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The importance of Asset Allocation

The importance of Asset Allocation. Mirko Cardinale Strategic Asset Allocation Specialist Milan, 8 November 2007.

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The importance of Asset Allocation

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  1. The importance of Asset Allocation Mirko Cardinale Strategic Asset Allocation Specialist Milan, 8 November 2007

  2. This document is for professional advisers and market counterparty or intermediate customers only. The content is not approved for use with private/retail investors or pension scheme members.

  3. Agenda • Importance of Asset Allocation • Evolution of Tactical Asset Allocation • Morley’s Tactical Asset Allocation process • Current outlook and positions • Performance and risk • Summary • Q & A

  4. Efficient Frontier with Alpha Efficient Frontier Correlation Expected Return Individual Asset Classes Risk Time Importance of Asset Allocation • Most significant driver of portfolio returns • Academic studies agree asset mix is crucial • Combines assumptions on expected returns, volatility, and correlations Asset allocation needs to exploit asset-class diversification Source:Morley/ Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebower, Determinants of Portfolio Performance, The Financial Analysts Journal, July/August 1986 Blake D, Lehmann, B Timmermann, A (1999) Asset Allocation Dynamics and Pension Fund Performance Journal of Business 72 , 429-62

  5. Long-term beta-return forecasts Long-term asset class returns are far more predictable Fundamental economics & empirical research create building blocks of “sustainable returns” Source: Morley Strategy Team, June 2007 Sustainable returns vary significantly over time and assets Page 5 The content of this slide is designed to illustrate the results of a research strategy employed by Morley Fund Management Limited for its internal use only.  It is not to be relied on by anyone else for their investment decisions.

  6. 10.5% Diversified Strategy 9.5% Fund (incl. alpha) EM Equities 8.5% UK Equities Asia Pacific Equities (hedged) 7.5% Diversified Strategy EU Equities Return Fund (beta only) Emerging Market Local Debt US Equities Global REITs 6.5% Emerging Market US$ Debt (hedged) UK Cash Convertibles Commodities 5.5% UK Corporates UK Property 4.5% Global Aggregate Bonds UK Gilts Japan Equities (hedged) UK Index-Linked Gilts 3.5% 2% 7% 12% 17% 22% 27% 32% Risk Sustainable returns combined with historical volatility Risk and return of conventional asset groups Sustainable returns demonstrate sensible order; but vary over time Source: Morley Strategy Team, illustrative example as at 18 September 2007

  7. Extending the asset allocation framework • Theory and practice show the benefits of a Strategic Asset Allocation framework • But is there any value in shorter-term market opportunities? • Incorporating short-term opportunities is known as Tactical Asset Allocation TAA exploits short-term asset allocation opportunities

  8. Cash Cash 10% 10% Bonds Bonds Equities Equities 30% 30% 60% 60% Origin of Tactical Asset Allocation (TAA) • First used to inform “asset-timing” decisions in the 1970s • A “top down” investment process • Captures shorter-term opportunities TAA added “flexibility” to the strategic benchmark

  9. Evolution of Global Tactical Asset Allocation (GTAA) Single country TAA Multi-country GTAA Multi country / currency GTAA 1980s 1990s 2000s Futures markets broader and more liquid Currency market predictability found Cheap index futures available Empirical studies highlight asset class inefficiencies Multi-country models find regional inefficiencies Pooled funds developed under UCITS III TAA becomes a broader, standalone investment

  10. Diversified range of long/short positions Exploits market inefficiencies Cheap and efficient execution Low correlation with traditional asset classes Asset Class Selection Equity Market Selection Currency Selection Bond Market Selection A modern GTAA process Source: Morley as at 30th September 2007. Global TAA has become more diversified and consistent

  11. Can be considered as a way to reduce overall fund volatility or boost returns Efficient Frontier with TAA Efficient Frontier without TAA • Correlation of GTAA Returns • Data uses >8 years of performance data from MPPL Balanced Managed Overlay (Q4 98-Q2 07) Return Risk Initial portfolio with optimised strategic allocation Improved return expectations for the same level of risk Improved risk profile for an identical level of return Characteristics of GTAA returns • Interest in GTAA driven by surge in demand for uncorrelated returns Uncorrelated, absolute returns

  12. Philosophy • Inefficiencies between markets more significant than those within markets • Inefficiencies are persistent & exploitable, from • Investor sentiment • Structural anomalies between markets • Non profit-maximising participants • Transactions in futures and forward markets are quick and cheap enough to exploit these opportunities Morley’s process can exploit these opportunities with the high degree of consistency that our clients desire

  13. Economic scenario analysis Optimal portfolio analysis Forecasting returns Portfolio selection Implementation Investment process A robust process that aims to deliver consistent, excess returns

  14. Why asset allocation? • Asset allocation is the most significant driver of portfolio returns • GTAA takes advantage of short-term asset allocation opportunities • Generates returns from diversified long/short positions across global equity, bond, and currency markets Represents an excellent source of uncorrelated absolute-returns

  15. Q&A

  16. Important information • This document is intended for institutional or professional investors and experienced advisers only. • Except where stated as otherwise, the source of all information is Morley as at 31 October 2007. • Where past performance has been illustrated it is not intended to be a guide to the future. • The value of an investment and any income from it may go down as well as up, and the investor may not get back the original amount invested. • Any future returns and opinions expressed are based on our internal forecasts and should not be relied upon as indicating any guarantee of return from an investment with Morley. No part of this document is intended to constitute advice of any nature nor should any part be construed as a recommendation to purchase or sell stocks. • Morley is a business name of Morley Fund Management Limited, registered in England No. 1151805. Registered Office: No. 1 Poultry, London EC2R 8EJ. Authorised and regulated in the UK by the Financial Services Authority and a member of the Investment Management Association. • Morley Fund Management is also a business name of Morley Fund Services Limited and Morley Fund Management International Limited. All are Aviva companies. • Contact us at Morley Fund Management Limited, No. 1 Poultry, London EC2R 8EJ. • MFM 07/941

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