1. ADVANCE
CONNECT
Strengthen

2. INNOVATIONS IN ASSET allocation
Allocation strategy in a dynamic investment
environment

3. RISK – MANAGING IT AND DE-RISKING
portfolios
Kej Somaia
Portfolio Manager, Multi Asset, Colonial First State Asset Management

4. Measuring, managing and
reducing risk
Leah Kelly & Kej Somaia
7th & 9th June 2011

5. Risk

6. What is risk?
6
Risk has a different definition depending on your objective
– Uncertainty around expected returns?
– Not beating benchmark?
– Chance of not being able to meet liabilities when they fall due?
– Chance of losing capital?
– Probability of a negative return over certain periods?
– Probability of an extreme event?
Risk is the probability that investment objectives will not be met

7. Typical risks in a diversified portfolio
7
Market
– Interest rate moves, credit spread moves, inflation moves, equity market moves,
currency moves, stock specific
Credit
– Typically, related to fixed income investments, it is the risk that the borrower will be
unable to meet its payment obligations (coupons, repayment of principal for example)
Liquidity
– Typically, we define it as the risk that we will be unable to sell assets without having a
significant impact on the market or without having to take a significant haircut in value
Counterparty
– Closely related to credit risk, counterparty risk is the risk that the one of the parties
involved in an over-the-counter derivative is unable to meet its contractual obligations

8. Measuring risk

9. Recap on some key terms
9
Total portfolio risk measures Non-normal distributions
Mean / expected
portfolio value
Volatility (σ)
describes the width of
the modelled portfolio
CVaR is the avg VaR is a point on
region beyond the distribution σ
VaR
Portfolio value

10. Measuring market and credit risk
10
Can be used to measure: Appropriate for:
Risk Description Equity Interest Credit Default Inflation Skewed Fat tailed
measure market rate risk spread risk risk distributions distribution
risk risk
Tracking •Measures the difference in Yes Yes Yes – but No No No No
Error volatility between its benchmark only if no
and the portfolio interest
•Relies on normality assumptions rate risk
•Point in time is
•No probability included
Beta •Measures the sensitivity of a Yes Yes Yes No No No No
portfolio to a move in the relevant
benchmark
•Point in time
•No probability
Duration •Measures the sensitivity of a No Yes Yes No Yes No No
portfolio to a move in the relevant
yield, inflation expectations or
credit spread curve
•Point in time
•No probability
Volatility •Measures the variability around Yes Yes Yes No Yes No No
the expected return
•No directional indication
•Returns must be symmetric

11. Measuring market and credit risk
11
Can be used to measure: Appropriate for:
Risk Description Equity Interest Credit Default Inflation Skewed Fat tailed
measure market rate risk spread risk risk distributions distribution
risk risk
VaR •Specifies the minimum loss that Yes Yes Yes Yes – Yes Yes Yes
could be incurred with a given but
probability over a given period of typically
time underest
•Comparable across portfolios and imates
different asset classes the risk
•A shortcoming is that it does not
provide an indication of the
expected size of the loss beyond
the VaR point
CVaR •Calculated as the weighted Yes Yes Yes Yes Yes Yes Yes
average loss exceeding the VaR
•Includes the entire tail of the
distribution
•Comparable across portfolios and
asset classes
Draw •Refers to the decline in returns Yes Yes Yes Yes Yes Yes Yes
down from a peak over a certain period
•Provides a measure of the
magnitude but not the likelihood
•Not directly comparable

12. Caveats around the risk measures
12
– All of the quantitative risk measures rely on assumptions; the extent of which depends
on the method used to calculate them
– Beta and duration, typically only make sense for small changes in equity markets or
yield curves and are not comparable across markets
– That is, a duration of 5 that includes fixed income securities in two different
currencies implies that those markets move together and by the same amount
– VaR can underestimate the risk depending on the underlying asset classes because
there is a technical flaw in its design

