Kristi C. Barger, CTFAVice President & Senior Trust Officer

Relyance BankWealth Management & Investments

Introduction to Investments

Trust clients are bombarded daily with investment information from television, newspapers, magazines, radio and the internet.

The investments that most commonly comprise trust accounts are…

In recent years, the financial market place has been quick to identify, create and market new investments to meet their perceived needs.

Easy access to the latest investment information helps to create demanding, knowledgeable investors.

Real Estate, Farm and Ranch, Timber, Mineral Interests, Partnership Interests, Notes and Mortgages, Life Insurance and Collectibles.

Investments that are bought and sold in the “open” market, such as New York Stock Exchange (NYSE) or the National Association of Security Dealers Automated Quotation System (NASDAQ).

Money market funds, CDs, Commercial Paper, Repurchase Agreements and Bankers Acceptances. These can easily convert into cash without substantial loss of principal.Liquid

Over the Counter

Publicly Traded

Unique Assets

Investors engage in one-off deals with each other often through informal networks of bond dealers. Unlike exchanges, bids to buy and sell a particular bond are not centralized or seen by all market participants. Dealers can quote different bid and ask prices to different customers.

Money Market Mutual Funds

Money market mutual funds account for the vast majority of cash held in discretionary trust accounts.

The money market fund is a registered mutual fund that limits its investments to very short term securities, pays out income to participating accounts and provides immediate cash for withdrawals.

Although not insured against loss, these funds offer the ability to invest in a diversified portfolio of overnight and short term securities that generally provide trust accounts with a higher yield and improved liquidity.

Liquid

Certificates of Deposit

CDs are fixed income securities issued by banks and are an alternative to government issued securities when an investor wants the backing of the federal government but does not want to buy Treasury securities.

A CD is a promise (an IOU) by a bank to return the original deposited amount at a future date and pay interest in the interim.

The initial amount invested earns income based on the fixed interest rate—normally higher than regular savings accounts—and is credited each time the CD compounds its interest.

Liquid

Commercial Paper

Unsecured, short term debt that is issued by major corporations with a typical maturity of 270 days or less. (longer maturity = corporate bond)

Since commercial paper is riskier than deposits, it normally carries a higher interest rate.

If interest bearing commercial paper is issued, an investor pays the full face value at purchase and at maturity, receives the face value plus the accrued interest.

It can sell at a discount (below face value) and pays back at full face value at maturity.

Liquid

Repurchase Agreement

Also called repo, it involves an investor (lender) having short term cash to invest, and another investor (borrower) temporarily needing cash.

The borrower, usually a large financial institution or securities dealer, is willing to pay interest and to secure the borrowing with collateral to be repurchased at a future maturity date. (The collateral offered by the lender is often U.S. government securities.)

Many repos mature within one day, but term or “open” repos may extend for several weeks.

Interest rates on repos are usually higher than other investments depending on the maturity date and collateral requirements.

Liquid

Banker’s Acceptance

A banker’s acceptance is an order, drawn on and accepted by a bank to pay a specific sum of money at a specific date.

It usually arises from international trade transactions where there is any underlying buyer obligation to pay a seller at a future date.

The security behind the banker’s acceptance is the assurance given by the issuing bank, making a banker’s acceptance similar to a guaranteed letter of credit.

The acceptances normally last for short-term periods, depending on the estimated shipping time.

Liquid

Over the Counter

Fixed Income Securities - Bonds

A bond is a contract. As an investor, you lend money to a corporation, government entities (counties, towns, states) or the U.S. Treasury with the stipulation that it will be paid back on a certain date. Until that date, you will receive specific, pre- determined interest payments at regular intervals for making that loan.

A well-functioning bond market provides crucial funding that allows companies and governments to borrow more affordably, creating jobs and economic growth.

There are 3 key components of bonds

InterestCoupon

Maturity

PrincipalValue

The loan amount; also known as “par” or “face value”

the date when the bond issuer will return the full amount of the bond

pre- determined rate of interest payment to be paid at regular intervals

Loans that investors make

states, cities, counties and towns….

to the U.S. Treasury….

