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APPLIED INVESTMENTS Overview of the Course Content (RISK AND RETURN ARE…

- - - - Sub-asset classes may be created by different characteristics.
      - U.S. stocks vs. foreign developed markets vs. foreign emerging markets vs. foreign frontier markets
      - For example, stocks might be grouped by industry ("Technology" vs. "Consumer Products" vs. "Transportation" vs. "Energy" ... etc.)
    - - Commodities
      - Hedge Funds
      - Many, many types
      - Private Equity / Venture Capital
- - - - VALUE FACTOR: Over any given 20-year period of time, there exists an 80% or greater probability that a diversified basket of inexpensive (value) stocks (as measured by price-earnings, price-book, price-sales, price-dividend ratios, or some combination thereof) will outperform a diversified basket of expensive (growth) stocks (as measured by the same ratios).Research on the field of value investing stretches back many decades. In 1949, Benjamin Graham urged investors to buy stocks at a discount to their intrinsic value. He argued that expensive stocks with lofty expectations leave little room for error, while cheaper stocks that can beat expectations may afford investors more upside. With the rise of computers, the value factor, or value risk premium, was demonstrated statistically in the 1980's.
      - The FAMA-FRENCH 3-FACTOR MODEL includes the equity factor, the value (price) factor, and the size factor.
      - The FAMA-FRENCH 5-FACTOR MODEL adds the profitability and investment factors.
    - - For example, a bond with a 10-year maturity that pays a 4% coupon rate may possess a duration of 8.43 years, while a bond with the same maturity that pays a 6% coupon rate may possess a duration of only 7.36 years.
    - - Bonds rated AAA to BBB- are "investment-grade bonds" (per Standard and Poors' ratings).
      - Bonds rated BB+ to C are "junk bonds" per Standards and Poors.
      - Other bond rating agencies exist, including Fitch and Moody's. Weiss Research also rates bonds. Not all bonds are rated; companies pay to have their bonds rated, which creates a conflict of interest for credit rating agencies.
      - Some investment advisers believe that a decreased exposure to credit quality risk (i.e., default risk) should be undertaken, by limiting investments to U.S. government bonds and highly-rated, shorter-term corporate bonds. They believe that "default risk" is not adequately compensated, and that investing in equities (stocks) results in higher returns for the "specific company risk" undertaken.
      - If a bond defaults, typically shareholders get ZERO while bondholders receive a percentage of the face value of the bond, as the corporation's assets are liquidated (during bankruptcy proceedings). The typical RECOVERY RATE for corporate bonds is 30% to 50%, but can be higher or lower.
    - - The equity or market factor, also known as the equity risk premium, in essence states that a diversified basket of stocks (such as a total stock market index fund) possesses an 80% or greater probability of outperforming the risk-free rate (i.e., the return found by owning 30-day U.S. Treasury securities) over any given 20-year period of time.
      - The ERP is also defined as the amount of return required by an investor above and beyond the risk free rate, where the risk free rate is commonly the rate of return from a sovereign government bond with a maturity comparable to the investor’s time horizon.
    - - Attempts at defining quality have so far been unsatisfyingly nebulous, from the all-encompassing “characteristics that make a company valuable,” (Asness, Frazzini and Pedersen 2013) to the more exact, yet contentious “high and stable profitability and low debt” (Calvert, 2012). Definitions aside, there is even considerable disagreement in the number of metrics that should be used to identify high-quality stocks. One opinion simply equates it to some description of profitability. By contrast, other industry professionals favor an approach that accounts for the manifold aspects of high-quality companies.
      - Low-Volatility Factor: “More risk equals more return” – this is a common misperception among investors. While highly volatile stocks may indeed deliver bursts of impressive performance, academic research has found that lower-volatility stocks have historically generated better risk-adjusted returns over time. This is known as the “low volatility anomaly." Similar to momentum and unlike other fundamental investment factors, low volatility is based purely on a stock’s price history. Haugen’s low-volatility anomaly states that stocks which have demonstrated low risk in the past, as measured by historical volatility, will not only continue to do so, but they will also achieve roughly the same returns as other stocks.
- - - - Recency bias occurs when investors put an emphasis on recent events and give less weight to those that have happened in the past. It skews perception toward short-term thinking.
        
        During a bull market, investors' appetite for risk is generally increased as they extrapolate recent gains into the future. Since stocks have been moving higher as of late, investors are more likely to believe that stocks will continue to appreciate in value.
        
        However, the same holds true in the depths of a bear market. Risk appetites dry up as investors flee stocks. The future looks hopeless due to the latest, depressed pricing action.
- - - - Tactical asset allocation is an active management portfolio strategy that shifts the percentage of assets held in various categories to take advantage of market pricing anomalies or strong market sectors. For example, the portfolio manager may be given the discretion to invest as little as 20% or up to 50% in U.S. stocks, as little as 20% or up to 50% in foreign stocks, and as little as 30% and up to 60% in fixed income stocks. Stated differently, tactical asset allocation as intentional market timing – taking over- and under-weight positions around the policy portfolio targets. Tactical mutual funds and ETFs are not preceded by a reputation for generating superior investment returns.
      - SAA: Very much accepted in the investment community. This is a portfolio strategy whereby the investor sets target allocations for various asset classes and rebalances the portfolio periodically. The target allocations are based on factors such as the investor's risk tolerance, time horizon, and investment objectives. Generally, the allocation to investment asset classes does not change in response to economic factors or market conditions, but only changes to reflect changes in the client's circumstances (such as reaching an older age, or inheriting money, or losing a job, or changing the time horizon until retirement).
    - - Targeted Rebalancing is most often utilized by investment portfolio managers today, in large part due to the availability of software that aids in monitoring portfolios and in rebalancing. For example:
        Target allocation for U.S. large cap stocks: 30% Lower limit for rebalancing: 30% x .8 = 24% Upper limit for rebalancing: 30% x 1.2 = 36%
        The above technique - in which rebalancing occurs when an asset class deviates 20% or more from its target, is utilized by some investment advisors.
        However, for the allocation to fixed income investments (if they are grouped together as one large asset class), often the rebalancing target is set as the target asset allocation (such as 50%), plus or minus 5% (e.g., 45% and 55% lower and upper limits, respectively).
      - Periodic Rebalancing: This occurs when the investor (or portfolio manager) rebalances the investment portfolio at particular intervals, such as quarterly or annually. Research supports rebalancing at quarterly or longer intervals, rather than daily or weekly.
- - - - COMMODITIES?
        
        Ferri concludes that commodities are not an attractive addition to portfolios because:
        
        (1) They have had historically low returns;
        
        (2) They generally do not provide a long-term rate of return higher than inflation; and
        
        (3) They also have the potential of become positively correlated with other asset classes when you don’t want them to.
        In fact, commodities are generally positively correlated with equities (except during the 1970’s, when stock prices fell while commodity prices – primarily oil prices – rose substantially).
        
        ‘Da Bear does not recommend commodities to his clients. But some investment advisers do.
      - The asset class is fundamentally different from other asset classes in a portfolio.
      - Each asset class is expected to earn a return higher than the inflation rate over time.(BUT: THIS PROPOSITION DOES NOT HOLD UP IN A VERY LOW-INTEREST RATE ENVIRONMENT, AS SEEN FOR MUCH OF 2008-2020);
      - The asset class must be accessible with a low-cost diversified fund or product.”
- - - - 15% U.S. Small Cap Value
      - 7.5% Int’l Small Cap Value
      - 7.5% Emerging Markets Value
      - 70% Intermediate Bonds