Class Note 5_F2011(2) - RSM 330 Investments Class Note 5...

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RSM 330 – Investments Class Note 5 – Oct. 13, 2011 Maureen Stapleton, CFA 1 RSM 330_Note 5_F2011
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Plan for Today Asset Allocation – Modern Portfolio Theory (MPT) Expand on last week’s discussion Consider investing in more than one risky asset The Separation Property Impact of Asset Allocation Policy Required Readings Bodie text Ch. 6.1-6.5; 23.1-23.4 (omit pg 879-880) – (or 6 th edition 7.1-7.5;23.2-23.4, omit pg. 862-863) “Does Asset Allocation Explain 40, 90 or 100 Percent of Performance?” Exchange Rate Risk Today- Hand in your Group’s Project Proposal – 1 page only Tutorials RSM 330_Note 5_F2011 2
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What’s happening in markets? RSM 330_Note 5_F2011 3 Earnings Season: Disappointments & downward revisions Interest rates low in North America “a safe haven”
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RSM 330_Note 5_F2011 4
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RSM 330_Note 5_F2011 5
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Two kinds of asset allocation: Strategic (long-run returns, risks and covariances) Policy Portfolio Long term horizon – 5 to 10 years Tactical (short-run returns, risks and covariances) Active Management Short term horizon – market cycle (12 to 24 months) A portfolio’s strategic asset allocation or “policy portfolio” should shift only in response to changing client circumstances or to long run market developments (ie a change in liabilities or risk tolerance or the availability of a new asset class) Examples: Life Cycle investing for individuals is a simple form of strategic asset allocation. Also, pension funds will change their policy portfolio if the average age of plan members increases significantly, thus changing their risk tolerance! Tactical allocation alters the portfolio in response to changes in the 6 RSM 2302_Note 4_F2011
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Example: OTPP Policy Portfolio – Strategic Asset Allocation RSM 2302_Note 4_F2011 7 We will discuss this next week! This week, we’ll explore how the policy portfolio is determined!
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Tactical Asset Allocation - Active Management Adjust the portfolio composition, relative to the policy portfolio , to capitalize changes that occur over the market cycle Expansionary – early signs of economic recovery Increase common stock exposure Move from defensive to cyclicals Peak Central bank is increasing short term rates Reduce equity exposure and increase money market Contraction Signs of recession Buy bonds & lengthen the maturity of bonds Reduce equity exposure Buy defensive stocks: utilities, consumer staples & (usually) banks Trough Sell long term bonds; implement defensive yield curve strategies 8 RSM 2302_Note 4_F2011
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Important points about asset allocation Objective: We want to obtain the highest possible return available, given our tolerance for risk Diversification allows us to obtain a higher return /risk ratio Diversification increases the return/risk ratio only if we combine assets whose performance is not perfectly correlated RSM 330_Note 5_F2011 9
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RSM 330_Note 5_F2011 10 Remember from last week… Asset allocation with one risky asset (stocks)and a riskless asset 12.1%  S  (standard deviation)  E
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This note was uploaded on 10/21/2011 for the course RSM 330 taught by Professor Stapleton during the Fall '11 term at University of Toronto- Toronto.

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Class Note 5_F2011(2) - RSM 330 Investments Class Note 5...

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