Corporate Bonds

Municipal Bonds

Treasury Bonds

to corporations…

to government entities/agencies,

The backing for the bond is usually the payment ability of the company, which is typically money to be earned from future operations.

In some cases, the company's physical assets may be used as collateral for bonds.

Corporate debt instruments with maturity shorter than one year are referred to as commercial paper.

A corporate bond is a debt security issued by a corporation in order to raise financing for a variety of reasons such as to ongoing operations, merger or acquisition, or to expand the business.

The term is usually a longer term security with a maturity of at least one year.

U.S., state and local government entities issue what are essentially IOUs in order to obtain cash from investors to fund their operations.

U.S. Treasury securities are backed by the full faith and credit of the U.S. government.

U.S. Government agency securities are backed by the moral obligation of the U.S. government.

Besides not being subject to state or local income taxes, U.S. Treasury securities are regarded as the most secure and marketable of all investments.

The outstanding debt of the many U.S. government agencies, though large, is much smaller than that of Treasury securities.

Agency securities are issued by either:

FNMA GNMA FHLMC FHLB

Fannie Mae Ginnie Mae Freddie Mac ??Federal National Mortgage Association

Government National Mortgage Association

Federal Home Loan Mortgage Corporation

Federal Home Loan Bank

Fannie Mae is a United States government-sponsored enterprise and, since 1968, a publicly traded company.

It’s purpose is to expand the secondary market by buying loans from lenders and pooling them into a mortgage backed security that can be purchased as a fixed income investment.

This allows lenders the freedom to make mortgage loans knowing they will get those funds back and be able to lend it again to another home buyer.

FNMA

Ginnie Mae is a wholly owned government corporation within the Department of Housing and Urban Development whose mission is to expand affordable housing in America.

Lenders then can use the proceeds to make new mortgage loans available to consumers.

With a government guarantee this allows mortgage lenders to obtain a better price for their loans in the capital markets and lower financing costs create opportunities for sustainable, affordable housing for families seeking home ownership.

GNMA

Its brother organization is the Federal Home Loan Mortgage Corporation (FHLMC), better known as Freddie Mac.

The Federal Home Loan Mortgage Corporation (FHLMC), known as Freddie Mac, is a public government-sponsored enterprise.

Freddie Mac buys mortgages on the secondary market, pools them, and sells them as a mortgage-backed security to investors on the open market.

FHLMC

The Federal Home Loan Banks are eleven (11) U.S. government-sponsored banks that provide reliable liquidity to member financial institutions (not individuals) to support housing finance and community investment.

With their members, the FHLBanks represents the largest collective source of home mortgage and community credit in the United States.

It’s primary mission is to provide member financial institutions with products and services that assist and enhance the financing of housing and community lending.

FHLB

Municipal bonds have federal income tax exemption and many states offer state and local income tax exemption on local municipal bonds.

State and local government or instrumentalities (school district or hospital) issue municipal securities in short or long term maturities.

Tax exemption is attractive to investors, as the net after tax return from municipal securities may exceed that from other taxable investments.

Municipals

A general obligation bond is secured by a state or local government pledge to use legally available resources, including tax revenues, to repay bond holders.

Most general obligation pledges at the local government level include a pledge to levy a property tax to meet debt service requirements, in which case holders of general obligation bonds have a right to compel the borrowing government to levy that tax to satisfy the local government's obligation.

Because property owners are usually reluctant to risk losing their holding due to unpaid property tax bills, credit rating agencies often consider a general obligation pledge to have very strong credit quality and frequently assign them investment grade ratings.

A revenue bond is distinguished by its guarantee of repayment solely from revenues generated by a specified revenue-generating entity associated with the purpose of the bonds, rather than from a tax.

Unlike general obligation bonds, only the revenues specified in the legal contract between the bond holder and bond issuer are required to be used for repayment of the principal and interest of the bonds.

Because the pledge of security is not as great as that of general obligation bonds, revenue bonds may carry a slightly higher interest rate than G.O. bonds

T-bills are the shortest term obligations of the U.S. Government with maturities of one year or less. They are purchased at a discount and the par (face) value is received at maturity.

T-notes pay a fixed rate of interest every six months with the par value paid at maturity. They mature in more than one year but less than 10 years from the issue date.

