1. finance
2. investing
3. stocks

SUMMER 2015
A quarterly publication of CLS Investments
Global Portfolios:
The Importance of Effective Risk Management
The past 20 years have seen an accelerated amount of innovation and
globalization. Technological inventions, including computers, the Internet,
and smart phones, have connected people around the world and spurred
leaps of collaboration and progress across borders. This connectedness has
propelled companies to enhance their global footprints. As a result, investors
must now factor these considerations into their investment decision making
process. In this quarter’s Directions newsletter, I will make the case for the
importance of risk management when investing in today’s global setting.
About the Author
In 2015, Joe Smith joined CLS under
the role of Senior Market Strategist.
Prior to joining CLS, Mr. Smith
worked at Russell Investments,
Russell ETFs, and Charles Schwab
Investment Management.
It is no secret that global financial
markets have become more
integrated over the years. The
Mr. Smith received his Bachelor
of Science in Economics from the
University of Washington, and an
MBA degree from the Tepper School
of Business at Carnegie Mellon.
Global Stocks Historical Risks and Returns
34%
60%
29%
40%
25%
20%
19%
0%
14%
9%
-20%
-12.29
-24.05
Annualized Return
Annualized Risk
80%
-40%
-48.20
4%
-60%
May-15
Sep-14
Dec-13
Mar-13
Jun-12
Sep-11
Dec-10
Mar-10
Jun-09
Sep-08
Dec-07
Mar-07
Jun-06
Sep-05
Dec-04
Mar-04
Jun-03
Sep-02
Dec-01
Mr. Smith is also a Level III
candidate for the Chartered
Financial Analyst (CFA) designation,
and holds memberships with the
CFA Society of San Francisco and
Pittsburgh. He also serves on CLS’s
Investment Committee.
global financial crisis of 2008 serves
as a constant reminder of risk’s
ability to move across markets in a
big way. Looking at risk as defined
by volatility, we can see increases
have typically coincided with large
Why Is Risk Management
So Important Today?
ACWI Risk
ACWI Return
Source: MSCI, data from December 2001 through May 2015
1
Low
0.90
High
1.00
Diversification Benefit
DIRECTIONS
Mitigating Risks through
Risk Budgeting
Diversification Benefits Over Time
0.95
Risk can be managed more
effectively
through
means
beyond diversification. One
method is risk budgeting, which
is the hallmark approach to many
CLS portfolios. Risk budgeting
provides a way to limit the
amount of risk being driven from
each investment. For example,
an investment that allocates to
three regional exposures (as
mentioned above) can limit the
risk from each investment to no
more than one-third of the total
risk. This means the strategy
will serve to dedicate an equal
amount of its risk budget to each
0.85
0.80
0.75
0.70
0.65
0.60
0.55
0.50
May-15
Aug-14
Dec-13
Apr-13
Aug-12
MSCI AC Europe
Dec-11
Apr-11
Aug-10
Dec-09
Apr-09
Aug-08
Dec-07
Apr-07
Aug-06
Dec-05
Apr-05
Aug-04
Dec-03
MSCI USA
MSCI AC Asia Pacific
Source: MSCI, data from December 2003 through May 2015
two
points
together, investors can arrive
at a powerful conclusion: simple
diversification may not be enough
to meet their longer-term goals.
Annualized Comparisons
Portfolio
MSCI ACWI
MSCI USA
MSCI AC Europe
MSCI AC Asia Pacific
Risk Budgeted Portfolio
Risk
15.61%
14.00%
19.30%
16.96%
14.77%
Return
8.56%
8.41%
8.17%
9.29%
9.38%
Source: MSCI, data from December 2002 through May 2015
Allocation Adjustments in Risk Budgeted Portfolio
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Jan-15
May-14
Sep-13
Jan-13
May-12
Sep-11
Jan-11
May-10
Sep-09
Jan-09
May-08
Sep-07
Jan-07
May-06
Sep-05
Jan-05
May-04
Sep-03
2
these
Jan-03
During those same periods,
the effects of diversification
diminished
significantly.