13. Measuring liquidity risk
13
Liquidity is a function of the relevant market
– It depends on such things as
– The number of traders
– The frequency and size of trades
– The time it takes to execute
– The bid-ask spread
– How big your portfolio is!
– A variety of approaches exist and there is NO consensus
– Methods vary:
– Add a liquidity factor to the risk measure of the portfolio
– Assume properties of the bid ask spread – usually normally distributed

14. Measuring liquidity risk
14
– “Know your portfolio” approach
– VWAP for equities; takes into account the spread and the size of the portfolio
relative to the market in which it is invested
– No liquidity for any type of alternative
– Look through into cash portfolios and all fixed income portfolios
– Stress OTCs to see the impact of collateral calls
– Stress Forward FX positions to see the funding impact on rolling the hedge

15. Measuring counterparty risk
15
– Know or derive a credit rating of the counterparty
– Only applied in practice to OTC derivatives, where the notional exposure is not a true
indication of the size of the possible obligation
– Many participants use a “potential exposure” number, which is calculated using some
kind of volatility and/or distribution to estimate the potential size of the obligations (on
both sides)
– Different treatment of different types of OTC derivatives

16. Managing risk

17. Risk management strategies
17
Relevant risk management strategies depend on your investment objective
– Risk management also depends on the
risk you are trying to manage
– If tracking error, volatility, beta or duration
are your relevant risk metric knowing the
contributions to your total portfolio
volatility, for example, helps
– Portfolios can then be adjusted
accordingly so that the risks you expect to
be rewarded are the dominant risk factors

18. Risk management strategies
18
– A Liability Mismatch
– Asset portfolios should be constructed to evolve in line with liabilities
– Note that liabilities evolve through time
– This may be through duration, convexity matching, through credit spread matching,
through cash flow matching
– If tail risk, loss of capital are the focus:
– Recognising that in extreme events all markets tend to move together though often
at different rates; a number of strategies exist:
• Volatility hedging through actively managed equity put options, VIX futures or
some other volatility derivative
• Credit default swap indices is also another way.

19. Risk management strategies
19
– Credit risk: diversification is key. There is no upside in taking credit risk, the best you
can hope for is that you get your principal plus interest back.
– Lend a little to a lot
– Know your position in the capital structure
– Counterparty risk:
– Vigilant monitoring of the financial strength of the counterparty
– Diversification helps
– Collateralisation (albeit carefully)
– Strong documentation is critical
– Strong record and settlement procedures are key
• Note that a confirmation overrules a schedule overrules the ISDA Master
agreement

20. Risk management strategies
20
– Liquidity risk:
– Know your portfolio!
– Hold a buffer of cash and synthetically replicate your market exposure
– Keep your methods of rebalancing a portfolio open
– Manage your resets
• Not all Forward FX rolling at the same time
• Not all your derivatives resetting at the same time
– If you have collateral agreements in place, maintain some flexibility in what you can
post

21. Risk management strategies
21
And finally:
– STRESS TEST , STRESS TEST, STRESS TEST all of your assumptions

22. Practice is changing

23. How has practice changed?
23
– Certainly there is a focus from regulators, advisor networks, superannuation firms
regarding DB and DC risk
– More and more conversations are focusing on portfolio design that has meeting
investor objectives as a key
– Furthermore, investors are focussing on the total risk of their portfolios, rather than just
one metric
– Increased focus on education of Boards and Trustees with regards to communicating
risks of investment options

