Presenter: David McGruer CFP

Financial Planner, Dundee Private Investors Inc.

October 2006 Client Education Night

Portfolio Building For Growth And Stability

Agenda: Portfolio building using the lessons of the past decade

Math basics of portfolio construction

The world market index as a benchmark

Selecting money managers

Typical portfolio construction

Constructing a portfolio for growth and stability - some ways in which I differ from the standard approach

Before portfolio: start at the beginning

• Your goal: Time horizon, usually more than a few years is

considered long term Dave: consider life expectancy for long term goals

Rate of return required or desired Ability to handle uncertain results

Why diversify?

Reduce the systematic risk of being in an investment asset class such as stocks, bonds, etc.

The variability inherent in a type of asset

Increase portfolio reliability, consistency

How to diversify: portfolio efficiency

Constructing a portfolio so as to obtain the maximum return for a given level of variability

Efficient market hypothesis (with flaws)

Modern portfolio theory - MPT (with flaws)

Efficient frontier based on MPT

Typically selects 7-10 narrower asset classes and combines them “efficiently”

Classic efficient frontier curveLooks to past and combines assets with less than perfect correlation to optimize portfolio mix

Typically includes lower returning assets in order to reduce risk. Thus: stability with a price, sometimes steep.

Source: Institute of chartered accountants of BC, Feb 2006

Measuring diversity

Overlap analysis of investment holdings

Correlation analysis - a correlation of 1 means they always move together. A low correlation between assets is desirable.

Reliability of the correlation is important, most often ignored

They say diversification is the “free lunch” of investing, but it depends on how you diversify

Portfolio uncertaintyVariability of returns

Frequency of negative returns

Standard deviation of returns

usually based on 36 monthly data points (3 years)

2/3 of results fall within 1 S.D. of mean, 95% within 2 S.D.

Low number desirable

Should be, is not usually goal-time sensitive

Dave’s modification: annual returns instead of monthly

Advanced risk measures combine data

Risk ratios such as Sharpe ratiohow much extra return (over the “risk-free” return of treasury bills) is provided when you take on a higher variability? A higher number indicates better reward for a given level of variability

The efficient portfolio spectrum

Typically five portfolios varying by equity/fixed income weights

Typical efficient portfolio

Top one is for you

Bottom one is for people 100km south of here, has essentially zero Canadian content

LifePoints® Long-Term Growth Portfolio

Dave’s objective: build an efficient equity portfolio with minimal funds

Market and fund data sources: Globefund.com and mutual fund companies

To be used for long term goals

First consider the global market index (MSCI World) as a benchmark

Add first fund with all possible desirable criteria

Add second and third, looking for meaningful added return and/or consistency

Calculate portfolio effect of combining three

Review the MSCI World equity indexStart in 1994, inception of youngest of 3 funds in the model

Index has range of +31.2% to -19.6%

Average index return of 7.1%

Standard deviation of annual returns is 14.2%, same as monthly S.D. over the same period

Two thirds of returns fall between -7.1% and +21.3%

95% would fall between -21.3% and +35.5%

World IndexCalendar Year Index $10,000

1994 11.6% $11,1601995 17.9% $13,1581996 13.6% $14,9471997 19.9% $17,9221998 31.2% $23,5131999 19.1% $28,0042000 -10.6% $25,0362001 -10.7% $22,3572002 -19.6% $17,9752003 10.2% $19,8082004 7.8% $21,3532005 7.9% $23,040

2006 YTD 30/9 4.7% $24,11920072008

Standard Deviation 14.2%Compound annual return 7.1%Information RatioSharpe Ratio 0.22

Do we choose active or passive management?

There are funds which mimic the index returns even after accounting for fund management expenses: they do earn their keep but do not add value to the market results

Earning more than their keep: value added

There are two ways an active manager can propose to add value to their fund

Increase the performance, which may come with the price of higher volatility

Increase stability, which may come with the price of lower returns

Some managers have done bothAdded performance along with lower volatility

They could say they increase performance by avoiding needless risks

Selecting an active money manager1. Do you invest in businesses? (equities)

2. Do you have a very wide scope? (global)

3. Are you likely to stay put? (vested interest)

4. Do you work within a solid fund company?

5. Do you have a clear investment philosophy?

6. How have you used your philosophy to do well over the long term, especially in down markets?

7. Do you diversify the portfolio?

8. What are the expected tax implications?

9. Can you stand as a sole portfolio holding?

10. Are you on Dundee’s recommended list?

Start with one fund that adds value

Better than index performance, 1.6% higher

SD=5.9%, less than half index volatility=14.2%

Very good downside management in 2000-2002!

WorldCalendar Year Trimark Index

1994 13.5% 11.6%1995 14.2% 17.9%1996 14.0% 13.6%1997 12.6% 19.9%1998 5.2% 31.2%1999 16.0% 19.1%2000 10.7% -10.6%2001 9.9% -10.7%2002 -6.5% -19.6%2003 7.0% 10.2%2004 5.3% 7.8%2005 2.6% 7.9%

2006 YTD 30/9 8.6% 4.7%20072008

Standard Deviation 5.9% 14.2%Compound annual return 8.7% 7.1%Information RatioSharpe Ratio 0.8 0.22

Selecting the second and subsequent money manager

In the classic model, low correlation to the first is the criterion

Dave’s added criterion for long term portfolios: added fund is expected to have a return similar to the first, does not lower the expected return

Diversifying within equities

Don’t sacrifice returns to obtain stability, seek low correlating but similar assets, each of which is already diverse and stable

