Morningstar Advisor - April/May 2013 - (Page 66)

Gray Matters Exhibit 2 The Amihud Illiquidity Measure 1980–2010 1.0 Amihud-NYSE Threshold 0.8 0.6 0.4 the horizontal line, or negative 0.065. At first glance, it may appear counterintuitive to hold a greater allocation to stocks when market liquidity is low. However, this idea makes sense when placed in the context of a market-liquidity premium. That is, investors want to extract potential excess market returns in the form of a liquidity premium by offering market liquidity when it’s needed most and, in turn, be compensated for doing so. We rebalance both the strategic and dynamic portfolios monthly. Transaction costs for our dynamic asset-allocation portfolio are assumed to equal 0.1% and applied to the amount of portfolio turnover. Performance results are summarized in Exhibit 1, reported on an annualized basis. 0.2 0.0 –0.2 –0.4 Risky Assets –0.6 01/80 01/82 01/84 01/86 01/88 01/90 01/92 01/94 01/96 01/98 01/00 01/02 01/04 01/06 01/08 01/10 Exhibit 3 Upside and Downside Capture and Performance in Crisis Periods for the Amihud DAA (Downside Capture) DAA (Upside Capture) DAA Oct. 1987 (%) SAA Oct. 1987 (%) DAA SAA DAA SAA Apr. 2000– Apr. 2000– Sept. 2008– Sept. 2008– Dec. 2001 (%) Dec. 2001 (%) Feb. 2009 (%) Feb. 2009 (%) Large Growth 0.90 1.03 –5.58 –10.63% –18.86 –16.48 –17.76 –20.95 Large Value 0.90 1.02 –4.66% –9.09% 11.30% 8.45% –22.79% –24.04% Small Growth 0.92 1.05 –8.50% –15.49% –11.74% –11.01% –21.99% –25.15% Small Value 0.88 1.03 –7.10% –13.15% 29.70% 25.80% –24.47% –25.42% REIT 0.89 1.03 –3.19% –6.63% 30.33% 28.28% –32.34% –33.38% EAFE 0.91 1.01 –2.81% –6.01% –10.82% –10.67% –19.78% –23.71% Each row in Exhibit 3 represents performance associated with one of our six underlying risky assets used in portfolio construction. As mentioned, the BarCap US Gov/Credit 1–3 Year is used for the bond portfolio in constructing all portfolios. For example, the first row reports performance for our dynamic (DAA) and strategic (SAA) portfolios whereby largegrowth stocks are the risky asset. The second through fifth columns report total annualized portfolio return and standard deviation of return for the DAA and SAA portfolios, respectively. As can be seen from Exhibit 1, in comparing the SAA and DAA portfolios, the DAA portfolios consistently generate higher returns with roughly the same level of risk. Recall that the risk levels between SAA and DAA are roughly the same by design because the allocations are required to be the same, on average. The outperformance of DAA portfolios results in slightly higher Sharpe ratios for DAA across the board. We next regress the monthly returns of the DAA against the SAA portfolio for the full sample period in order to calculate the monthly alpha for the DAA portfolio. The reported risk-adjusted alpha is simply the 66 Morningstar Advisor April/May 2013

Table of Contents for the Digital Edition of Morningstar Advisor - April/May 2013

Morningstar Advisor - April/May 2013
Contents
Contributors
Letter From the Editor
The Pursuit of Happiness and Financial Advice
What Strategies Do You Use to Control Risk?
Driven to Succeed for Clients and Family
How to Assess a Portfolio’s Bond Risk
Luck, Skill, and Investing
Investments á la Carte
Investment Briefs
Investing’s No- Brainers Have Costs
A Defensive Ride
Risk On/On Risk
The Risk of Being Overconfident
Year of Living Dangerously
The Risk-Parity Approach
A Guide to Mutual Funds Running Risk-Parity Strategies
What Moats Tell Us About Risk
Risk’s Wake-Up Call
Seeing Is Believing
Why Investors Lag the Returns of Their Funds
Liquidity Signals
Pump Them Up
Golden Oldies Keep on Truckin’
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Our Social Blind Spot

Morningstar Advisor - April/May 2013