T-bonds pay a fixed rate of interest every six months with the par value paid at maturity. They mature 10 years to 30 years from their issue date.

STRIPS is the U.S. Treasury’s acronym for Separate Trading of Registered Interest and Principal of Securities zero coupon instruments.

For example, when “stripped”, a 30 year bond can be separated into 61 STRIPS of 60 interest parts and 1 principal part, with each STRIP possibly selling or trading at a discount and redeemed at maturity for its full price.

Because STRIPS are direct Treasury obligations, they carry the full faith and credit of the United States.

While free from state and local taxes, federal taxes are due on the earned interest each year, although investors receive no interest until maturity.

Any questions about “over the counter”, bonds or fixed income securities?

Publicly Traded Equities

Stocks

Equity securities give investors the benefit of being an actual corporation owner with a share in the ongoing success of the enterprise.

Equity securities are different from fixed income securities in that they make no promise to pay the investor current income or any guaranteed amount at a future date.

This is acceptable if clients are instead looking to receive the results of potential growth (increased dividends and value).

Equities

Common stock is evidence of ownership in a corporation, the most prevalent form of equity investment held by trustees.

Although they are owners, shareholders do not actively participate in managing the corporation, other than to elect directors, select auditors or vote on other matters required by law.

Corporations reward common stockholders by declaring and paying regular quarterly dividends.

If the common stock’s value increases, investors may choose to sell at a profit.

Shares are usually highly liquid and are bought and sold on the various markets (NASDAQ and NYSE).

Preferred stock is an equity security with many fixed income characteristics.

Corporations issue preferred stocks with stated par value and fixed or variable dividend rates at the issue date.

Preferred stock dividends are guaranteed, which means that when companies declare dividends, preferred stockholders receive dividends before common shareholders.

In addition, when a corporation is liquidated, preferred stockholders have preference, ahead of common stockholders, to the corporation’s assets.

Unlike common stock, preferred stock does not usually entail voting rights.

The shares of some foreign corporations trade on the New York Stock Exchange (NYSE) and are known as American Depository Receipts (ADRs).

They represent a dollar denominated investment in shares of the foreign corporation.

By using ADRs, trust institutions are able to globalize a portfolio thereby participating in several world markets.

“Returns” from common stock investing generally come from the overall movement of the prices of all stocks, as measured by a market index such as the Dow Jones Industrial Average or the Standard & Poor’s 500 Index.

General economic activity significantly affects the movement of all stock prices, thereby influencing a company’s prosperity.

Dow Jones Industrial Average (DOW) is an index that shows how 30 large publicly owned companies based in the U.S. have traded during a standard trading session.

Components of the DOW3M

American Express

Apple

Boeing

Caterpillar

Chevron

Cisco Systems

Coca Cola

Dow DuPont

Exxon Mobil

General Electric

Goldman Sachs

Home Depot

IBM

Intel

Johnson & Johnson

JP Morgan Chase

McDonald’s

Merck

Microsoft

Nike

Pfizer

Procter & Gamble

Travelers

United Health Group

United Technologies

Verizon

Visa

Wal Mart

Walt Disney

The S&P 500 Index is an index of stocks issued by 500 large companies with market capitalizations of at least $6.1 billion.

It is seen as a leading indicator and widely regarded as the most accurate gauge of the performance of U.S. large-cap equities

It is considered representative of the entire market because it includes a significant portion of the total value of the market.

The S&P 500 uses a market cap methodology, giving a higher weighting to larger companies, whereas the Dow uses a price weighting methodology which gives more expensive stocks a higher weighting.

There are various type and quality categories for classifying common stocks:

Blue Chip

Growth

Income

Cyclical

Emerging Growth

Interest Sensitive

Defensive

Blue Chip

Growth

Income

is the stock of a company that is a major industry leader, well established and having considerable financial strength and stability; proven dividends during both strong and weak periods of economic activity

is the common stock of companies whose earnings grew at a faster than average annual rate; may pay a small dividend but generally retain a major portion of earnings for future growth

is the common stock of companies offering investors a higher dividend rate relative to the price appreciation of the stock

Imagine you now have to make all of the investment decisions for a trust portfolio.