24. Disclaimer
24
Product Disclosure Statements (PDS) and Information Memoranda (IM) for the funds issued by Colonial First State Investments Limited ABN 98 002 348
352, Commonwealth Managed Investments Limited ABN 33 084 098 180, and CFS Managed Property Limited ABN 13 006 464 428 (collectively CFS) are
available from Colonial First State Global Asset Management. Investors should consider the relevant PDS or IM before making an investment decision.
Past performance should not be taken as a reliable indication of future performance.
Information in this presentation is confidential. No part of this material may be reproduced or transmitted in any form or by any means without prior written
consent of Colonial First State Asset Management (Australia) Limited ABN 89 114 194 311 (CFSAMAL). This material contains or is based upon
information that we believe to be accurate and reliable. While every effort has been made to ensure its accuracy, none of CFS or CFSAMAL offers any
warranty that it contains no factual errors. We would like to be told of any such errors in order to correct them.
This material has been prepared for general information. You should not rely on the contents. To the fullest extent allowed by law, CFS and CFSAMAL
exclude all liability (whether arising in contract, from negligence or otherwise) in respect of all and each part of the material, including without limitation,
any errors or omissions.
This material is intended only to provide a summary of the subject matter covered. It does not purport to be comprehensive or to render specific advice. It
is not an offer document, and does not constitute a recommendation of any securities offered by any of the CFS or CFSAMAL. No person should act on
the basis of any matter contained in this material without obtaining specific professional advice.
CFS and CFSAMAL are wholly owned subsidiaries of Commonwealth Bank of Australia. The Bank and its subsidiaries do not guarantee the performance
of any funds invested in by clients of CFS and CFSAMAL or the repayment of capital. Investments are not deposits or other liabilities of the Bank or its
subsidiaries and are subject to investment risk including loss of income and capital invested.
Colonial First State Global Asset management is the consolidated asset management division of the Commonwealth Bank of Australia
ABN 48 123 123 124
Copyright © Colonial First State Group Limited 2011
All rights reserved

25. INNOVATIONS IN ASSET allocation
Allocation strategy in a dynamic investment
environment

26. LIFECYCLE INVESTING strategies
Professor Michael Drew SF Fin
Managing Director, Lifecycle Strategies, QIC

27. Innovations in Asset Allocation
Allocation strategy in a
dynamic investment environment
Finsia workshops
June 2011

28. Disclaimer
QIC Limited ACN 130 539 123 (“QIC”) is a wholesale funds manager and its
products and services are not directly available to retail investors. QIC is a company
government owned corporation constituted under the Queensland Investment
Corporation Act 1991 (Qld). QIC is regulated by State Government legislation
pertaining to government owned corporations in addition to the Corporations Act
2001 (“Corporations Act”). QIC does not hold an Australian financial services
(“AFS”) licence and certain provisions (including the financial product disclosure
provisions) of the Corporations Act do not apply to QIC. Please note however that
some wholly owned subsidiaries of QIC have been issued with an AFS licence and
are required to comply with the Corporations Act. QIC Lifecycle Strategies is a
business division of QIC.
QIC, its subsidiaries, associated entities, their directors, employees and
representatives (“the QIC Parties”) do not warrant the accuracy or completeness of
the information contained in this document (“the Information”). To the extent
permitted by law, the QIC Parties disclaim all responsibility and liability for any loss
or damage of any nature whatsoever which may be suffered by any person directly
or indirectly through relying on the Information, whether that loss or damage is
caused by any fault or negligence of the QIC Parties or otherwise. The Information
is not intended to constitute advice and persons should seek professional advice
before relying on the Information.
Copyright QIC Limited, Australia 2011. All rights are reserved. Do not copy,
disseminate or use, except in accordance with the prior written consent of QIC.
28

29. QIC Lifecycle Strategies
QIC Lifecycle Strategies works with superannuation funds to develop and
manage sophisticated investment solutions and lifecycle programs for the sole
purpose of improving the retirement outcomes of defined contribution (DC)
members.
Our customised solutions allow trustees to deliver tailored outcomes for their
members based on their investment horizon.
29

30. Lifecycle Strategies key beliefs
30

31. The problem (1) –
Members aren’t always long-term investors
• Investing for the long term does not reduce the probability of experiencing a loss in any one
year
• Therefore, the probable range of outcomes widens as a member’s investment horizon
shortens.
31

32. The problem (1) –
History isn’t kind when timeframes are finite
• History shows that, in their final year, a 40-year investor has a:
• 42% chance of not achieving a 7.5% return
• 24% chance of falling short of CPI+3%
• 14% chance of a negative return
Source: QIC Lifecycle Strategies
• This is interesting, but doesn’t factor in the dollars (portfolio size) against this return. 32

