETFs
that represent various sectors of the U.S., Canadian, and international markets. We also included one
fixed-income ETF, and an inflation protected fixed income instrument.
The first group of ETFs comprises of assets that display all of our four required characteristics. They
expose a positive correlation to our recession and market factors, while exposing a negative correlation to
inflation and interest rates. These ETFs are following indexes of biotechnology companies (IBB), clean
energy companies (PBD), and equities exhibiting growth characteristics (IVW, RPG).
We are especially excited about investing in clean energy as it relates directly to your request to invest in
assets that are ethical and will help sustain the environment in the future.
The biotechnology sector was chosen partially due to your preference and partially due to the large upside
potential of the underlying companies. The two growth ETFs were selected to ensure that your portfolio
continues to perform well in the future, and because growth stocks’ returns usually exhibit a negative
correlation to inflation10
The second group of ETFs comprises of assets that display three out of four of our required
characteristics. They expose a positive correlation to our recession and market factors, while exposing a
negative correlation to interest rates. They are positively correlated to our inflation factor, but were
retained in the final portfolio for they are invested in different industries, bringing additional diversification
effects to our portfolio. These ETFs are following indexes of emerging markets (DEM, AIA), industrial
companies (IYJ), consumer services companies (IYC, UCC), and large capitalization companies (MGV).
We chose to add an emerging market ETF in order to diversify your portfolio away from the North
American markets as well as earn a premium from their perceived risk11
. Consumer services added further
diversification to the portfolio. MGV, a large capitalization ETF was added to lower the overall risk of the
portfolio as the blue chip stocks it comprises are viewed as reliable investments12
. Industrial companies
were added as your long-term investment horizon allows you to tolerate their cyclical business cycles.
We have decided to include gold in the portfolio for two reasons. The first is that it exhibits a strong
negative correlation to our inflation factor. This will allow your portfolio to be tilted back towards a negative
inflation correlation, correcting for the effects from the 2nd group of ETFs. The second reason is that it has
historically been used as a hedge against movements in the financial markets, allowing you to decrease
your overall exposure to this factor.
The last group of assets comprises of a fixed-income ETF (TLT), and inflation-protected treasuries (TIPS).
We selected these two assets for their positive correlation to our recession factor, and their negative
correlation to our inflation and interest rate factors. Like gold, their small to negative correlation to the
market factor will act to balance your portfolio’s overall exposure to the market. We chose TLT on the
belief that average investors perceive the strategy of investing in long-term bonds on a short-term horizon
as risky. Thus, we believe that you can earn a premium on this investment.
2015 THE FOUR PROFITEERS
Following your opinion on different portfolio allocations, we have narrowed down the possibilities to three
choices. The portfolios have less than 15% invested in each asset to ensure diversification. These
portfolios are built using a combination of our personalized model and the Fama-French model.
A word of caution needs to be mentioned on the standard deviations o f these portfolios. We believe that
our model gives reliable estimates upon expected returns, however the standard deviations are expected
to be higher than our estimates give. We believe that more accurate standard deviations for these
portfolios are in the range of 15 to 20%.
This portfolio was built with the intention to reduce its overall volatility. The standard deviation of this
portfolio is equal to 11.40%, while the expected return is 6.48%. Management fees are equal to 0.25%.
This portfolio has an emphasis on safe assets, technology, and growth equities.
This portfolio combines a balance of risk and return. The standard deviation of this portfolio is equal to
13.61%, the expected return is 7.49%. Management fees are equal to 0.33%.
High Return Portfolio
This portfolio exhibits the highest return of our selection. The standard deviation of this portfolio is equal to
16.41%, the expected return is 8.50%. Management fees are equal to 0.39%.
We recommend you select the balanced portfolio, as you expressed your main concern to be the
safeness, and the steady growth of your investment. This allocation will provide you with a good
compromise in between risk and return, as well as a reasonable management fees ratio. The betas to
each factor are equal to 0.51 (Recession), -0.29 (Inflation), -0.46 (Interest Rates), and 0.68 (market).
Allocation of recommended balanced portfolio
2015 THE FOUR PROFITEERS
1. Short, Doug. "The 4 Official Recession Factors Indicators." Http://www.businessinsider.com. August 31,
2013. Accessed March 30, 2015.
2. Data retrieved from Bloomberg Terminal
3. Canada. Statistics Canada. Consumer Price Index, by Province. Accessed March 30, 2015.
4. "GSPC Historical Prices | S&P 500 Stock." Yahoo! Finance. March 30, 2015. Accessed March 30, 2015.
5. United States. Federal Reserve. New York. Inflation Risk and the Cross Section of Stock Returns. By
Fernando M. Duarte. New York: Federal Reserve Bank of New York Staff Reports, 2013. Accessed
March 30, 2015. http://www.newyorkfed.org/research/staff_reports/sr621.pdf.
6. Hördahl, Peter. "The Inflation Risk Premium in the Term Structure of Interest Rates." Bank for
International Settlements. September 2008. Accessed March 30, 2015.
7. Nestorovski, Metodija, and Aleksandar Naumoski. "Economic Crisis and the Equity Risk Premium."
Association of Economic Universities of South and Eastern Europe and the
8. Fernandez, Pablo. "Market Risk Premium: Required, Historical, and Expected." University of Navarra.
October 2004. Accessed March 30, 2015. http://core.ac.uk/download/pdf/6536299.pdf.
9. "How to Choose an Exchange-Traded Fund." Wall Street Journal. Accessed March 30, 2015.
10. Zucchi, Kristina. "Inflation's Impact On Stock Returns." Investopedia. Accessed March 30, 2015.
11. Damodaran, Aswath. "Country Default Spreads and Risk Premiums." New York University. January 2015.
Accessed March 30, 2015.
12. Wayman, Rick. "Understanding Small- And Big-Cap Stocks." Investopedia. Accessed March 30, 2015.