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Q1 Slideshow Posted 2012


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Financial Concerns for Proper Investment

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Q1 Slideshow Posted 2012

  1. 1. Legacy², LLCRegistered Investment Advisor Firm Q1 2012 Review Slide Presentation _ 15 Apr 2012
  2. 2. Agenda □ Review of First Quarter (what happened); □ Investment Outlook (what is happening now); □ Our Portfolio Positioning (what we’re doing about It). LEGACY², LLC2 Registered Investment Advisor
  3. 3. Key Takeaways o Stocks and other risk assets were up sharply:  This further reduces our five-year return expectations; o Rising Treasury yields resulted in flat first quarter returns for core bonds:  Our flexible fixed-income strategies did well, given their latitude to invest; differently than the core bond benchmark o The euro-zone averted a crisis but did not resolve the longer-term structural problems that threaten the EU system; o Our portfolios continue to be underweight stocks/equity-risk and core bonds/interest-rate risk. LEGACY², LLC3 Registered Investment Advisor
  4. 4. Review of First Quarter 2012
  5. 5. Drivers of October-March Stock Market Rally o Successful intervention that took a European financial crisis off the table, at least for the time being; o Positive U.S. economic data points, particularly with respect to employment; o Encouraging results of the Fed’s recent banking stress tests; o As a result, stocks had one of the strongest gains over that six-month period in many decades. LEGACY², LLC5 Registered Investment Advisor
  6. 6. Investment Outlook
  7. 7. Developed World is Still Struggling to Climb Out of Debt o High debt levels create economic headwinds; o High debt levels increase risk; o There is no solution that does not involve economic pain. LEGACY², LLC7 Registered Investment Advisor
  8. 8. Refinancing Operations Slowed Europe’s Financial Crisis (For Now) o Liquidity injection reduced risk of a run on the banking system; o Government bond yields have fallen, reducing these countries’ borrowing costs:  Allows countries to borrow cheaply to finance deficits and reduce overall debt; o Provides countries additional time and space to enact difficult economic and political reforms; o However, the markets are recognizing that underlying problems remain:  Yield on Spanish debt has been moving sharply higher on renewed concerns about government’s ability to meet deficit reduction targets;  New Greek debt is trading at prices that reflect a high probability of another default/restructuring. LEGACY², LLC8 Registered Investment Advisor
  9. 9. Problems at Home: The Looming U.S. “Fiscal Cliff” o January 1, 2013: “massive fiscal cliff of large spending cuts and tax increases”:  Expiration of Bush-era tax cuts, the temporary payroll tax cut, extended unemployment benefits ;  $1.2 trillion of automatic spending cuts will begin to kick in as a result of last year’s Congressional Super Committee’s failure to reach consensus; o Impact would be roughly 3.5% hit to GDP next year; o Seems unlikely it will play out that way, but risk of policy errors and political dysfunction—particularly in an election year—remain high! LEGACY², LLC9 Registered Investment Advisor
  10. 10. Our Portfolio Positioning
  11. 11. Portfolio Positioning Reflects our Longer-Term Concerns o Core bonds are set to generate very low returns over the next five years:  Underweighted to core bonds in favor of flexible fixed-income and alternative strategies; o Stocks also offer subpar returns over our long-term investment horizon: o Underweighted to stocks/equity-risk; o Continue to see attractive tactical opportunities in emerging-markets local- currency bonds, absolute-return-oriented fixed-income and alternative strategies; o Expect periods of heightened volatility along the lines of what we saw last year: o These environments can create opportunities to increase our weightings to riskier asset classes at lower prices. LEGACY², LLC11 Registered Investment Advisor
  12. 12. Future Returns of Stocks and Bonds Will be Lower than We’re Used To Seeing 1 1 Projections under our base case, subpar economic scenario as of 3/31/12 2 2 As measured by the Barclays Aggregate Bond Index . LEGACY²,of LLC 1 Projections as 10/1/11.12 Registered Investment Advisor 2 As measured by the Barclays Aggregate Bond Index .