33. The problem (1) illustrated
• One version of reality … a 25% drawdown five years from retirement destroys up to 1.5 times a
member’s lifetime contributions to superannuation and reduces their annuity income by one-third. This
situation was the lived experience for some super fund members in 2008/09.
$2,000,000
$1,493,608
$1,500,000
$1,000,000
$500,000 $1,071,515
(-28% impact)
$0
40 38 36 34 32 30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30
-$500,000
-$1,000,000
-$1,500,000
-$2,000,000
Base case - Accumulation (7.5% p.a.) Base case - Decumulation (4.5% p.a.)
Drawdown 1 - Accumulation (-25%, year 35) Drawdown 1 - Decumulation (-25%, year 35)
33

34. The problem (2) –
The portfolio size effect
• It’s what you do when the largest amount of money is at risk that matters
• Due to this size effect, a member’s final investment outcomes become more sensitive to asset
allocation in later years relative to early years
• Switching to less volatile assets before retirement can lessen the impact of severe stock market
downturns
• can be justified only when the accumulation at the point of switch exceeds the target set by the Fund
Source: Basu, A. and Drew, M.E. (2009)
Portfolio Size Effect in Retirement Accounts:
What Does It Imply for Lifecycle Asset
Allocation Funds, Journal of Portfolio
Management, 35:3, 61-72.
34

35. So, are target date funds the solution?
Stylised asset alloction of XYZ Target Date Fund
100%
90% Cash
80%
70% Bonds
60%
50%
40%
30% Equities
20%
10%
0%
40 35 30 25 20 15 10 5 0 5 10 15 20 25 30
Years to Retirement Years Post Retirement
35

36. Issues with 1st generation target date funds
• The proponents of 1st generation target date strategies cite the convenience to members of putting
their investing activities on autopilot
• However, the GFC has reminded us that:
- what's safe and what’s risky changes as you move through life
- sequencing risk impacts differently in savings years versus spending years
- negative compounding matters!
• Unlike the ‘auto-pilot’ or static approach, QIC's approach to lifecycle investing is dynamic:
- The riskiness (or otherwise) of the glidepath is informed (among other things) by the extent to
which the members' retirement wealth accumulation objective has been achieved
36

37. So, is switching between MIC options the solution?
• Superannuation funds already have ‘target risk’ member investment choice (MIC) options available for
members
• Some funds already have a ‘partial lifecycle’ strategy that moves members from one MIC option to
another at set birthdays
• Our modelling shows that these strategies have the potential to expose members to unintended risks
- essentially require the planets to perfectly align 2, 3 or 4 times in a members’ life, at the exact time
de-risking takes place
• Most funds employ active managers and dynamic asset allocation strategies, so why be deterministic
in designing a glidepath?
37

38. The solution
38

39. The solution
39

40. Our solution – The Lifecycle Completion Portfolio
• The QIC Lifecycle Completion Portfolio takes the form of an overlay
• This allows the superannuation/pension fund to manage (or complete) the
competing investment horizons of:
- the superannuation fund’s long-term investment portfolio, and
- the finite investment horizons of members
• QIC Lifecycle Strategies analyses the investment objectives set for every member
cohort by the trustees to identify the most appropriate glidepath from a return, risk,
and constraint perspective
• This frees the CEO/CIO (and their advisers) from the burden of managing
competing retirement horizons of members
- concentrates their efforts on constructing and managing the core investment
portfolio over a long-time horizon
40

41. The Completion Portfolio in practice
41

42. Lifecycle Strategies investment process
42

43. Lifecycle Strategies glidepath design
43

44. Implementation
Implementation via ...
QIC
Lifecycle Completion Completion
Strategies Portfolio Portfolio
construction management
Optimal Multiple implementation Performance
glidepath paths and risk To
design
monitoring phase
Client Glidepath to Receive
client/ data
or delegate Performance
delegate reporting to
client
44

45. Dynamic lifecycle solutions
Key steps:
• Analyse membership cohorts
• In consultation with the Trustees - determine objectives appropriate to membership
• Design customised asset allocation glide path:
• Take account of portfolio size effect, market conditions, and objectives
• Incorporate downside protection as relevant
• Manage asset allocation dynamically
• Review glide path periodically (e.g. monthly) versus objectives and adjust as necessary
45