You not only need to know what to buy but also when to buy it.

To achieve diversification, (will be discussed in detail in the strategy discussion) which is a method to reduce the risk and volatility of a trust portfolio, you could buy a variety of stocks and bonds and gamble that these companies would be successful.

An alternative would be….

These funds can own several different securities with the mutual fund managers doing most of the work.

In simple terms, a mutual fund is a business entity that invests on the behalf of investors who deposit monies with it.

Understanding mutual funds allows you to assist clients who want to achieve diversification without having to buy a variety of individual stocks and bonds.

Questions on Equity Securities

Unique Assets

These will be discussed in a separate course

Kristi C. Barger, CTFAVice President & Senior Trust Officer

Relyance BankWealth Management & Investments

Fiduciary Duty to Invest

A trustee who invests and manages trust assets owes a duty to the beneficiaries of the trust to comply with the prudent investor rule.

A trustee shall invest and manage trust assets as a prudent investor would, by considering the purposes, terms, distribution requirements, and other circumstances of the trust.

Elements of Fiduciary Duty to Invest

In satisfying this standard, the trustee shall exercise reasonable care, skill, and caution.

A trustee's investment and management decisions respecting individual assets must be evaluated not in isolation but in the context of the trust portfolio as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the trust.

Among circumstances that a trustee shall consider in investing and managing trust assets as are relevant to the trust or its beneficiaries are….

There is no such thing as an inherently prudent investment.

The prudence of any single investment can be determined only by analyzing its investment characteristics and how the investment compliments other investments in a portfolio.

General Economic Conditions

Need for liquidity or income vs. capital preservation

Special value to the interests of the trust purpose

Role with the overall portfolio

Other resources of beneficiaries

Effect of inflation or deflation

Tax Consequences

Return from income and appreciation

A trustee shall make a reasonable effort to verify facts relevant to the investment and management of trust assets.

A trustee may invest in any kind of property or type of investment consistent with the standards of this rule.

A trustee who has special skills or expertise, or is named trustee in reliance upon the trustee's representation that the trustee has special skills or expertise, has a duty to use those special skills or expertise.

Standard of Care

A trustee shall invest and manage the trust assets solely in the interest of the beneficiaries.

If a trust has two or more beneficiaries, the trustee shall act impartially in investing and managing the trust assets, taking into account any differing interests of the beneficiaries.

ImpartialityLoyalty

periodically reviewing the agent's actions in order to monitor the agent's performance and compliance with the terms of the delegation.

establishing the scope and terms of the delegation, consistent with the purposes and terms of the trust; and

selecting an agent;

A trustee may delegate investment and management functions that a prudent trustee of comparable skills could properly delegate under the circumstances. The trustee shall exercise reasonable care, skill, and caution in:

Delegation of Investment and Management Functions

Compliance with the prudent investor rule is determined in light of the facts and circumstances existing at the time of a trustee's decision or action and not by hindsight.

In investing and managing trust assets, a trustee may only incur costs that are appropriate and reasonable in relation to the assets, the purposes of the trust, and the skills of the trustee.

Within a reasonable time after accepting a trusteeship or receiving trust assets, a trustee shall review the trust assets and make and implement decisions concerning the retention and disposition of assets, in order to bring the trust portfolio into compliance with the purposes, terms, distribution requirements, and other circumstances of the trust, and with the requirements of the Prudent Investor Act.

A trustee shall diversify the investments of the trust unless the trustee reasonably determines that, because of special circumstances, the purposes of the trust are better served without diversifying.

Diversification

It involves reducing the risk associated with equity and fixed income securities by selecting holdings in different industries.

Client objectives may limit diversification when there is an income need that only fixed income securities can provide.

Trying to achieve diversification creates capital gains when selling low income tax cost basis assets.

Questions on Fiduciary Duty to Invest

Kristi C. Barger, CTFAVice President & Senior Trust Officer

Relyance BankWealth Management & Investments

Introduction to Portfolio Management

Portfolio management is the process of determining which assets should be held in an account---and in what amounts---to achieve a desired rate of return, while subjecting to an acceptable level of investment risk.

