Investment Portfolio Construction

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1 Investment Portfolio Construction CLA Local Government Conference May 2014 CLAconnect.com/privateclient Steven D. Jones, CFA, CFP, CAIA Director, Institutional Investment Services

2 Disclosures CliftonLarsonAllen Wealth Advisors, LLC ( CLA Wealth Advisors ) The purpose of this publication is purely educational and informational. It is not intended to promote any product or service and should not be relied on for accounting, legal, tax, or investment advice. The views expressed are those of CLA Wealth Advisors. They are subject to change at any time. Past performance does not imply or guarantee future results. Investing entails risks, including possible loss of principal. Diversification cannot assure a profit or guarantee against a loss. Investing involves other forms of risk that are not described here. For that reason, you should contact an investment professional before acting on any information in this publication. Financial information is from third party sources. Such information is believed to be reliable but is not verified or guaranteed. Performances from any indices in this report are presented without factoring fees or charges, and are provided for reference and competitive purposes only. Any fees, charges, or holdings different than the indices will effect individual results. Indexes are unmanaged; one cannot invest directly into an index. Investment Advisory Services offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC Registered Investment Advisor. Prior approval is required for further distribution of this material. 2

3 Investment Portfolio Construction Agenda Today s Goal - Improved Governance Introduction to the Risk/Return Graph Step 1 - Determine Risk Tolerance Step 2 - Select Amount of Diversification Step 3 - Analyze Fees Return Expectations are the Residual of Steps 1, 2 & 3 3

4 Investment Portfolio Construction Today s Goal - Improved Governance Fiduciaries have control over the following three factors: 1) Risk 2) Diversification 3) Fees Fiduciaries should act prudently and weigh the above issues carefully. Return Expectations are residual & systematic. Fiduciaries should develop and maintain the proper documentation to support their decisions. 4

5 Investment Portfolio Construction An Introduction to the Risk/Return Graph 5

6 Investment Portfolio Construction Risk/Return Graph in the Real World Source: Envestnet 6

7 Investment Portfolio Construction Step 1 Determine Risk Tolerance Where should you position your portfolio on this axis? 7

8 Investment Portfolio Construction Step 1 Measuring Risk Tolerance I. Qualitative Measures Psychological Factors Questionnaires & Surveys II. Quantitative Measures Cash Flow Analysis Time Horizon Asset/Liability Management Techniques Cash Reserve Cash Matching Duration Matching Monte Carlo Simulation Financial Stress Test 8

9 Investment Portfolio Construction Step 1 Set Portfolio Risk Target Risk Target, STD DEV = 11% 9

10 Investment Portfolio Construction Step 2 Select Amount of Diversification Source: Envestnet 10

11 Investment Portfolio Construction Step 2 Select Amount of Diversification Portfolio risk can be effectively diversified (reduced) by combining securities that do not move in tandem with each other. Source: Morningstar 11

12 Investment Portfolio Construction Step 2 Mathematics behind the Benefits of Diversification Correlation Coefficient Formula* Correlation is the covariance of security A and B divided by the product of the standard deviation of these two securities. It ranges between -1 and +1 A correlation of +1 means the two securities always move in the same direction. A correlation of 0 means the two securities have no relationship to each other. A correlation of -1 means the two securities always move in the opposite direction. Portfolio Variance Formula* Lower correlations equal lower portfolio volatility. * Two Securities 12

13 Investment Portfolio Construction Step 2 Diversification & Correlation Source: Morningstar 13

14 Investment Portfolio Construction - Return Expectations Diversification & Correlation 14

15 Investment Portfolio Construction Step 2 Diversification and the Efficient Frontier Efficient Frontier Source: Envestnet 15

16 Investment Portfolio Construction Step 3 Analyze Fees: Does Active Management Pay? Active managers perform no better than what would be expected by pure luck. Active managers cost significantly more than passive managers. 16

17 Investment Portfolio Construction Step 3 Analyze Fees 17

18 Investment Portfolio Construction Step 3 Analyze Fees Fiduciaries should review fees at least once per year. 18

19 Investment Portfolio Construction - Return Expectations Faith in the System Source: Envestnet 19

20 Investment Portfolio Construction - Return Expectations Long-Term Forecasts Are More Accurate than Short-Term Long-term asset class returns Source: Envestnet 20

21 Investment Portfolio Construction - Return Expectations Residual of Steps 1, 2 & 3 Return Target = 8.5% #3 Fees #2 Diversification #1 Risk Target 21

22 Investment Portfolio Construction Building a Target Return Is your Target Return reasonable, given current market conditions? 22

23 Steven D. Jones, CFA, CFP, CAIA Director, Institutional Investment Services & Private Investment Research CliftonLarsonAllen Wealth Advisors, LLC PROFILE Steven is the Director of the Institutional Investment Services at CliftonLarsonAllen Wealth Advisors, LLC. He has over thirty years of investment management experience with expertise in all major asset classes, and specializes in asset/liability management, macroeconomic analysis and asset allocation strategies. EXPERIENCE IN SERVING CLIENTS Steven began serving institutional clients in 1990, as a portfolio manager for a major trust company in St. Louis. In 2006, he joined LarsonAllen Financial and expanded his client facing skills to include high net worth individuals. In 2009, Steven joined Hammond Associates as a Senior Investment Consultant where he served foundations, endowments, healthcare and high net worth clients. Hammond Associates was acquired by Mercer in In 2013, Steven rejoined CliftonLarsonAllen Wealth Advisors to help lead the organization s institutional business efforts as well as their private investments research. EDUCATION/PROFESSIONAL INVOLVEMENT Steven is a CFA charterholder and serves as the Immediate Past President of the CFA Society of St. Louis. He also holds the following designations: Chartered Alternative Investment Analyst (CAIA) and the Certified Financial Planner (CFP). Steven received his MBA from Washington University in St. Louis and his BSBA from the University of Missouri-Columbia, where his major was Finance & Banking. SPECIAL INTERESTS Steven currently resides in St Louis with his wife and youngest daughter. His eldest daughter is attending the University of Missouri-Columbia. Steven is an active member of the St. Gerard parish. He likes to ride bikes with his wife on the many trails in-and-around St. Louis. Steven s hobbies include guitar, singing, exercising, movies and watching the Rams and Cardinals. CONTACT INFORMATION Mobile steven.jones@claconnect.com CLAconnect.com/privateclient