46. Case study excerpt – results comparison
R a n kin g s (1-9)
W eig h ted W eig h ted W eig h ted W eig h ted
W eig h tin g DL C2050 S c ore T DF 2050 S c ore B a la n c ed S c ore 100% E q u ities S c ore
R etirem en t W ea lth R a tio
Mean 5% 6 0.3 3 0.2 3 0.2 7 0.4
Median 18% 6 1.1 3 0.5 3 0.5 7 1.3
Maximum 1% 6 0.1 3 0.0 3 0.0 7 0.1
Minimum 1% 3 0.0 7 0.1 6 0.1 3 0.0
Quartile 1 5% 6 0.3 3 0.2 3 0.2 3 0.2
Quartile 3 5% 6 0.3 3 0.2 3 0.2 3 0.2
Coefficient of Variation 5% 3 0.2 6 0.3 6 0.3 2 0.1
Interquartile range ratio 5% 3 0.2 6 0.3 6 0.3 2 0.1
T OT A L 45% 2.4 1.7 1.7 2.2
Down s id e R isk a n d P erform a n c e M ea su res
LPM0 (Probability of Shortfall) 17% 6 1.0 2 0.3 2 0.3 5 0.9
LPM1 (Expected Shortfall) 20% 7 1.4 3 0.6 2 0.4 5 1.0
LPM2 (Downside Semi-variance) 1% 6 0.1 5 0.1 3 0.0 2 0.0
Sortino Ratio (SR) 1% 6 0.1 3 0.0 3 0.0 7 0.1
Upside Potential Ratio (UPR) 1% 6 0.1 3 0.0 3 0.0 7 0.1
T OT A L 40% 2.6 1.1 0.8 2.0
T a il R isk E stim a tes
Value-at-Risk (VaR) 10% 8 0.8 4 0.4 3 0.3 5 0.5
Expected Tail Loss (ETL) 5% 6 0.3 7 0.4 5 0.3 2 0.1
T OT A L 15% 1.1 0.8 0.6 0.6
Defa u lt Op tion S u ita b ility Ra tin g * 6.1 3.5 3.1 4.8
*Maximum Score = 9.0 DL C2050 T DF 2050 B a la n c ed 100% E q u ities
R ec om m en d
46

47. Comparing alternative default designs
Target Risk Age-based Target Date Dynamic
(with DAA) MIC Switch Fund Lifecycle
Strategy
Ability to take account of assets outside of
super û û û û
Provide adequate retirement savings if
market conditions are generally bad û û û û
Age / time to retirement
asset allocation
considered in
û ü ü ü
Market conditions considered before a
change to asset allocation ü û û ü
Protection strategies offered during
transition phase û û û ü
Strategy customised to the characteristics
of the funds cohort membership û û û ü 47

48. Thanks .....
Questions?

49. CASE STUDY: ASSET ALLOCATION – A
PRACTICAL example
Paul Chin F Fin
Senior Investment Analyst, Investment Strategy and Research Group,
Vanguard Investments Australia

50. FINSIA Conference: Innovations in Asset Allocation
Current reflections on Asset Allocation (including a Case Study)
Sydney, Australia: Tuesday 7th June 2011
Melbourne, Australia: Thursday 9th June 2011
Paul W. Chin
Senior Investment Analyst
Investment Strategy & Research Group
Investments Team (Asia-Pacific)

51. Agenda
1. Constructing portfolios: topical
issues
2. Asset Allocation: revisiting
key themes
3. A Case Study:
n Vanguard Diversified Funds’
asset allocation
> 51 Confidential

