Diversification
- 1. Financial Advisor Development Program Diversification © 2013 CIBC Retail & Business Banking Learning & Development Internal | 9/8/2014
- 2. Quote “To invest successfully over a lifetime does not require stratospheric IQ, unusual business insight or inside information. What's needed is a sound intellectual framework for decisions and the ability to keep emotions from corroding that framework.” — Warren Buffet © 2013 Internal | 2
- 3. Consider This… © 2013 Internal | 3
- 4. Learning Objectives By the end of this workshop, you will be able to: Explain the importance of diversification and how it benefits client portfolios Describe the various methods of diversification and how they fit into a portfolio © 2013 Internal | 4
- 5. Why Diversify? Client portfolio CIBC Money Market 5.75% Province of Ontario 5.25% CAD Eurobond BCE incorporated TD U.S. small cap equity CIBC Latin America Moderate investor profile 5% Cash 40% Canadian bond 10% International bond 15% Canadian equity 20% U.S. equity 10% International equity © 2013 Internal | 5
- 6. Why Diversify? Asset Allocation is the first step in building an investment portfolio. The next step is to decide how to diversify within each asset class. Diversification within each asset class can help to: • Reduce volatility • Enhance returns • Provide a disciplined approach to investing © 2013 Internal | 6
- 7. Diversification Methods — Equity Asset Class • Geography • Capitalization • Active vs. passive management (indexing) • Active management styles © 2013 Internal | 7
- 8. Diversification Methods — Equity Asset Class • Geography • Capitalization • Active vs. passive management (indexing) • Active management styles © 2013 Internal | 8
- 9. Geography © 2013 Internal | 9
- 10. Geography Why invest globally? Investing in different geography regions can reduce risk and enhance returns: • Different equity markets behave differently at different times • Currency fluctuations add an additional level of diversification • Positive or negative events may affect some regions but not others © 2013 Internal | 10
- 11. Diversification Methods — Equity Asset Class • Geography • Capitalization • Active vs. passive management (indexing) • Active management styles © 2013 Internal | 11
- 12. Capitalization © 2013 Internal | 12 50 40 30 20 10 0 -10 -20 Returns 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Year Russell 1000 Large Cap Russell 2000 Small Cap
- 13. Capitalization 100% Large cap stocks • Large capitalization stocks = Russell 1,000 index (US$) • Active vs. Passive Management (indexing) • Active management styles • Geographic • Capitalization (Large Cap vs. Small Cap) • Sector/Specialty • Small capitalization stocks = Russell 2,000 index (US$) © 2013 Internal | 13 13.2% 13.0% 12.8% 12.6% 12.4% 12.2% 12.0% 11.8% 11.6% 11.4% 17.5% 17.7% 17.9% 18.1% 18.3% 18.5% 18.7% 18.9% 19.1% 19.3% 19.5% Portfolio Risk (%) Portfolio Return (%) Source: www.barra.com Large cap versus small cap? 100% Small cap stocks
- 14. Capitalization Why have both large and small cap funds in a portfolio? • Provides additional diversification • Helps minimize portfolio risk • Potentially enhance returns The amount of exposure of large and small cap funds will depend on the client’s: • Risk tolerance • Objectives © 2013 Internal | 14
- 15. Diversification Methods — Equity Asset Class • Geography • Capitalization • Active vs. passive management (indexing) • Active management styles © 2013 Internal | 15
- 16. Active vs. Passive Management Active or passive? © 2013 Internal | 16
- 17. Passive • Mandate simply to replicate index • Exposure to full market cycle • Lower fees • Tendency to be tax efficient Active vs. Passive Management Active • Has objective to outperform the market • Can hold cash • Has higher fees • Offers various mandates • Tax efficiency depends on the mandate of the fund © 2013 Internal | 17
- 18. Active vs. Passive Management Which is a better approach, active or passive management? • Neither, both can have a place in a well-diversified portfolio The breakdown of active versus passive management within a portfolio depends on: • Client preference • Efficiency of the market © 2013 Internal | 18
