The Myth of Asset Allocation

or
Would you rather beat the market or make money?

John O. Low
Institutional Investor Counsel
American Asset Management Group, Inc.
50 West Montgomery Avenue Suite 110
Rockville, MD 20850
Phone 301-251-1002
john@aamg.com
2012 American Asset Management Group, Inc.

Archetypal Investment Philosophies

Absolute Return vs. Relative return
Risk
Ascent of Relative Return
o 1952-MPT
o 1960s-EMH
o 1964-CAPM

Secular Market Cycles

The Investment Policy Statement and IPS
Conclusion

Risk
Systematic Risk a.k.a. undiversifiable risk or market risk
The risk inherent in the entire market or an entire market segment.*

changes in interest rates

war
consumer prices
employment/unemployment factors
political/regulatory changes

Non-Systematic Risk a.k.a. diversifiable risk or unsystematic risk

Risk that is unique to a certain asset or company. **

labor strikes and other problems

natural disaster/weather problems
result of unfavorable litigation
Management
corporate fraud/malfeasance,

*. [Financial Dictionary, <a href="http://financial-dictionary.thefreedictionary.com/Systematic+risk">Systematic

Risk</a>]
**[Financial Dictionary, <a href="http://financial-dictionary.thefreedictionary.com/unsystematic+risk">Unsystematic
Risk</a>]

Modern Portfolio Theory [MPT]

Harry Markowitz
1952/1959
Volatility = Risk
Mathematical model/proof showing that
diversification could reduce volatility (risk)
Efficient Frontier
Underlying assumption: Correlation is the key-assets in a portfolio should NOT be chosen on their
own individual merits, but rather in consideration
of how their changes in price (volatility) relate to
the other assets in the portfolio.

Efficient Frontier

Efficient Market Hypothesis

Eugene Fama 1960s PhD. Thesis for University
of Chicago Booth School of Business.
Republished and refined in 1970
Weak prices already reflect all past publicly
available information
Semi-Strong prices reflect all publicly available
information AND instantly change to reflect new
information
Strong prices also instantly reflect all
private/insider information

Capital Asset Pricing Model [CAPM]

Bill Sharpe (among others) 1964
Defines volatility (risk) as beta
Mathematical model for individual asset
pricing (beta coefficient)

Dominant and Secondary Risks

RELATIVE RETURN (BENCHMARK)
INVESTING

ABSOLUTE RETURN INVESTING

MARKET

SECURITY

SECURITY

MARKET

Why?
Wall Street Sales Machine
Training
Research/punditry
Regulatory Environment
Secular Bull Market

Easterling, Ed. Unexpected Returns. Fort Bragg: Cypress House, 2005. Print.

Time Frame

Duration

1901-1920

Number of
Recessions

Starting P/E

Finishing
P/E

Decline (Inf.
Adjusted)

19 Yrs 6 Mos 6

25.2

5.1

-69%

1929-1949

19 Yrs 9 Mos 4

32.6

9.1

-67%

1966-1982

16 Yrs 6 Mos 4

24.1

6.6

-62%

AVERAGE

18 Yrs 7 Mos 4.7

27.3

6.9

-66%

2000Present
(as of July 9,
2012)

11 Yrs 5 Mos 2

44.2

22.4

-37%

Pring Turner Capital Group www.pringturner.com

Relative Return Manager 2002-2003

Absolute Return Manager 2002-2003

Relative vs. Absolute

Easterling, Ed. Unexpected Returns. Pps. 197-198

The Investment Policy Statement

Any organization that has assets to invest should also have appropriate policies to
guide these investments. One set of policies does not fit every organization but
each organization needs to define its own goals and understand its own fiduciary
responsibilities. Here is a list of the basic points to cover. Any investment policies
should
be developed with the advice of a financial professional or be reviewed by legal
counsel
define general objectives (preserve and protect the assets; achieve aggressive
growth)
delegate day-to-day asset management to an independent finance committee or a
professional manager
set asset allocation parameters (include diversification)
describe asset quality (itemize quality ratings for stocks, bonds, or short-term
reserves based on your risk tolerance)
define the investment manager's accountability (include risk in transactions, social
responsibility, reporting requirements, and coverage of cash flow needs)
establish a system for regular review of the policies

Thomas A. McLaughlin, Financial Committees (BoardSource 2004).

Robert P. Frye, Jr., Minding the Money: An Investment Guide for Nonprofit Board Members (BoardSource 2004).

Sample Asset Allocation Models

EXAMPLE 1:
UCRP [$3.2b]

EXAMPLE 2:
501(c)3 reserve acct. [$2.6mm]

The Investment Policy Statement

Primacy
Self-authored
Vision
Clarity
Flexibility
Revisited

John O. Low
Institutional Investor Counsel
American Asset Management Group, Inc.
50 West Montgomery Avenue Suite 110
Rockville, MD 20850
Phone 301-251-1002
john@aamg.com

This presentation is copyrighted 2012 by American Asset Management Group, Inc. and is its property. No
unauthorized duplication or rebroadcast is allowed.
The owner gratefully acknowledges Ed Easterling, and Crestmont Research for their help.