SEI s Approach to Asset Allocation

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1 SEI s Approach to Asset Allocation Presented by: Jim Smigiel Managing Director and Portfolio Manager Portfolio Strategies Group

2 What is diversification? Sharpe ratio? Peak Sharpe Ratio Loss of efficiency: Less diversification More concentration Expected Return Tangent 60/40 100% Equity 100% Emerging Equity 100% Commodities 100% 100% Bonds Expected Risk For illustrative purposes only. 2

3 Traditional asset allocation Estimating asset class returns Asset class returns are constantly changing Historical returns may reflect secular trends that aren t expected to persist History is a poor predictor 6% For illustrative purposes only. Source: SEI. Estimating asset class risk Risks constantly change Poor market outcomes are rarely consistent with observed standard deviations Non-normality is the norm Probability Probability 5% 4% 3% 2% 1% 0% Return Estimating asset class correlations Correlations among risky assets tend to rise when volatility is high Correlations between risky assets and government bonds tend to fall when volatility is high Correlations are time variant 3

4 Traditional asset allocation: History is a poor guide 3.50 The Life of a Turkey Time 4

5 Traditional asset allocation: The volatility of volatility 50.00% Trailing 1 Year Volatility: S&P % 40.00% 35.00% 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% Source: SEI. 5

6 Traditional asset allocation: Correlations and crises S&P 500 vs. BarCap Aggregate Source: S&P,BarCap, SEI Dec 09 Dec 73 Dec 74 Dec 75 Dec 76 Dec 77 Dec 78 Dec 79 Dec 80 Dec 81 Dec 82 Dec 83 Dec 84 Dec 85 Dec 86 Dec 87 Dec 88 Dec 89 Dec 90 Dec 91 Dec 92 Dec 93 Dec 94 Dec 95 Dec 96 Dec 97 Dec 98 Dec 99 Dec 00 Dec 01 Dec 02 Dec 03 Dec 04 Dec 05 Dec 06 Dec 07 Dec 08 Dec 10 Dec 11 NBER Recession Rolling 1yr Correlation Long Term : 0.26

7 Building forward looking return assumptions: U.S. Core Fixed Income example Equilibrium Return Assumption 5.66% Adjustments -2.65% + = 10-Year Return Assumption 3.01% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% -1.00% -2.00% -3.00% Real Short-Term Risk-Free Rate Inflation Term Premium Credit Spread Volatility Premium 10-Year Yield Curve Adjustment 10-Year Total Return Source: SEI Capital Market Assumptions. SIMC develops forward-looking, long-term capital market assumptions for risk, return, and correlations for a variety of global asset classes, interest rates, and inflation. These assumptions are created using a combination of historical analysis, current market environment assessment and by applying our own judgment. In certain cases, alpha and tracking error estimates for a particular asset class are also factored into the assumptions. We believe this approach is less biased than using pure historical data, which is often biased by a particular time period or event. Please see the Important Information at the back of this presentation for more information. 7

8 Estimating risk and correlations 6% Estimating asset class risk Risks constantly change Poor market outcomes are rarely consistent with observed standard deviations Non-normality is the norm SEI incorporates 3 rd and 4 th moments Fit distributions to the left tail Probability Probability 5% 4% 3% 2% 1% % Return Source: SEI. For illustrative purposes only. Estimating asset class correlations Correlations among risky assets tend to rise when volatility is high Correlations between risky assets and government bonds tend to fall when volatility is high Correlations are time variant SEI incorporates stress correlations into our estimates Purposefully not overly-reliant on fleeting diversification 8

9 Diversification of capital Diversification of risks Traditional Asset Allocation, 60/40 Portfolio Capital Allocation 40% 60% Equity Fixed income Risk Allocation 8% 92% The traditional diversified portfolio is highly concentrated in equity risk Source: SEI. Equities = S&P 500, Fixed Income = Barclay s U.S. Aggregate, 20 years monthly data as of

