Q1 Slideshow Posted 2012

Legacy², LLC

Registered Investment Advisor Firm

Q1 2012 Review

Slide Presentation _ 15 Apr 2012

□ Review of First Quarter (what happened);

□ Investment Outlook (what is happening now);

□ Our Portfolio Positioning (what we’re doing about It).

Agenda

2 LEGACY², LLC Registered Investment Advisor

o Stocks and other risk assets were up sharply:

This further reduces our five-year return expectations;

o Rising Treasury yields resulted in flat first quarter returns for core bonds:

Our flexible fixed-income strategies did well, given their latitude to invest; differently than the core bond benchmark

o The euro-zone averted a crisis but did not resolve the longer-term structural problems that threaten the EU system;

o Our portfolios continue to be underweight stocks/equity-risk and core bonds/interest-rate risk.

Key Takeaways


Review of First Quarter 2012

Drivers of October-March Stock Market Rally

5

o Successful intervention that took a European financial crisis off the table, at least for the time being;

o Positive U.S. economic data points, particularly with respect to employment;

o Encouraging results of the Fed’s recent banking stress tests;

o As a result, stocks had one of the strongest gains over that six-month period in many decades.

LEGACY², LLC Registered Investment Advisor

Investment Outlook

o High debt levels create economic headwinds;

o High debt levels increase risk;

o There is no solution that does not involve economic pain.

Developed World is Still Struggling to Climb Out of Debt


Refinancing Operations Slowed Europe’s Financial Crisis (For Now)

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o Liquidity injection reduced risk of a run on the banking system;

o Government bond yields have fallen, reducing these countries’ borrowing costs:

Allows countries to borrow cheaply to finance deficits and reduce overall debt;

o Provides countries additional time and space to enact difficult economic and political reforms;

o However, the markets are recognizing that underlying problems remain:

Yield on Spanish debt has been moving sharply higher on renewed concerns about government’s ability to meet deficit reduction targets;

New Greek debt is trading at prices that reflect a high probability of another default/restructuring.


o January 1, 2013: “massive fiscal cliff of large spending cuts and tax increases”:

Expiration of Bush-era tax cuts, the temporary payroll tax cut, extended unemployment benefits ;

$1.2 trillion of automatic spending cuts will begin to kick in as a result of last year’s Congressional Super Committee’s failure to reach consensus;

o Impact would be roughly 3.5% hit to GDP next year;

o Seems unlikely it will play out that way, but risk of policy errors and political dysfunction—particularly in an election year—remain high!

Problems at Home: The Looming U.S. “Fiscal Cliff”


Our Portfolio Positioning

o Core bonds are set to generate very low returns over the next five years:

Underweighted to core bonds in favor of flexible fixed-income and alternative strategies;

o Stocks also offer subpar returns over our long-term investment horizon:

o Underweighted to stocks/equity-risk;

o Continue to see attractive tactical opportunities in emerging-markets local-currency bonds, absolute-return-oriented fixed-income and alternative strategies;

o Expect periods of heightened volatility along the lines of what we saw last year:

o These environments can create opportunities to increase our weightings to riskier asset classes at lower prices.

Portfolio Positioning Reflects our Longer-Term Concerns


Future Returns of Stocks and Bonds Will be Lower than We’re Used To Seeing

12 1 Projections as of 10/1/11.

2 As measured by the Barclays Aggregate Bond Index .

1

2 1 Projections under our base case, subpar economic scenario as of 3/31/12

2 As measured by the Barclays Aggregate Bond Index .


o We expect low returns from U.S. and developed international market stocks over the next five years;

o Emerging-markets stocks look attractive on a long-term basis, but, given higher short-term downside, we aren’t increasing our weightings;

o Periods of short-term volatility should create opportunities for skilled managers to take advantage of shorter-term mispricing at the individual stock level.

We Remain Underweighted to Stocks


o We expect low returns in all our five-year scenarios, with minimal downside protection;

o We favor flexible and absolute-return-oriented fixed-income managers:

Managers have wide latitude to adjust portfolio characteristics. such as duration, credit quality, sector, currency and foreign bond exposure;

o We expect inflationary pressures to increase toward the end of our five-year horizon:

Our non-core bonds funds should do much better than the core bond index if inflation heats up.

We Remain Underweighted to Core Bonds


o Core bonds (investment-grade bond funds) traditionally:

Reduce portfolio risk because they are far less volatile than stocks;

Provide protection against a major economic shock/recession;

Generate current income;

o There are two major risks inherent in bonds:

Credit risk;

Interest-rate risk;

• The longer until a bond is repaid (maturity), the more its value falls due to a rise in interest rates.