Diversification tends to be high
when correlations to the MSCI
ACWI are modestly lower than
one. As seen in the chart above,
those benefits have historically
been more evident for Asia
Pacific stocks than for U.S.
and European stocks. What is
also important to note is the
diversification benefits for all
three markets have gradually
reduced over time. This suggests
regional markets are becoming
more integrated with the
broader global market.
Putting
Portfolio Allocations
drops in global financial markets.
The MSCI All Country World
Index (ACWI), a broad measure
of global stocks, shows modest
spikes in its risk levels in 2003,
2008, and 2012. Each time period
for which risk levels have peaked
has also met disappointing returns.
(The MSCI ACWI is down -24,
-48, and -12 percent respectively.)
Source: CLS Investments, data from January 2003 through May 2015
SUMMER 2015
DIRECTIONS
investment in the portfolio. As
the table on the previous page
shows, risk budgeting has the
potential over time to not only
lower the risk associated with a
global portfolio but also enhance
its return potential.
changes. This adaptive approach
may reduce risk across global
markets over time.
More importantly, as illustrated
in the chart at the bottom of the
previous page, risk budgeting
provides a way for portfolios
to dynamically adjust their
allocations as new information
becomes available and risk
Conclusions
SUMMER 2015 You
can
explore
more
about CLS’s Risk Budgeting
Methodology by visiting CLSinvest.
com/riskbudgeting
As globalization and technology
have resulted in worldwide
market integration, the need
for risk management is even
more important for globally
diversified portfolios. Although
diversification benefits can help
manage some risk in global
portfolios, it is important
for investors to think of risk
management beyond traditional
rules of thumb. At CLS, we
constantly seek to manage risk in
a global setting, primarily through
advanced applications of risk
budgeting. By doing so, we aim
to keep global portfolios balanced
over the long term with a more
direct focus on risk and its
changing nature in global markets.
3
DIRECTIONS
2015 Investment Themes
from CLS Chief Investment Officer, Rusty Vanneman, CFA
HIGH QUALITY
Emphasizing high quality in our domestic equity holdings is a carry-over
theme from last year. In defining “high quality,” we like companies that have
relatively stable profitability, strong balance sheets, and higher dividend
growth. These companies should do better in slower growth environments,
which we expect in the year(s) ahead. Their stocks should also generally hold
up better in volatile markets.
EMERGING MARKET OPPORTUNITIES
We believe that strategically incorporating international securities, particularly
emerging markets, in a portfolio provides additional opportunities to enhance
long-term returns and reduce portfolio risk. In addition, many emerging equity
markets are sporting far more attractive valuations than the U.S., suggesting
that future returns will be higher overseas than they will be domestically.
TECHNOLOGY/INNOVATION
The technology sector offers one of the most attractive opportunities within
domestic equities. Despite the sector’s robust performance in 2014 and strong
momentum, the relative valuation of technology remains among the cheapest. In
addition, it’s important to remember that innovation often creates the positive
“surprises” that push the economy higher.
TACTICAL FIXED INCOME
We believe bond returns will likely be below average in the years ahead. In
turn, we will actively manage our fixed-income holdings. For instance, we
may rotate between duration, credit, inflation break-evens, and international
holdings to give us an opportunity to take advantage of changes in bond
market relative valuations.
4
SUMMER 2015
DIRECTIONS
How much time do you spend
planning your retirement?
Sierra Morris-Fuchs
CLS Investment Research Analyst
Figuring out how to spend your money can be
difficult. If you are like me, even a decision as
simple as where to go for dinner can turn into a
lengthy quest of nearby restaurants, researching
menus for plates and prices, and making a
persuasive argument for the food I’m craving.
What about a bigger purchase, say a flat screen
TV or a tablet? For me, a purchase like this can
take weeks of research before I’m satisfied. My
research is extensive – I read up on brands,
features, and customer reviews, and I’m willing
to bet most people have a similar process.
As it turns out, I’m right. (Full disclosure – I
already knew the answer.) In fact, a recent
survey done by TIAA-CREF found that most
Americans spend a greater amount of time
making decisions on what restaurant to eat at,
or which TV/tablet to buy than they do deciding
how to set up their IRA retirement account.