- 19. Active vs. Passive Management Characteristics of an efficient market: • Large, well established • Free flow of information • Highly regulated • Large number of analysts covering the companies in the market place © 2013 Internal | 19
- 20. Active vs. Passive Management More efficient markets: U.S. large cap Canadian large cap European equity International bond Canadian bond Less efficient markets: U.S. small cap Canadian small cap International small cap Specialty sectors Emerging economies © 2013 Internal | 20
- 21. Efficiency of the Market and Management Style In more efficient markets, what management style would be your first consideration? • Passive Why? • The probability of outperforming the market over the long term is significantly lower © 2013 Internal | 21
- 22. Efficiency of the Market and Management Style In less efficient markets what management style would be your first consideration? • Active Why? • The probability of outperforming the market over the long term is significantly higher © 2013 Internal | 22
- 23. Active vs. Passive Management There’s a case for both styles: A sound strategy for virtually all portfolios Use passive management in more efficient markets as the anchor of your portfolio, and complement with active management to further reduce risk Use active funds to explore in less efficient markets © 2013 Internal | 23
- 24. Diversification Methods — Equity Asset Class • Geography • Capitalization • Active vs. passive management (indexing) • Active management style © 2013 Internal | 24
- 25. Active Management Styles Four types of managemAecntti vsety mleasn: agement styles Value Growth Growth at a reasonable price (GARP)/Blend Top Down versus Bottom Up Activity: In your groups discuss and fill in the blanks using the words given in the workbook. © 2013 Internal | 25
- 26. Active Management Styles Value: Main focus is on price Managers select high-quality, undervalued companies (often at 40% — 60% discount) Willing to hold long-term and sell when stock reaches intrinsic value Look for low P/E, low P/BV, high dividend yield © 2013 Internal | 26
- 27. Active Management Styles Growth: Main focus is on earnings Managers select companies with strong growth prospects You should look for higher-than-average growth in EPS, ROE and revenue © 2013 Internal | 27
- 28. Active Management Styles GARP or blend: This offers a blend of growth and value styles Managers seek to buy reliable future growth at a P/E lower than the growth rate of earnings GARP managers may be biased towards one of the blended styles © 2013 Internal | 28
- 29. Active Management Styles Top down: • Looking at the big picture • Analyzing general economic conditions • Then determining which industries, sectors or countries should benefit from an improved economy © 2013 Internal | 29
- 30. Active Management Styles Bottom up: •Identifying companies regardless of economic or industry climate •Analyzing companies financial statement including ratios © 2013 Internal | 30
- 31. Active management styles and the market cycle ? ? © 2013 Internal | 31 PEAK TROUGH EXPANSION CONTRACTION RECESSION PEAK RECOVERY Active Management Styles
- 32. Active Management Styles © 2013 Internal | 32
- 33. Active Management Styles Where do they fit into a portfolio? • It makes sense to include a mixture of active styles in a portfolio, as different styles will perform well under different market conditions •The exact mix of styles can be tailored to the client’s risk tolerance and objectives © 2013 Internal | 33
- 34. Fixed Income Diversification © 2013 CIBC Retail & Business Banking Learning & Development Internal | 9/8/2014
- 35. Fixed Income Diversification When building the fixed income component of a portfolio, how can we diversify? • Fixed income mutual funds • Individual securities © 2013 Internal | 35
- 36. Fixed Income Mutual Funds What are some ways to diversify using fixed income mutual funds? Active vs passive management style Geography: Canadian vs international Term: Short-term vs long-term Quality: Government bond vs high-yield bond © 2013 Internal | 36
- 37. Fixed Income Securities Diversify individual securities by using: • Maturity dates (laddered portfolio) • Issuer: o Government versus corporate bonds o Federal versus provincial bonds o Sector (such as auto manufacturing & financials) © 2013 Internal | 37
- 38. Summary © 2013 Internal | 38