  13. 13. We Remain Underweighted to Stocks o We expect low returns from U.S. and developed international market stocks over the next five years; o Emerging-markets stocks look attractive on a long-term basis, but, given higher short-term downside, we aren’t increasing our weightings; o Periods of short-term volatility should create opportunities for skilled managers to take advantage of shorter-term mispricing at the individual stock level. LEGACY², LLC13 Registered Investment Advisor
  14. 14. We Remain Underweighted to Core Bonds o We expect low returns in all our five-year scenarios, with minimal downside protection; o We favor flexible and absolute-return-oriented fixed-income managers:  Managers have wide latitude to adjust portfolio characteristics. such as duration, credit quality, sector, currency and foreign bond exposure; o We expect inflationary pressures to increase toward the end of our five- year horizon:  Our non-core bonds funds should do much better than the core bond index if inflation heats up. LEGACY², LLC14 Registered Investment Advisor
  15. 15. Traditional Role of Core Bonds in a Portfolio o Core bonds (investment-grade bond funds) traditionally:  Reduce portfolio risk because they are far less volatile than stocks;  Provide protection against a major economic shock/recession;  Generate current income; o There are two major risks inherent in bonds:  Credit risk;  Interest-rate risk; • The longer until a bond is repaid (maturity), the more its value falls due to a rise in interest rates. LEGACY², LLC15 Registered Investment Advisor
  16. 16. Current Bond Market Environment Argues for Investing Outside of Core Bonds o Treasury yields are near all-time lows and we expect to see rates rise within the next five years:  When rates do rise, bond values will fall; o Flexible and absolute-return- oriented fixed-income managers have more latitude to pursue return and lessen impact of rising rates; o It is important to maintain some exposure to core bonds as protection in a very negative scenario. LEGACY², LLC16 Registered Investment Advisor
  17. 17. Positioning of Our Fixed-Income Strategies Our fixed-income portfolios have less interest-rate sensitivity and higher yields than traditional core bond portfolios 9.0% Source: Morningstar 8.0% Double Line Total Return 7.0% D I The longer the duration, the greater S 6.0% a funds interest-rate sensitivity T Y R I 5.0% Osterweis Strategic Income I E B L 4.0% U D T Pimco Total Return I 3.0% O VBMFX N 2.0% Pimco Unconstrained Bond The core bond index is generally lower yielding 1.0% and has more interest-rate sensitivity 0.0% 0 1 2 3 4 5 6 7 8 INTEREST-RATE SENSITIVITY (DURATION—IN YEARS) LEGACY², LLC17 Registered Investment Advisor
  18. 18. Alternatives Provide Further Portfolio Diversification o Arbitrage positions could potentially earn mid-single-digit returns over the next five years with relatively low risk over the shorter term; o We view these positions as “dry powder” that can generate better returns than core bonds in the meantime (not subject to the risk of rising rates). LEGACY², LLC18 Registered Investment Advisor
  19. 19. Looking Ahead o We remain confident in our portfolio positioning; o We are focused on the long term, while remaining flexible and nimble through this highly unstable and uncertain environment; o We will take on more risk when our research convinces us it is prudent and, in so doing, we believe we can get better returns than just what the market yields. LEGACY², LLC19 Registered Investment Advisor
  20. 20. Asset Class Returns Asset Class 12 5 Years (current tactical overweighting  or Index 1Q 2012 Months (Ann.) underweighting )U.S. Larger-Cap Blend ( since Nov-08) Vanguard 500 12.54% 8.37% 1.94%U.S. Larger-Cap Growth iShares Russell 1000 Growth 14.61% 10.83% 4.93%U.S. Larger-Cap Value iShares Russell 1000 Value 11.05% 4.60% -0.91%U.S. Smaller-Cap Blend ( since Sep-06) iShares Russell 2000 12.42% -0.18% 2.18%U.S. Smaller-Cap Growth iShares Russell 2000 Growth 13.28% 0.75% 4.17%U.S. Smaller-Cap Value iShares Russell 2000 Value 11.55% -1.20% -0.05%Developed Intl Stocks ( since May-09) Vanguard MSCI EAFE ETF 11.50% -5.43% -3.05%Emerging-Markets Stocks ( since Jan-12) Vanguard