52. 1. Constructing portfolios: topical issues
> 52 Confidential

53. Individual Investors:
- Investor behaviour: left to their own devices (U.S.)
Rolling 12-month excess returns:
Dow Jones U.S. Total Stock Market Index versus Barclays Capital Aggregate Bond Index
50% 2009
Equities: $40b outflows
40%
Stocks outperform 2006–2007
Equities: $464b inflows
Bonds: $398b inflows
Bonds: $182b inflows
30%
20%
10%
0%
-10%
1999
Equities: $160b inflows 2001
-20% Bonds: $2b inflows Equities: $70b inflows
2000 Bonds: $81b inflows
-30% Equities: $262b inflows 2002
Bonds: $48b outflows Equities: $37b inflows
-40% Bonds: $148b inflows
Bonds outperform
-50%
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Date label as of 31 December for each year.
Stock returns use the Dow Jones U.S. Total Stock Market Index from 1990 through April 22, 2005 and the MSCI US Broad
Market Index thereafter. Bonds consist of the Barclays Capital U.S. Aggregate Bond Index. Sources: Vanguard Investment
Strategy Group and Strategic Insight.
> 53 Confidential

54. Financial Planning (intermediated advice):
- A value chain under pressure
Financial Advice Industry
Margins
Regulators Total costs need to reduce Investors
in area of
0.5 – 1.0%
Investment Dealer Advice
Platforms
Managers Groups Businesses
Value proposition changes; impacts to portfolio construction
> 54 Confidential

55. Some other major Asset Allocation trends
- Portfolio construction challenges still exist
“May you live in interesting times…”
n Defined Benefit challenges (e.g. GFC & impact
on funding levels, regulatory):
– é to FI, ê in EQ allocations
– Rise of alternative investments & riskier n A rise in the number of Asset
assets: PE/VC, commodities, Classes used
infrastructure, absolute return, structured,
alternative/systematic betas n A focus on liabilities
n A growth in types (and
n Intermediated/Individual: ‘value for services’ top complexity) of derivatives
of mind:
– Use of indexing in portfolios
– Rapid growth of ETFs
> 55 Confidential

56. Building policy portfolios…
- Perspectives of different investors
Focus: AA is tailored to meet liabilities & maximise Focus: earning the highest level of return for a given
the surplus given acceptable risk level acceptable risk level
Surplus, given - Cash n Define investor’s
acceptable risk level - Bonds
return requirement
- Listed Property
- Bonds n Identify current
- Intl Equities
wealth position
- Listed Property n List investment
- Intl Equities
constraints
- Aus Equities - Aus Equities
Modelled Strategic Strategic
Liabilities Asset Asset
Allocation Allocation
Source: Vanguard (stylised)
> 56 Confidential

57. Common issues in investing/Asset Allocation (AA)
- Expecting a perfect AA leads to disappointment
Are you succumbing to the effects of behavioural finance?
n The temptation to respond to Pleasure
market dynamics is high
– Regret minimisation
– Overconfidence
– Aversion to ambiguity
– Loss Aversion -$50
Loss Gain
+$50
Pain
Source: Kahneman and Tversky (1979)
> 57 Confidential

58. Core Portfolio Construction principles haven’t changed
Be mindful of constantly responding to short-term market dynamics
n Perhaps a ‘New Normal’ in economic terms
n Strategic Asset Allocation ≠ “buy & hold” or “set & forget”
n The underlying premises of portfolio construction remains highly relevant
– Expectations in return, risk, correlation periodically
– Funding needs/liabilities may have changed
– Risk management is gaining prominence
– Rebalancing within tolerances
– Taxation, costs and fees
> 58 Confidential

59. 2. Asset Allocation: revisiting key themes
> 59 Confidential

60. What do you see in this picture?
> 60 Confidential

61. Interpreting the same data
- A range of views on the same data
US wealth management recommended Asset Allocations:
(moderate-risk) Box & Whisker Plot (at March 2011)
70%
60%
50%
40%
30%
20%
10%
Equities Fixed Interest US Fixed Interest
Source: Vanguard Investments Australia calculations using data from Barrons, March 2011
> 61 Confidential