Correlations rise as you add more funds

Add a second and similar fund which has a low correlation to the first

Return increased by 0.9%,

But standard deviation increased by 2.7%

Both managers added value by performance

0.53 correlation between managers

Both handled down market better than index

Only two negative years

Cundill & WorldCalendar Year Cundill Trimark Trimark Index

1994 15.4% 13.5% 14.4% 11.6%1995 8.2% 14.2% 11.2% 17.9%1996 10.8% 14.0% 12.4% 13.6%1997 3.5% 12.6% 8.2% 19.9%1998 -10.7% 5.2% -2.1% 31.2%1999 33.4% 16.0% 23.3% 19.1%2000 20.4% 10.7% 15.1% -10.6%2001 13.1% 9.9% 11.4% -10.7%2002 -13.8% -6.5% -10.1% -19.6%2003 35.2% 7.0% 20.1% 10.2%2004 12.4% 5.3% 9.0% 7.8%2005 12.1% 2.6% 7.7% 7.9%

2006 YTD 30/9 3.8% 8.6% 5.9% 4.7%20072008

Standard Deviation 13.6% 5.9% 8.6% 14.2%

Comp. annual return 10.4% 8.7% 9.6% 7.1%Information RatioSharpe Ratio 0.5 0.8 0.22

Add a third fund which has low or medium correlation to the first two

Is there really much left to do after that?

You own about 100 companies from all over the world

You have three excellent managers, three fund companies working for you

Diversification without di-worsification

Review of three funds meeting selection criteria

Calendar Year Cundill Rank Trimark Rank AGFEur Rank1994 15.4% 1 13.5% 2 6.0% 31995 8.2% 3 14.2% 1 10.1% 21996 10.8% 3 14.0% 2 17.7% 11997 3.5% 3 12.6% 2 27.3% 11998 -10.7% 3 5.2% 2 32.9% 11999 33.4% 1 16.0% 2 0.9% 32000 20.4% 1 10.7% 2 12.4% 32001 13.1% 1 9.9% 2 0.2% 32002 -13.8% 3 -6.5% 1 -7.8% 22003 35.2% 1 7.0% 3 21.6% 22004 12.4% 2 5.3% 3 12.5% 12005 12.1% 1 2.6% 3 10.0% 2

2006 YTD 30/9 3.8% 3 8.6% 2 23.2% 120072008

Standard Deviation 13.6% 5.9% 11.1%Compound annual return 10.4% 8.7% 12.5%Information RatioSharpe Ratio 0.5 0.8 0.8

Still a wide range of +33.4 to -13.8%

Good to much better overall performance than index

Slightly lower to much lower standard deviations

Correlations: Cund/AGF = 0.42 Trim/Cund = 0.53 Trim/AGF = 0.74

Consider the combination of the three funds

Higher returns than index and two of three funds

S.D. close to most stable fund, 91% of returns from +7.7% to +21.3%

Sharpe ratio better than all three funds, much higher than index

Portfolio Portfolio World IndexCalendar Year Cundill Rank Trimark Rank AGFEur Rank Avg. $10,000 Index $10,000

1994 15.4% 1 13.5% 2 6.0% 3 11.6% $11,162 11.6% $11,1601995 8.2% 3 14.2% 1 10.1% 2 10.8% $12,373 17.9% $13,1581996 10.8% 3 14.0% 2 17.7% 1 14.2% $14,126 13.6% $14,9471997 3.5% 3 12.6% 2 27.3% 1 14.5% $16,171 19.9% $17,9221998 -10.7% 3 5.2% 2 32.9% 1 9.1% $17,648 31.2% $23,5131999 33.4% 1 16.0% 2 0.9% 3 16.8% $20,607 19.1% $28,0042000 20.4% 1 10.7% 2 12.4% 3 14.5% $23,594 -10.6% $25,0362001 13.1% 1 9.9% 2 0.2% 3 7.7% $25,415 -10.7% $22,3572002 -13.8% 3 -6.5% 1 -7.8% 2 -9.4% $23,032 -19.6% $17,9752003 35.2% 1 7.0% 3 21.6% 2 21.3% $27,931 10.2% $19,8082004 12.4% 2 5.3% 3 12.5% 1 10.1% $30,744 7.8% $21,3532005 12.1% 1 2.6% 3 10.0% 2 8.2% $33,276 7.9% $23,040

2006 YTD 30/9 3.8% 3 8.6% 2 23.2% 1 11.9% $37,222 4.7% $24,11920072008

Standard Deviation 13.6% 5.9% 11.1% 6.9% 14.2%Compound annual return10.4% 8.7% 12.5% 10.9% 7.1%Information Ratio 0.32Sharpe Ratio 0.5 0.8 0.8 1.00 0.22

Consistent performance wins out over index

Portfolio value over timeStarting with $10,000 in January 1994

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Market Value

Model MSCI World

Limitations of this approach

Long cycles may suggest persistence of results when they may in fact change (same problem with traditional models

Correlations are a moving target

Manager-specific results means you need to monitor the managers, versus market mimicking allocation where manager is irrelevant

Conclusions

Can build simple, more efficient portfolios using reason, statistics and portfolio theory

Traditional models select 7-10 narrower asset classes and combine them efficiently

A different approach: select value added managers with already broad mandates and combine them efficiently

Can seek value-added managers instead of relying on market data

Reduce portfolio volatility, increase consistency of results

Fewer funds, simpler, each one stands alone

Rebalancing may not be required to stay on track (added only 0.22% to the annual return of the three equity fund model), might equally take away from performance

Action steps

Review your portfolio with your advisorDoes the portfolio still match your goals?

Assess the value-added of fund managers after lesson of the hard bear market 2000-2002

Level of diversification?

Can it be more efficient?

May elect to make a shift over time rather than a sudden change

Recent reading

Question and answer period

Door prize draw

Mackenzie branded items

Senators Tickets