Emerging Market ETF 13.96% -9.02% 4.55%REITs Vanguard REIT 10.71% 12.74% 0.31%Investment-Grade Bonds (since Dec-09) Vanguard Total Bond 0.23% 7.56% 6.12%Absolute-Return-Oriented Bonds (since Dec-09) Citigroup 3 Month T-Bill Index 0.04% 0.07% 1.12%High-Yield Bonds Merrill Lynch High-Yield 5.04% 5.70% 7.74%Inflation-Protected Bonds iShares Barclays TIPS Bond 0.78% 11.98% 7.46%Floating-Rate Loans (since Mar-11) S&P/LSTA Leveraged Loan 3.74% 2.80% 4.52%Commodity Futures Dow Jones-UBS Commodities 0.89% -16.27% -2.78%Global Investment-Grade Bonds Citigroup World Gov’t Bond -0.51% 5.12% 6.78%Emerging-Markets Local-Currency Bonds (since Aug-09) JPMorgan GBI-EM Global Div. 8.29% 3.44% 10.05%
  21. 21. We Expect to See More Volatility Ahead The Chicago Board Options Exchange Volatility Index, or VIX, is a commonly used indicator of market volatility. Often referred to as the “fear index” it is a measure of investors’ expectations of S&P 500 volatility over the near term. LEGACY², LLC21 Registered Investment Advisor
  22. 22. Our Fixed-Income Positions Are Likely to Outperform Core Bonds in Most Long Term Environments Litman Gregory’s Five-Year Scenario Analysis Short-Term “Flight to Quality” Period Severe Recession Stagflation Subpar Recovery Average Recovery (e.g. 3rd Quarter 2011) Best Barclays Capital Floating-Rate Floating-Rate Emerging-Markets Emerging-Markets Returns Aggregate Bond Loan Funds Loan Funds Local-Currency Local-Currency Index Bond Funds Bond Funds Investment-Grade Multi-Sector Emerging-Markets Multi-Sector Multi-Sector Bond Funds Bond Funds Local-Currency Bond Funds Bond Funds Bond Funds Absolute-Return- Investment-Grade Multi-Sector Floating-Rate Floating-Rate Oriented Bond Funds Bond Funds Bond Funds Loan Funds Loan Funds Floating-Rate Barclays Capital Absolute-Return- Absolute-Return- Absolute-Return- Loan Funds Aggregate Bond Oriented Bond Funds Oriented Bond Funds Oriented Bond Funds Index Multi-Sector Absolute-Return- Investment-Grade Investment-Grade Investment-Grade Bond Funds Oriented Bond Funds Bond Funds Bond Funds Bond Funds Worst Emerging-Markets Emerging-Markets Barclays Capital Barclays Capital Barclays Capital Returns Local-Currency Local-Currency Aggregate Bond Aggregate Bond Aggregate Bond Bond Funds Bond Funds Index Index Index LEGACY², LLC22 Registered Investment Advisor
  23. 23. Reminder: Our Portfolio Management Approach Maximize risk-adjusted returns through tactical asset allocation and “best-in-class” active manager selection. INVESTMENT MANAGEMENT APPROACH Active Passive/Indexing Litman Gregory Tactical LEGACY², LLC ASSET ALLOCATION APPROACH Static LEGACY², LLC23 Registered Investment Advisor
  24. 24. Our “Fat Pitch” Tactical Allocation Strategy When Long-Term Fundamentals and Current Valuations Diverge… We May Find a “Fat Pitch” Investment Opportunity Current Valuations Asset Class Valuations Fair Value Based on Fundamentals Shifting allocation back down to neutral Potential “fat pitch” shift to allocation above neutral Years Over the long term we expect valuations and fundamentals to converge. LEGACY², LLC24 Registered Investment Advisor
  25. 25. Our Four Broad Economic Scenarios* SCENARIO DEFINITION • We experience a severe recession, e.g., due to another financial crisis or debt crisis Severe Recession • Weak recovery in the later years • Assumes inflation is around 1% and the 10-year Treasury yield is around 2% at end of year 5 • Subpar economic growth Stagflation • Strong inflation spike at the end of our forecasting period • Assumes inflation is around 6% and the 10-year Treasury yield is around 7% at end of year 5 • Recovery that began late in 2009/early 2010 continues, a recession is Subpar Recovery probable within the five-year horizon • Assumes inflation is around 3% and the 10-year Treasury yield is around 5% at end of year 5 • Recession is avoided and the economy recovers due to a combination of effective government policy and positive self-reinforcing economic and Average Recovery business cycle dynamics • Re-flation works, but Fed avoids monetary inflation • Assumes inflation is around 3% and the 10-year Treasury yield is around 6% at end of year 5 LEGACY², LLC25 Registered Investment Advisor *As of 3/31/12.