62. Dynamic Asset Allocation
- Getting the timing, magnitude & direction right…
Fixed Interest
Fixed Interest
…strategies range from reducing World’s largest bond investor PIMCO dumps U.S. Treasuries
…strategies range from reducing
longest-dated holdings and shifting
longest-dated holdings and shifting - The Guardian UK, 11 April 2011
to higher-yielding corporate debt,
to higher-yielding corporate debt,
to investing in stocks, commodities
to investing in stocks, commodities
& non-U.S. bonds... Fidelity says yields may stay low, conflicting with PIMCO
& non-U.S. bonds...
- Bloomberg, 12 May 2011
Global Equities
Global Equities
…the average super fund on Ratings houses silent on Japan fund fallout
…the average super fund on
Morningstar’s database had aa
Morningstar’s database had - Financial Standard, 15 March 2011
23.2% weighting to Japan (vs aa
23.2% weighting to Japan (vs
Feb-11 index weight of 10.4%).
Feb-11 index weight of 10.4%).
Currencies & Commodities
Currencies & Commodities
…head of Toscafund hedge fund Aussie dollar will rise further, expert predicts
…head of Toscafund hedge fund
Dr Savouri predicts the AUD could
Dr Savouri predicts the AUD could - Financial Standard, 13 May 2011
keep climbing, reaching $US1.30
keep climbing, reaching $US1.30
by 2013 & $US1.70 by 2014.
by 2013 & $US1.70 by 2014.
RBA dismisses commodity price bubble talk
- The Age, 26 May 2011
> 62 Confidential

63. The body of notable research on Asset Allocation
Effect on
differences in
Effect on Total Ave Total Returns
Return Variability: Policy Return / Ave across funds:
Researcher Data Set Period Ave time series R2 Actual Return cross sectional R2
Brinson et al. (1986) 91 Pension Funds 1974-1983 93.6% 112% n.a.
Brinson et al. (1991) 82 Pension Funds 1978-1987 91.5% 101% n.a.
58 Pension Funds 1993-1997 88.0% 99% 35%
Ibbotson & Kaplan
(1991)
94 US Balanced Funds 1988-1998 81.4% 104% 40%
Drobetz & Kohler 51 German & Swiss
1995-2001 82.9% 134% 65%
(2002) balanced funds
420 US Balanced Funds 1962-2001 76.6% 114% n.a.
Vanguard (2003)
66 US Balanced Funds Bear markets 69.4% 100% n.a.
Vanguard
227 US Balanced funds 1966-2003 81.6% 122% 19%
Tokat et al. (2006)
Vanguard
189 US Balanced funds 1966-2006 82.1% 108% 20%
Davis et al. (2007)
> 63 Confidential

64. Some forthcoming Vanguard research (2011)
n In Australia…
n Over 80% of the variability of monthly
returns can be explained by the variability of
the fund’s policy benchmark
n Funds detracted from their performance and
increased their volatility relative to their
Asset Allocation policies
n The distribution of alpha is highly skewed:
only a small number of funds have been
able to generate statistically positive alpha
> 64 Confidential

65. 3. A Case Study: Vanguard Diversified Funds
> 65 Confidential

66. Building a Strategic Asset Allocation
n Maintain an appropriate policy portfolio
n Diversify to the maximum possible extent
n Hold investment costs to the bare bones minimum
n Be realistic with your return expectations
> 66 Confidential

67. Building a Strategic Asset Allocation:
- International Equity hedging considerations
Diversification benefits from unhedged International Equity allocation
10%
Level of hedging needs to consider
overall risk minimisation objective – no
y = 0.48x + 0.004
one clear strategy for equities (unlike R 2 = 0.4
5%
global bonds)
0%
Local market return Scatter plot of monthly
local market returns and
return to hedging shows
-5%
positive relationship
-10%
When local returns are negative, the
-15% AUD return has tended to be also
negative ⇒ mitigates unhedged AUD AUD Hedge Impact
return Index
-20%
-20% -15% -10% -5% 0% 5% 10% 15%
Source: Vanguard team analysis
> 67 Confidential