10 Diversification by economic regime? Varying Economic Regimes and Preferred Exposures Rising GROWTH Falling Rising Growth / Falling Inflation Risk Premiums i.e. Equities Falling Growth / Falling Inflation Duration i.e. Nominal bonds Rising Growth / Rising Inflation Scarcity Assets i.e. Commodities Falling Growth / Rising Inflation Hedges i.e. Inflation-linked bonds Falling Source: SEI, 20 years monthly data as of INFLATION Rising 10

11 Harnessing the power of the total portfolio approach Siloed Approach (Sub-optimal) Fixed Income Equity Optimizer Optimizer Fixed Income Portfolio Equity Portfolio Sub-optimal Portfolio Fixed Income All Asset Classes Optimizer Total Portfolio Approach (Optimal) Optimal Portfolio Equity For illustrative purposes only. 11

12 Optimization framework Capture portfolio metrics from CMA and historical perspective Traditional and non-traditional portfolio metrics Return, risk, Sharpe ratio Potential drawdown, excess return / average drawdown (similar to Sortino ratio) All-season score (measures consistency of returns across economic regimes) Flexible framework considers whole range of highly-optimal portfolios Offers insights into tradeoffs and guidance to make informed asset allocation decisions Conservative Models Growth Models For illustrative purposes only. 12

13 Summary SEI defines diversification through several lenses Return-based (i.e. highest Sharpe ratio over a given return target) Risk-based Regime-based SEI utilizes a forward looking approach to Capital Market Assumptions Separate returns into their component parts (building blocks) Capture the left tail in return distributions for risk estimates Utilize stress correlations to address time variance SEI takes a total-portfolio approach to optimizations Avoids the asset class approach to building portfolios Analyses a suite of objective-oriented metrics for each portfolio Optimizes on multi-dimensional, goal-specific factors 13

14 Overcoming the flaws of traditional asset allocation Focus on diversification through multiple lenses Risk aware Regime aware Continuously evaluate and seek to identify asset classes with favorable diversification characteristics Multi-asset Managed volatility equity Actively manage the strategic asset allocation to take advantage of shorter term, asymmetric market anomalies Return enhancement Risk mitigation 14

15 Asset class rankings by calendar year % 26.07% 20.98% 18.26% 11.62% 11.39% 11.13% 9.15% 7.1% 4.34% 1.25% 34.32% 21.36% 14.34% 12.16% 10.25% 6.24% 4.51% 3% 2.74% 2.43% 1.87% Short Duration Short Duration 0.91% 1.62% 35.06% 32.53% 27.27% 18.31% 15.41% 11.85% 9.86% 4.81% 4.33% Short Duration 3.92% 2.07% 1.56% 39.66% 16.23% 11.86% 11.45% Short Duration 7.31% 6.97% 6.16% 5.79% 4.78% 1.87% -1.58% % Short Duration 6.67% 5.24% 1.75% -2.43% % % % % % % % % 78.89% 58.21% 32.67% 29.82% 28.39% 27.99% 27.08% 18.91% 12.02% 5.93% Short Duration 0.8% 0.14% 27.95% 26.82% 19.33% 16.83% 16.1% 15.12% 12.24% 8.49% 6.54% 5.22% 2.4% 0.13% 8.93% 8.28% 7.84% 7.35% 4.98% Short Duration 1.55% 1.48% 0.07% -4.19% % % % 19.7% 18.65% 18.11% 17.44% 16.41% 16.37% 15.81% 5.04% 4.22% Short Duration 0.43% 0.07% -1.06% 38.81% 33.12% 23.59% 7.44% 2.86% Short Duration 0.36% 0.04% -2.02% -2.27% -5.25% -5.59% -9.52% Asset categories represented by: U.S. Large Cap (Russell 1000 Index), U.S. Small Cap (Russell 2000 Index), Developed International (MSCI Index), Bond (Barclays U.S. Corporate Index), (USD 3 Month LIBOR), Short Duration (Barclays US Treasury 1-3 Year Index), (Barclays U.S. Aggregate Bond Index), Commodities (Dow-Jones UBS Commodity Index), (Barclays U.S. Treasury Inflation Notes 1-10Yr Index), Emerging Market Debt (JP Morgan EMBI Global Diversified Index), U.S. (FTSE NAREIT All Equity Index), and Emerging Market Equity (MSCI Emerging Markets Index). Performance as of 12/31/2013. Source: SEI. 15

