Historical Performance of Financial Assets What are our investment alternatives? How have stocks, bonds, cash, and other financial assets performed in terms of risk and return? Why is a global perspective on investing important? How does historical performance influence the asset allocation decision?
21
Embed
Historical Performance of Financial Assets zWhat are our investment alternatives? zHow have stocks, bonds, cash, and other financial assets performed in.
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Historical Performance of Financial Assets
What are our investment alternatives?How have stocks, bonds, cash, and
other financial assets performed in terms of risk and return?
Why is a global perspective on investing important?
How does historical performance influence the asset allocation decision?
Historical Performance of Financial Assets
Investment alternatives? Real vs. financial? Capital Market vs. Money Market?
Issues which should matter in return performance Risk!
Seniority of claim (bonds vs. stock)Business riskFinancial risk
Liquidity!Secondary market issues
Historical Performance of Financial Assets
Ibbotson and Sinquefield (I&S) examined nominal and real rates of return for seven major classes of assets in the United States 1. Large-company common stocks 2. Small-capitalization common stocks 3. Long-term U.S. government bonds 4. Long-term corporate bonds 5. Intermediate-term U.S. Treasury bills 6. U.S. Treasury bills 7. Consumer goods (inflation)
Basic Series: Historical Highlights (1926 - 1998)
GEOMETRIC ROR ARITHMETIC ROR STANDARD DEVIATION
Large Stocks 11.2% 13.2% 20.3% Small Stocks 12.4 17.4 33.8 LT Corporate Bonds 5.8 6.1 8.6 LT US Gov’t Bonds 5.3 5.7 9.2 US Tbills 3.8 3.8 3.2 CPI 3.1 3.2 4.5
Other markets?
Importance of the Global Perspective
1. Absolute and relative sizes of U.S. and foreign markets for stocks and bonds U.S. = about 52% of total value of securities More opportunities globally
2. Rates of return available on non-U.S. securities often exceed U.S. Securities Higher returns on equities are justified by higher growth
rates for the countries where they are issued
3. Diversification with foreign securities can reduce portfolio risk
Importance of the Global Perspective: Market Size, $2.3 Trillion in 1969
U.S. Equity31%
Cash Equivalent7%
Japan Equity2%
U.S. Real Estate12%
Other Bonds14%
U.S. Bonds21%
Japan Bonds1%
Other Equity11%Venture Capital
0%
Dollar Bonds1%
Importance of the Global Perspective: Market Size, $49.1 Trillion in 1997
Japan Equity5%
All Other Equity15%
Japan Bonds8%
Emerging Debt Market
2%
All Other Bonds18%
High Yield Bonds1%
Dollar Bonds20%
U.S. Real Estate5%
Cash Equivalent4%
Emerging Market Equity
1%
Private Markets0%
U.S. Equity21%
Importance of the Global Perspective: Better Returns in Bonds? (1987-1996)
Domestic Return US $ Return E-rate Return
Canada 10.89 10.98 0.01
France 10.52 12.73 2.00
Germany 7.41 9.79 2.22
Japan 6.49 9.90 3.20
UK 11.30 12.91 1.45
US 8.10 8.10 0.00
Importance of the Global Perspective: Better Equity Returns? (1986-1997)
Europe 14.8 9 16.5 8Pacific Basin 5.7 16 9.9 16Europe and Pacific 10.0 15 13.1 14North America 16.4 6 16.4 9World 12.4 12 14.1 11aBased on rank within seventeen countries and areas(rank for only the twelve countries)
Europe 14.8 9 16.5 8Pacific Basin 5.7 16 9.9 16Europe and Pacific 10.0 15 13.1 14North America 16.4 6 16.4 9World 12.4 12 14.1 11aBased on rank within seventeen countries and areas(rank for only the twelve countries)
Ranka Percent Percent
LOCAL CURRENCY U.S. DOLLARS
Ranka
Importance of the Global Perspective: Diversification of Risk
Returns from risky assets can stabilize one another when held together.
Why? Some sources of risk are different (unsystematic) Some sources of risk are common (systematic)
Unsystematic sources of risk tend to offset. Only systematic risk matters in a well diversified portfolio.
Importance of the Global Perspective: Diversification of Risk (Correlation!)
Diversification of Risk: Computing Covariance and Correlation
Covariance: absolute measure of comovement between two rate of return series
Correlation: relative measure of comovement can be positive or negative can be strong or weak
Example
Importance of the Global Perspective: Summary
Many opportunities to invest outside the US
May be able to enhance expected return
Opportunity to exploit weaker correlations among country returns to diversify risk
Asset Allocation and Investment Objectives
Investment Objectives – the articulation of risk and return issues;
Risk Tolerance• depends on many factors (insurance, cash
reserves, dependents, age, time horizon, net worth, income)
Return Objective• can be absolute (“8% per year”) or relative (“1%
above the S&P”); Can also state return objective as a general goal
Asset Allocation and Investment Objectives
Investment Constraints – 5 classes of constraintLiquidity Needs
• need for income now? at some specific point in the future?
Time Horizon• typically, longer time horizon means lower liquidity
needs and higher risk toleranceTax Concerns
• taxes must be paid by most investors on current income and on realized capital gains. Unrealized capital gains allow an investor to defer a tax liability to a later date.
Legal and Regulatory FactorsUnique Needs and Preferences
Asset Allocation and Investment Objectives
Given objectives and constraints, portfolio formation involves:
Asset Allocation - proportions invested by asset class
Equity, Fixed Income, Cash, RE, …Foreign vs domestic