Traditional Role of Core Bonds in a Portfolio


Current Bond Market Environment Argues for Investing Outside of Core Bonds

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o Treasury yields are near all-time lows and we expect to see rates rise within the next five years:

When rates do rise, bond values will fall;

o Flexible and absolute-return-oriented fixed-income managers have more latitude to pursue return and lessen impact of rising rates;

o It is important to maintain some exposure to core bonds as protection in a very negative scenario.


Positioning of Our Fixed-Income Strategies

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Osterweis Strategic Income

Double Line Total Return

Pimco Unconstrained Bond

VBMFX

Pimco Total Return

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

0 1 2 3 4 5 6 7 8

D

I

S

T

R

I

B

U

T

I

O

N

Y

I

E

L

D

INTEREST-RATE SENSITIVITY (DURATION—IN YEARS)

Our fixed-income portfolios have less interest-rate sensitivity and higher yields than traditional core bond portfolios

Source: Morningstar

The longer the duration, the greater a fund's interest-rate sensitivity

The core bond index is generally lower yielding

and has more interest-rate sensitivity


o Arbitrage positions could potentially earn mid-single-digit returns over the next five years with relatively low risk over the shorter term;

o We view these positions as “dry powder” that can generate better returns than core bonds in the meantime (not subject to the risk of rising rates).

Alternatives Provide Further Portfolio Diversification


o We remain confident in our portfolio positioning;

o We are focused on the long term, while remaining flexible and nimble through this highly unstable and uncertain environment;

o We will take on more risk when our research convinces us it is prudent and, in so doing, we believe we can get better returns than just what the market yields.

Looking Ahead


Asset Class Returns Asset Class

(current tactical overweighting or

underweighting )

Index 1Q 2012 12

Months

5 Years

(Ann.)

U.S. Larger-Cap Blend ( since Nov-08) Vanguard 500 12.54% 8.37% 1.94%

U.S. Larger-Cap Growth iShares Russell 1000 Growth 14.61% 10.83% 4.93%

U.S. Larger-Cap Value iShares Russell 1000 Value 11.05% 4.60% -0.91%

U.S. Smaller-Cap Blend ( since Sep-06) iShares Russell 2000 12.42% -0.18% 2.18%

U.S. Smaller-Cap Growth iShares Russell 2000 Growth 13.28% 0.75% 4.17%

U.S. Smaller-Cap Value iShares Russell 2000 Value 11.55% -1.20% -0.05%

Developed Int'l Stocks ( since May-09) Vanguard MSCI EAFE ETF 11.50% -5.43% -3.05%

Emerging-Markets Stocks ( since Jan-12) Vanguard Emerging Market ETF 13.96% -9.02% 4.55%

REITs Vanguard REIT 10.71% 12.74% 0.31%

Investment-Grade Bonds (since Dec-09) Vanguard Total Bond 0.23% 7.56% 6.12%

Absolute-Return-Oriented Bonds (since Dec-09) Citigroup 3 Month T-Bill Index 0.04% 0.07% 1.12%

High-Yield Bonds Merrill Lynch High-Yield 5.04% 5.70% 7.74%

Inflation-Protected Bonds iShares Barclays TIPS Bond 0.78% 11.98% 7.46%

Floating-Rate Loans (since Mar-11) S&P/LSTA Leveraged Loan 3.74% 2.80% 4.52%

Commodity Futures Dow Jones-UBS Commodities 0.89% -16.27% -2.78%

Global Investment-Grade Bonds Citigroup World Gov’t Bond -0.51% 5.12% 6.78%

Emerging-Markets Local-Currency Bonds (since Aug-09) JPMorgan GBI-EM Global Div. 8.29% 3.44% 10.05%

We Expect to See More Volatility Ahead

21

The Chicago Board Options Exchange Volatility Index, or VIX, is a commonly used indicator of market volatility. Often referred to as the “fear index” it is a measure of investors’ expectations of S&P 500 volatility over the near term.


Our Fixed-Income Positions Are Likely to Outperform Core Bonds in Most Long Term Environments

Best Returns

Worst Returns

Short-Term “Flight to Quality” Period

(e.g. 3rd Quarter 2011)

Litman Gregory’s Five-Year Scenario Analysis

Severe Recession Stagflation Subpar Recovery Average Recovery

Barclays Capital Aggregate Bond

Index

Floating-Rate Loan Funds


Emerging-Markets Local-Currency

Bond Funds


Bond Funds

Investment-Grade Bond Funds

Multi-Sector Bond Funds


Bond Funds



Absolute-Return-Oriented Bond Funds







Index










Bond Funds


Bond Funds


Index


Index


Index


Reminder: Our Portfolio Management Approach

Stat

ic

T

acti

cal

Active Passive/Indexing

ASSET ALLOCATION APPROACH

INVESTMENT MANAGEMENT APPROACH

Maximize risk-adjusted returns through tactical asset

allocation and “best-in-class” active manager selection.