A portfolio manager must understand the different investment types, objectives and strategies along with the concepts of return, risk, diversification, asset allocation, and legal and regulatory constraints to create an investment portfolio that meets specific objectives.

There are three parts to an effective investment process.

Profiling Portfolio Management

Portfolio Performance

Involves determining your clients’ needs and objectives

Sorting through client information and the employment of investment tools and techniques

Reporting performance to the client

Client needs can range from simple (saving for retirement) or complex (minimizing inheritance taxes and setting up and endowment fund).

Profiling involves delving into several areas of clients’ lives that may affect their investment plans and asking the right questions.

It is good practice to tell your clients why you are asking questions and how their answers are important.

Based on the answers, you may find that some needs and objectives compete with each other and you will have to help clients prioritize.

What are the clients needs for living expenses, tax payments, education, housing and gifts?

Can client tolerate short term swings in market or have a need for growth to offset inflation?

Does client have political, social or environmental sentiments?

How will income, estate, gift or capital gains tax affect client?

How long will funds be invested?

Liquidity

Risk

Unique

Tax Considerations

Time Horizon

To reduce and simplify investment decisions, trustees establish a written investment policy that addresses common or typical portfolio investments.

A well-written investment policy statement is useful when you are explaining the trustee’s investment of assets to trust clients, prospects or non-trust personnel who refer prospective clients.

The policy should address several different factors, including style and strategy.

The policy endorses a preferred investment style that embraces a growth, value or long-term fixed income basis.

It covers asset types such as equity investments in international or industry-specific stocks as well as bond investment choices such as government, corporate, or municipal and their quality ratings.

The policy specifies the bank’s belief in particular investment strategies, such as “buy and hold”, market timing, and dollar cost averaging.

It indicates asset allocation guidelines for typical trust accounts and defines any necessary distinctions in the management of personal, employee benefit or charitable accounts.

Style Strategy

Whereas the investment policy statement serves as a guide to the usage and delivery of all investments, the account investment objective statement serves as a written guide for determining appropriate type and mix of investments for each managed account.

Trustees write account investment objective statements only after having a clear understanding of the trust client’s financial goals.

A well designed statement clearly addresses a client’s situation including needs for current income, desire for safety of principal, expectations for account growth and the client’s tolerance for investment risk.

These are not of a permanent nature and trustees need to revisit them regularly—including annual reviews to determine if client needs or objectives have changed or if there have been situation changes.

Risk is the possibility that an investment will sustain a loss.

Investment risk is much more complex in concept and far more difficult to measure than investment return.

Most investors seek risk subjectivity, something felt rather than measured, and they dislike exposing any of their assets to risk.

Every investment involves some level or risk.

Many trust clients consider risk to be any factor or event that would lower the value of the portfolio.

There are 10 discrete and unique risk types….

1. Interest rate risk-

The risk that the value or the return on an investment will decrease because of an increase in interest rates.

Investors who purchase investments that bear a fixed interest rate (bonds) and a stipulated future maturity date WILL experience a decline in market value if interest rates rise.

This is the biggest risk faced by investors in the bond market.

2. Credit risk-

This is the chance that the investor will not be repaid by the borrower.

This risk is much greater for bondholders since the debt term is longer.

Many trustees feel that credit risk is just as crucial to bond investment as interest rate risk.

Therefore, they buy only U.S. Treasury or agency obligations and do not buy any corporate or municipal bond with a quality rating below “A” as published by major rating agencies.

3. Purchasing power risk-

Is the risk that investors will lose more in purchasing power than they gain in investment return.

With inflation, an increase in the volume of money and credit relative to available goods and services results in a continuing rise in the general price level.

When the inflation rate increases, investors require higher rates of return to offset the loss of purchasing power.

4. Market risk-

Is associated with a change in the entire market value for securities.

Certain events such as a general economic slowdown, a political crisis, or a world catastrophe may profoundly affect the values of all stock and bond investments.

5. Business risk--

Management changes, demographic factors and problems with internal production all are factors that could affect a company and the extent to which it can successfully react to these factors represents the degree of business risk associated with the investment.