68. Building a Strategic Asset Allocation:
- Were the changes worthwhile?
5yr rolling: Sharpe Ratio differentials between original & current allocations
0.25
Conservative (30/70) The Sharpe Ratio ends
up higher than original
Balanced (50/50)
0.20 allocation, so changes
Growth (70/30) were worthwhile
0.15 High Growth (90/10)
The positive difference in Sharpe
0.10 Ratio means greater return per
unit of risk
0.05
0.00
-0.05
Jun-04
Jun-06
Jun-03
Dec-03
Dec-04
Jun-05
Dec-05
Dec-06
Jun-07
Dec-08
Jun-09
Dec-09
Jun-10
Dec-10
Dec-00
Jun-02
Dec-02
Dec-07
Jun-08
Dec-99
Jun-00
Jun-01
Dec-01
The difference in Sharpe Ratio declined
Source: Vanguard team analysis during the GFC as returns dropped rapidly
> 68 Confidential and total risk increased

69. Relative performance
> 69 Confidential

70. In summary
n Don’t forget the (high) hurdles of costs, taxes and market impacts in assessing
investment approaches
n A highly dynamic investing environment: regulatory development, instrument
evolution, investor awareness
n Asset Allocation remains important; fundamental investment principles still hold
n Strategic Asset Allocation ≠ “buy & hold” or “set & forget”
> 70 Confidential

71. Disclosures - General advice warning
Connect with Vanguard® > www.vanguard.com.au > 1300 655 102
This presentation contains general information and is intended to assist you. We have not taken anybody's circumstances into
account so the information may not be applicable to your circumstances. Before making an investment decision, you should
consider your circumstances, whether the information is applicable your situation, and our Product Disclosure Statement (PDS) You
can access our PDS at www.vanguard.com.au or by calling 1300 655 102
Past performance is not an indication of future performance. Vanguard Investments Australia Ltd (ABN 72 072 881 086 / AFS
Licence 227263 / RSE Licence L0001335) (“Vanguard”) is the product issuer.
This publication was prepared in good faith and we accept no liability for any errors or omissions. We are the trustee of Vanguard®
Personal Superannuation Plan ABN 81 550 468 553.
‘Vanguard’, ‘Vanguard Investments’ and the ship logo are the trademarks of The Vanguard Group, Inc.
© 2011 Vanguard Investments Australia. All rights reserved.
> 71 Confidential

72. In summary

73. The Vanguard Group
“To be the world’s highest-value provider of investment products…”
n Global strength:
n In Australia:
n The Vanguard Group began 1975
n Retail Investors, Advisers &
n A pioneer in index management
Institutional Clients
n US$1.7 trillion under management*
n 23 Managed Funds
n ~44% of assets = actively managed
n 7 Exchange Traded Funds
n Mutually owned
n A$82 billion under management*
An unwavering focus on client value:
n Client first
As at March 2011
n Cost efficiency
> 73 Confidential

74. Vanguard professional biographies
Paul Chin, F Fin
Senior Investment Analyst
Investment Strategy & Research Group, Investments (Asia-Pacific)
Paul is responsible for providing investment thought-leadership and research for Vanguard Investments as a member of the global investment
research effort. He originally joined Vanguard to head the firm’s Research & Technical Services Group, overseeing the retail thought-leadership
agenda, researcher and platform relationships and delivering portfolio construction analytics for advisers.
Prior to joining Vanguard, Paul worked with Barclays Global Investors (now Blackrock) in San Francisco, USA for over 7 years, most recently as
principal, portfolio manager. In this money management role, he managed asset allocation, global macro and currency hedged strategies. Before
that, he worked with Advance FM (including fund manager incubator, Ascalon Capital Managers) and Colonial First State Investments in product
development and institutional client-facing roles across Australia and Asia-Pacific.
He has previously served as Director/Vice-President of the Australian-American Chamber of Commerce, played First Grade cricket in Victoria
and represented Barclays in the 2004/05 Global Challenge Round the World Yacht Race. Paul holds a Masters in Applied Finance & Investments
(Finsia) and a Bachelors of Commerce (Monash). He is a Fellow of the Financial Services Institute of Australasia, sits on the Finsia Regional
Council for Vic/Tas and occasionally lectures in the Asia-Pacific region in the areas of portfolio management, traditional and alternative
investments.
> 74 Confidential