  26. 26. Scenario Analysis: Asset Class Return Estimates More Pessimistic More Optimistic Economic Scenario Severe Recession Stagflation Subpar Recovery Average Recovery As of 3/31/12 S&P 500 at 1409, Barclays Aggregate yield at 2.0%, MSCI EM Index at 1041, BofA Merrill Lynch High-Yield Cash Pay Index at 7.0%. Equity Asset Classes Estimated Average Annual Returns over Next Five Years U.S. Equities -4.9% -3.5% 2.9% 11.2% Developed International Similar to U.S. Equities Emerging Markets 0.8% n/a 9.6% 18.9% REITs -0.4% -2.0% 1.5% 1.9% Fixed Income Asset Classes Investment-Grade Bonds 1.9% -0.4% 0.6% 0.2% High-Yield Bonds 1.7% 4.2% 3.5% 2.1% Floating-Rate Loans 3.7% 3.5% 4.0% 4.1% TIPS 2.4% 0.0% 0.0% -1.0% Emerging-Markets Low single-digit Low/Mid single-digit Mid/High single-digit Mid/High single-digit Local-Currency Bonds returns returns returns returns Alternative Asset Classes Arbitrage Strategies Mid single-digit returns in most scenarios LEGACY², LLC26 26 Registered Investment Advisor
  27. 27. Of Our Four Broad Economic Scenarios, We Believe “Subpar Recovery” is the Most Likely Economic Scenario: Subpar Recovery Equity Asset Classes U.S. Equities 2.9% Developed International Similar to U.S. Equities Emerging Markets 9.6% REITs 1.5% Fixed-Income Asset Classes Investment-Grade Bonds 0.6% High-Yield Bonds 3.5% Floating-Rate Loans 4.0% TIPS 0.0% Emerging-Markets Local-Currency Bonds Mid/High single-digit returns Alternative Asset Classes Mid-to-upper single-digit returns in Alternative Strategies most scenarios Chart is as of 3/31/12 S&P 500 at 1409, Barclays Aggregate yield at 2.0%, MSCI EM Index at 1041, BofA ML High Yield Cash Pay Index at 7.0%. LEGACY², LLC27 Registered Investment Advisor
  28. 28. Tactical Positioning of Conservative Balanced Portfolio % Underweight Current Neutral % Overweight of Current from Neutral Weight Weight of Current from Neutral 30 25 20 15 10 5 5 10 15 20 25 30 Fixed Income Core fixed income 37% 60% Floating-Rate Loans 6% 0 Absolute-return-oriented/Flexible 24% 0 Emerging-markets local-currency 5% 0 bonds Alternatives Arbitrage 5% Equities Larger cap 16% 20% Smaller cap 1.5% 4% Developed international 2.0% 8% Emerging-markets 3.5% 8% LEGACY², LLC28 Registered Investment Advisor