16 Naïve strategy results 30.00% 29.38% 25.00% 24.22% 20.00% 15.00% 12.65% 10.00% 7.14% 5.00% 0.00% 0.43% 3.59% Best of Previous Year Worst of Previous Year Equal Weighting Sharpe Ratio: Returns (Ann.) Risk (Std Dev) Asset class returns are based on the same indices as indicated on slide 15 disclosures. Performance begins in January 2004 and continues through December In each of these years, Best of Previous Year uses the current year return of best performing asset class of the previous year. Worst of Previous Year uses the current year return of worst performing asset class of the previous year. Equal Weighting uses a return equal to the return of a portfolio of equally weighted asset class returns in each year. Source: SEI. 16

17 Important Information This presentation is provided by SEI Investments Management Corporation (SIMC), a registered investment adviser and wholly owned subsidiary of SEI Investments Company. The material included herein is based on the views of SIMC. Statements that are not factual in nature, including opinions, projections and estimates, assume certain economic conditions and industry developments and constitute only current opinions that are subject to change without notice. Nothing herein is intended to be a forecast of future events, or a guarantee of future results. This presentation should not be relied upon by the reader as research or investment advice (unless SIMC has otherwise separately entered into a written agreement for the provision of investment advice). There are risks involved with investing including loss of principal. There is no assurance that the objectives of any strategy or fund will be achieved or will be successful. No investment strategy, including diversification, can protect against market risk or loss. Current and future portfolio holdings are subject to risk. Past performance does not guarantee future results. For those SEI products which employ a multi-manager structure, SIMC is responsible for overseeing the sub-advisers and recommending their hiring, termination, and replacement. References to specific securities, if any, are provided solely to illustrate SIMC s investment advisory services and do not constitute an offer or recommendation to buy, sell or hold such securities. Certain economic and market information contained herein has been obtained from published sources prepared by other parties, which in certain cases have not been updated through the date hereof. While such sources are believed to be reliable, neither SEI nor its affiliates assumes any responsibility for the accuracy or completeness of such information and such information has not been independently verified by SEI. Index returns are for illustrative purposes only and do not represent actual portfolio performance. Index performance returns do not reflect any management fees, transaction costs, or expenses, which would reduce returns. Indexes are unmanaged and one cannot invest directly in an index. 17

18 Important Information SIMC develops forward-looking, long-term capital market assumptions for risk, return, and correlations for a variety of global asset classes, interest rates, and inflation. These assumptions are created using a combination of historical analysis, current market environment assessment and by applying our own judgment. In certain cases, alpha and tracking error estimates for a particular asset class are also factored into the assumptions. We believe this approach is less biased than using pure historical data, which is often biased by a particular time period or event. The asset class assumptions are aggregated into a diversified portfolio, so that each portfolio can then be simulated through time using a monte-carlo simulation approach. This approach enables us to develop scenarios across a wide variety of market environments so that we can educate our clients with regard to the potential impact of market variability over time. Ultimately, the value of these assumptions is not in their accuracy as point estimates, but in their ability to capture relevant relationships and changes in those relationships as a function of economic and market influences. The projections or other scenarios in this presentation are purely hypothetical and do not represent all possible outcomes. They do not reflect actual investment results and are not guarantees of future results. All opinions and estimates provided herein, including forecast of returns, reflect our judgment on the date of this report and are subject to change without notice. These opinions and analyses involve a number of assumptions which may not prove valid. The performance numbers are not necessarily indicative of the results you would obtain as a client of SIMC. We believe our approach enables our clients to make more informed decisions related to the selection of their investment strategies. For more information on how SIMC develops capital market assumptions, please refer to the SEI paper entitled Executive Summary: Developing Capital Market Assumptions for Asset Allocation Modeling. If you would like further information on the actual assumptions utilized, you may request them from your SEI representative. 18