Litman Gregory LEGACY², LLC


Our “Fat Pitch” Tactical Allocation Strategy

Over the long term we expect valuations and fundamentals to converge.

Years

Asset C

lass V

alu

ations

Shifting allocation back down to

neutral

Current Valuations

Fair Value Based on Fundamentals

Potential “fat pitch” shift to allocation above neutral

When Long-Term Fundamentals and Current Valuations Diverge… We May Find a “Fat Pitch” Investment Opportunity


SCENARIO DEFINITION

Severe Recession

• We experience a severe recession, e.g., due to another financial crisis or

debt crisis

• Weak recovery in the later years

• Assumes inflation is around 1% and the 10-year Treasury yield is around

2% at end of year 5

Stagflation

• Subpar economic growth

• Strong inflation spike at the end of our forecasting period


7% at end of year 5

Subpar Recovery

• Recovery that began late in 2009/early 2010 continues, a recession is

probable within the five-year horizon


5% at end of year 5

Average Recovery

• Recession is avoided and the economy recovers due to a combination of

effective government policy and positive self-reinforcing economic and

business cycle dynamics

• Re-flation works, but Fed avoids monetary inflation


6% at end of year 5

Our Four Broad Economic Scenarios*

*As of 3/31/12. 25


Scenario Analysis: Asset Class Return Estimates

More Pessimistic More Optimistic

Economic Scenario Severe Recession Stagflation Subpar Recovery Average Recovery

As of 3/31/12 S&P 500 at 1409, Barclays Aggregate yield at 2.0%, MSCI EM Index at 1041, BofA Merrill Lynch High-Yield Cash Pay Index at 7.0%.

Equity Asset Classes Estimated Average Annual Returns over Next Five Years

U.S. Equities -4.9% -3.5% 2.9% 11.2%

Developed International Similar to U.S. Equities

Emerging Markets 0.8% n/a 9.6% 18.9%

REITs -0.4% -2.0% 1.5% 1.9%

Fixed Income Asset Classes

Investment-Grade Bonds 1.9% -0.4% 0.6% 0.2%

High-Yield Bonds 1.7% 4.2% 3.5% 2.1%

Floating-Rate Loans 3.7% 3.5% 4.0% 4.1%

TIPS 2.4% 0.0% 0.0% -1.0%

Emerging-Markets

Local-Currency Bonds

Low single-digit

returns

Low/Mid single-digit

returns

Mid/High single-digit

returns

Mid/High single-digit

returns

Alternative Asset Classes

Arbitrage Strategies Mid single-digit returns in most scenarios

26 26 LEGACY², LLC Registered Investment Advisor

Of Our Four Broad Economic Scenarios, We Believe “Subpar Recovery” is the Most Likely

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Economic Scenario: Subpar Recovery

Equity Asset Classes

U.S. Equities 2.9%

Developed International Similar to U.S. Equities

Emerging Markets 9.6%

REITs 1.5%

Fixed-Income Asset Classes

Investment-Grade Bonds 0.6%

High-Yield Bonds 3.5%

Floating-Rate Loans 4.0%

TIPS 0.0%

Emerging-Markets Local-Currency Bonds Mid/High single-digit returns

Alternative Asset Classes

Alternative Strategies Mid-to-upper single-digit returns in

most scenarios

Chart is as of 3/31/12 S&P 500 at 1409, Barclays Aggregate yield at 2.0%, MSCI EM Index at 1041, BofA ML High Yield Cash Pay Index at 7.0%.


% Underweight

of Current from Neutral

Current

Weight

Neutral

Weight

% Overweight

of Current from Neutral

30 25 20 15 10 5 5 10 15 20 25 30

Fixed Income

Core fixed income 37% 60%

Floating-Rate Loans 6% 0

Absolute-return-oriented/Flexible 24% 0

Emerging-markets local-currency

bonds

5% 0

Alternatives

Arbitrage 5%

Equities

Larger cap 16% 20%

Smaller cap 1.5% 4%

Developed international 2.0% 8%

Emerging-markets 3.5% 8%

Tactical Positioning of Conservative Balanced Portfolio


Q1 Slideshow Posted 2012

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Transcript of Q1 Slideshow Posted 2012