Asset Classes It is useful to think of three major asset classes - PDF document

Winning Investment Strategies A Global Vision Javier Estrada Winter, 2014 1. A Look Back • Bringing it all together 2. A Look Ahead • Some final thoughts Asset Classes  It is useful to think of three major asset classes Javier Estrada  Stocks IESE Business • Essential in almost all portfolios / Provide upside School • It may be best to invest in diversified groups of stocks Barcelona Spain  Bonds • Essential in almost all portfolios / Provide protection • Risk and return are relatively easy to assess • Can also be invested in diversified groups  Alternatives (Others) • Do not use them for short‐term speculative bets • Use them for their diversification benefits  The strategic decision determines most of the portfolio’s risk and return WININV Winter, 2014 1

Financial Products  Important distinctions Javier Estrada  Absolute performance (No benchmark) IESE Business • Active management (Absolute return funds / HFs) School • Higher costs than relative performance Barcelona Spain • Their benefits for investors are far from clear  Relative performance (There is a benchmark) • Active management (Mutual funds)  It is far from clear that they reach their goal consistently • Passive management (Index funds / ETFs)  Largely achieve their goal  Lower costs than active management  It is critical to think about (the absolute/relative performance and) the active/passive management proportions in the portfolio WININV Winter, 2014 Essential/Underrated Issues  Costs Javier Estrada  The most underrated variable in investing IESE Business  They can be visible or ‘hidden’ School  Determine observed and expected return Barcelona Spain  Lower costs are tied to higher return and lower risk  Should be a top criteria when choosing funds  The holding period  Determines the risk of the assets in the portfolio  All else equal, the longer the holding period, the more likely is that a higher exposure to risk will turn into a higher return  All else equal, the longer the holding period, the higher should be the exposure to risk WININV Winter, 2014 2

Complementary/Important Issues  Alpha and beta Javier Estrada  Alpha is what active managers should deliver IESE Business  Alpha is elusive and expensive, beta is cheap School  Pay very little for beta, only pay for alpha Barcelona Spain  The fallacy of growth  Growth is only part of the investment story  Valuation plays a critical role in this story  High (low) growth may result in a bad (good) investment ( Focus on how much you pay for growth )  Two well‐known (aggressive) tilts  The size and value effects are pervasive  Size and value tilts can be used to increase a portfolio’s expected return (and risk) WININV Winter, 2014 Portfolio Choice & Rebalancing  Focus on two/three major asset classes Javier Estrada  The allocation to stocks and bonds is critical IESE Business  Liquidity decisions are ‘exogenous’ School  Key variables Barcelona Spain  Holding period and risk tolerance  Tools  Assess your ability to tolerate losses  Asset allocation table  Performance of some benchmark portfolios  Online questionnaires  Rebalancing  A way to control the risk of the portfolio  Rebalancing once or twice a year with a 5% tolerance band is enough WININV Winter, 2014 3

Reference Portfolios  Some well‐known, easy‐to‐implement portfolios Javier Estrada  Discussion of observed performance IESE Business  No specific recommendation to invest in them School  Why, then? Barcelona Spain  To consider possible, easy‐to‐implement portfolios  To raise the issue of whether that (observed and expected) performance is appropriate for you  All model portfolios are not only easy to implement but also have low costs • Fees: They can be implemented with ETFs • Time: Annual rebalancing  Q : Does my portfolio have to be ‘complicated’? If so, why? How is it better than a simple(r) portfolio? WININV Winter, 2014 Behavioral Insights  The bottom line Javier Estrada  We make mistakes both in life and when investing IESE Business  Those mistakes can be identified (Psychology) School  The negative consequences of those mistakes can Barcelona Spain be predicted (Finance)  Strategies can be devised to overcome the negative impact on performance of those mistakes  In short  Know that you are not wired to be a good investor  Know that you can (and will) make mistakes  Put yourself on a leash!  And remember, pick up a Behavioral Finance book to learn more about this issue WININV Winter, 2014 4

Final Thoughts Javier Estrada Managing your savings requires … IESE Business School Barcelona Spain common sense and even ‘folk wisdom’ Set Observe realistic deviations goals and correct Be patient Be disciplined WININV Winter, 2014 Final Thoughts – Warren Buffett Javier Estrada What advice would you give to individual investors? IESE Business School ( Fortune , 2008) Barcelona Spain “If they’re not going to be an active investor, and very few should try that, then they should just stay with index funds. Any low-cost index fund. And they should buy it over time. They’re not going to be able to pick the right price and the right time.” WININV Winter, 2014 5

Final Thoughts – Warren Buffett Javier Estrada (Letter to Shareholders, 1993) IESE Business School “ By periodically investing in an Barcelona Spain index fund … the know-nothing investor can actually outperform most investment professionals. Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.” WININV Winter, 2014 Final Thoughts Javier Estrada Professional athletes … IESE Business School Barcelona Spain have two critical lessons for investors The road to success Losing is an can be pretty bumpy, inevitable part pretty often, and for of investing a pretty long time WININV Winter, 2014 6

Final Thoughts Javier Estrada The ‘sad truths’ of financial markets IESE Business School Barcelona Spain (1) The higher the required return, the higher should be the exposure to risk (2) The higher the exposure to risk, the longer should be the holding period WININV Winter, 2014 Final Thoughts – Carl Richards Javier Estrada IESE Business School “When it comes to investing, Barcelona Spain risk and reward are related. It’s as close as we get to a fundamental law in finance. If you want or need a greater expected return, you’ll have to accept more risk.” WININV Winter, 2014 7

Final Thoughts Javier Estrada Implications (More ‘sad truths’) IESE Business School Barcelona Spain (1) The higher the exposure to risk, the more patience the investor should have (2) The higher the exposure to risk, the more discipline the investor should have Think how you seriously get healthy and in good shape WININV Winter, 2014 Final Thoughts – Carl Richards Javier Estrada IESE Business School “We often resist simple solutions because they Barcelona Spain require us to change our behavior. And so we spend $40 billion a year on weight-loss programs and products rather than take the simple, do-it-yourself approach: consume fewer calories, burn more calories with exercise, or do both. We'd rather look for the magic bullet: something to save us from the day-to-day grind of simply doing the work that needs doing.” WININV Winter, 2014 8

Final Thoughts Javier Estrada A Checklist IESE Business School Barcelona Spain WININV Winter, 2014 Final Thoughts Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014 9

Final Thoughts Javier Estrada The 8 Essential Steps IESE Business School 1. Define your goal Barcelona Spain 2. Determine your holding period 3. Assess your risk tolerance 4. Choose your asset allocation 5. Target annual fees 6. Choose active/passive proportions 7. Select financial products 8. Forget until periodic rebalancing WININV Winter, 2014 Final Thoughts – Richard Branson Javier Estrada IESE Business School Barcelona Spain “ There’s really nothing to it. Start as a billionaire and then buy an airline.” WININV Winter, 2014 10

Final Thoughts – John Bogle Javier Estrada IESE Business School “ I wish I could assure you that Barcelona Spain the investment strategy outlined ... is the best strategy ever devised ... I can't promise that. But I can assure you that the number of strategies that are worse is infinite.” WININV Winter, 2014 Final Thoughts Javier Estrada IESE Outcome Business School Barcelona Spain Good Bad Deserved Deserved Bad Process Good Success Success Break Dumb Poetic Bad Luck Justice WININV Winter, 2014 11

Winning Investment Strategies Thank you! Javier Estrada Winter, 2014 12