6. Financial Risk-

The degree to which a company chooses to finance the activities with borrowed funds represents internal financial risk; the changing level of interest rates represents external financial risk.

The degree of financial risk often affects the volatility of the price of a company’s securities, especially common stock share prices.

7. Liquidity risk--

Refers to the ability to sell a security with little to no loss of principal.

U.S. Treasury bills are highly liquid (little to no loss) and readily marketable.

U.S. Treasury notes that mature in 10 to 20 years can be bought or sold easily but could entail substantial losses if interest rates are rising.

8. Currency risk--

The loss from unfavorable movements in foreign exchange rates.

More investors are using foreign markets as a place to put funds.

As the U.S. dollar increases in value, these investments decrease in value.

9. Systemic risk--

Is the portion of the total variability of return that affects all similar investments simultaneously.

Examples include interest rate risk, purchasing power risk, market risk and liquidity risk.

Diversification cannot eliminate systemic risk.

Changes in the economic, political and social environment tend to affect not only the value of one stock investment, but also the value of all similar invsetments.

10. Unsystemic risk--

Is the part of the total variability of return unique to a particular security, firm or industry.

Examples include business risk, financial risk and liquidity risk.

Diversification can reduce unsystemic risk.

A labor dispute at one company may not affect other companies.

Additional factors that influence unsystemic risk are regulation, the quality of a firm’s management and technological changes.

A number of decisions must be made about the investment strategy that will be used to manage any given trust investment portfolio.

Successful investment management requires skill in understanding human behavior and how constantly changing attitudes, biases, opinions, fears and hopes become powerful forces affecting investment management.

Several proven strategies exist that enable a trustee to lower the risk of investing in stocks and fixed income securities.

Investment Strategies

Passive Approach

“Buy and Hold”

Results in minimization of transaction costs

Changes only occur for the purpose of making major

corrections to rebalance or eliminate imprudent

investments

Active Approach

Involves searching for attractive investment alternatives within the constraints of the overall objective

Transaction costs will be higher and assets within the portfolio will have

a higher turnover.

Maintains balance in asset allocation, manages tax implications, captures capital gains and moves assets into and out of all sectors of the economy

Diversification

When diversifying common stocks, a portfolio manager can take any of these actions:

Select stocks of companies in different industries and with different geographic markets

Pick stocks ranging from small companies to the largest corporations

Choose a portfolio that represents both domestic and international holdings

Buy a large number of smaller holdings to avoid large losses due to stock market declines

Diversification of common stocks helps to reduce investment risk, which can never be fully eliminated.

Trustees have several options when trying to create a well diversified equity portfolio.

Select stocks in several different industries

Choose more than one company within an industry

Pick a number of investment types and disciplines

Will not be severely penalized if one industry encounters problems

Avoids the possible effect of one company having problems that otherwise effect whole portfolio

Use value and growth stocks, large and small companies, domestic and foreign stocks

Dollar cost averaging involves periodically investing a regular amount in the market, thereby reducing the risk of larger losses and smoothing out portfolio variations.

This strategy buys fewer shares if prices rise and more shares if prices fall.

Ultimately, the account should benefit from principal acceleration with lower risk.

When diversifying for the fixed income portion of a trust portfolio, the manager may take these actions:

Select bonds of varying maturities and interest rates as a hedge against interest rate risk

Buy U.S. Treasury bonds, government agency securities or domestic and foreign corporation securities to balance the needs of income beneficiaries and remaindermen.

Obtain premium bonds to create current income and discount bonds to provide some capital appreciation

Parmount fixed income decisions must be made about quality, maturity, coupon size (discount and premium) and duration.

Spread holdings among numerous sectors

Select holdings in several different industries

Choose holdings with various maturities

Avoids concentration in a single security

Avoids the possible effect of one company having problems that otherwise effect whole portfolio

Allows a more predictable income flow and avoids having to make big reinvestment decisions when interest rates are unfavorable

Diversification considerations in fixed income investments:

The barbell strategy refers to a fixed income portfolio that is heavily weighted with securities having very long and very short maturities.

When displayed as a chart showing maturity dates, the chart will assemble a barbell.

Although a relatively large amount is invested in the short term area at lower interest rates, the longer maturities provide additional income and serve to balance the portfolio.