Percentage of American who spent two hours
or more on various activities
Planning an
IRA investment
15%
Selecting a
restaurant for a
special occation
This is exactly why it’s so important to have
a trusted financial advisor. Not only are
Americans spending too little time planning
their investments, but when left to our own
devices, it’s human nature to make these
investment decisions emotionally – buying
at highs and selling at lows. A good financial
advisor will take goal and fears, constraints and
capacity into consideration when spending the
time to gather an ideal portfolio for investors –
allowing them that extra time to figure out the
perfect spot to eat on Friday night.
25%
Buying a
flat screen TV
Buying a tablet
Does that mean most people don’t care how
they are investing a good portion of their life
savings? I don’t think so. I believe it’s a reasonable
assumption that a lack of understanding of
financial accounts and products is at least
partially to blame for this shortage of IRA
planning. After all, the same study found that
more than one-third of their respondents did
not know the difference between employeesponsored plans and IRAs. And who can blame
them? The enormous amount of account types
and fund choices alone can be overwhelming
and on top of that investors need to consider
fees, geopolitics, investment structure, risks,
and diversification.
21%
16%
Source:TIAA-CREF 2014 IRA Survey
SUMMER 2015 5
DIRECTIONS
The views expressed herein are exclusively those of CLS Investments, LLC, and are not meant as investment advice and are
subject to change. No part of this report may be reproduced in any manner without the express written permission of CLS
Investments, LLC. Information contained herein is derived from sources we believe to be reliable, however, we do not represent
that this information is complete or accurate and it should not be relied upon as such. All opinions expressed herein are subject
to change without notice. This information is prepared for general information only. It does not have regard to the specific
investment objectives, financial situation and the particular needs of any specific person who may receive this report. You should
seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recom¬mended
in this report and should understand that statements regarding fu¬ture prospects may not be realized. You should note that
security values may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive back less
than originally invested. Past performance is not a guide to future performance. Investing in any security involves certain systematic
risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk. These risks are in addition to any
unsystematic risks associated with particular investment styles or strategies.
The graphs and charts contained in this work are for informational purposes only. No graph or chart should be regarded as a
guide to investing.
A client’s risk budget is derived from the client’s specific answers to CLS’s Confidential Client Profile questionnaire, which
establishes the client’s financial goals, ability to handle risk, and overall investment time horizon. The individual client risk budget
is expressed as a percentage of the risk of a well-diversified equity portfolio.
The MSCI ACWI captures large and mid cap representation across 23 Developed Markets (DM) and 23 Emerging Markets (EM)
countries. The MSCI USA Index is a free float adjusted market capitalization index that is designed to measure large and mid cap
US equity market performance. The MSCI USA Index is member of the MSCI Global Equity Indices and represents the US equity
portion of the global benchmark MSCI ACWI Index. The MSCI AC Europe Index captures large and mid cap representation across
15 Developed Markets countries and 6 Emerging Markets countries in Europe. The MSCI AC Pacific Index captures large and
mid cap representation across 5 Developed Markets countries and 7 Emerging Markets countries in the Pacific region. An index is
an unmanaged group of stocks considered to be representative of different segments of the stock market in general. You cannot
invest directly in an index.
High quality investments are investments in securities issued by companies with the propensity for higher than average characteristics
including higher and more consistent profitability, stronger balance sheets, and higher dividend growth. The primary diversifiable
risk is opportunity risk. Emerging market investing refers to the practice of investing in a developing market of a foreign nation.
The pre-requisites of this practice include a market within the foreign nation along with some form of regulatory body. Emerging
markets involve greater risk and potential reward than investing in more established markets. Diversifiable risks for emerging
markets include, but are not limited to, political risk, currency risk, and liquidity risk. The technology, or information technology,
sector is a sector representing enterprises engaged in the research, development, or distribution of technology goods and services.
Examples include electronics manufacturers, software creators, computer manufacturers, etc. Fixed Income is an investment style
designed to return income on a periodic basis. Generally, fixed income strategies invest in bonds, real estate, loans, and other
types of debt instruments. Diversifiable risks associated with fixed income investing include, but are not limited to, opportunity
risk, credit risk, reinvestment risk, and call risk.
1935-CLS-6/30/2015
6
SUMMER 2015