If interest rates rise, any depreciation in the longer term securities is partially offset by the increase income, as the investment of short term securities occur at the higher rates.

If interest rates fall, appreciation in the longer maturities helps make up for reinvesting the short securities at lower rates.

If a portfolio manager is uncomfortable owning longer term fixed income securities, the manager may reduce portfolio risk by using a strategy that calls for an equal amount of securities to come due each year over a given time period.

Laddered portfolios reduce the risk by diversifying maturity dates, continually reinvesting funds as the securities mature.

Investors do not bet on either short or long term interest rates.

Trustees can purchase thousands of different investments, but to do so would create investment and operational problems without enhancing account performance.

Consequently, most trustees limit their investment purchases to a closely managed approved investment list.

Approved lists provide a diversified and continuously updated focus on hundreds of different investment vehicles.

Portfolio efficiency refers to how well a given portfolio is structured to achieve the desired results.

Successful portfolio management depends on how well the portfolio manager achieves portfolio efficiency through deciding the portfolio’s asset allocation and controlling risk with proven investment strategies.

Asset allocation is the most important determinant of investment return and refers to determining what percentage of a portfolio should be invested in different types of assets in order to meet investment objectives.

Aggressive Growth

Growth & Income Balanced Conservative

An asset allocation model is a combination of investments that is usually represented as a pie chart.

On a spectrum, asset allocation models may range from very aggressive to very conservative.

Investment managers routinely differ in how they determine the exact allocations for differing types of accounts and may regularly offer a choice of three, five or more standardized portfolios that include other investment options such as international securities.

While the models indicate stocks and bonds, the investments may actually also be in stock or bond mutual funds.

Model portfolios provide a consistent guideline to govern asset allocation across all managed accounts.

It gives the client a better understanding of how a typical account is managed and allows them to clearly identify a risk level with which they are comfortable.

It provides an investment discipline and facilitates regular adjustments of asset holdings to bring a client’s portfolio in line with the model portfolio.

Imagine that a client requires an annual, sustainable investment return of 8%.

It may be possible to achieve this return by using a combination of investment types (allocating assets) within a portfolio.

Since each investment type has a different risk level, the size of each investment affects the portfolio’s overall risk level.

From the various investment types, portfolio managers need to select the asset combination that has the best chance of producing the desired rate of return while minimizing investment risk.

A disadvantage of using the model portfolio approach is that frequent adjustments can increase transaction costs and create capital gains tax liability for an account.

Helping clients understand the potential costs involved allows them to make informed decisions.

A portfolio manager who thinks the stock market is too high may take a conservative asset allocation approach and invest all assets in short-term securities, thus subjecting the portfolio to substantial risk.

Market timing can be an inexact and costly venture.

At times, eliminating a portfolio’s stock positions could avoid market setbacks.

However, the obvious risk is that the liquidation timing could be wrong and the account could sacrifice the growth in common stocks.

Return is the increase or decrease in the value of an investment over time.

When the increase is expressed as a percentage, it is known as the rate of return.

For a single interval, the investment rate of return can be expressed using a simple formula:

(Ending value – Beginning value) + Cash flow*Beginning value

(1,100 – 1,000) + 100 2001,000 = 1,000 = .20 or 20%

* Cash Flow = withdrawals - contributions

Returns also can be expressed as average returns over a series of intervals.

A dollar weighted return is the internal rate of return on the funds invested.

It measures the earnings over the period measured.

A time weighted return considers the timing of cash flows into and out of the investment.

It measures the performance of the investment, taking into account the average performance of many intervals.

Time-weighted returns are useful when comparing the investment performances of several different portfolios.

Portfolio performance can only be measured after portfolio objectives have been established and investment strategies have been implemented.

Determining investment performance and reporting the performance to clients is the culmination of the entire effort of managing the portfolio.

Performance measurement may involve…..

Index--Gauge the portfolio’s stock portion against a stock index and the bond portion against a bond index.

Results-Evaluate performance results against published results of other sources

Risk--Use risk analysis techniques that compare two different portfolios with equal risk.

Objectives---Compare the investment results with the account objective