1) The New Trust but Verify

2) Target Date Funds

1

March 9, 2010 Luncheon

Denotes Information you can useRight Now

(Find all 8)

2

Ron Surz, CIMA, MS, MBAPresident, PPCA IncPresident, Target Date Solutions(949)488-8339Ron@PPCA-Inc.com

GIPS committees:

Investment Performance CouncilAfter-Tax Investor/Consultant

About the Presenter

AgendaAgenda

The New Trust but VerifyBenchmarksStatistical SignificanceAttribution

Target Date FundsFiduciary ConsiderationsGlide Paths

3

ItIt’’s All About the Spins All About the Spin

“…each money manager has ready stories about other money managers with low alphas who snatched clients through clever marketing.”

- Professor Meir Statman

I have never met a money manager who has performed below median.

Every manager wins against the right benchmark.

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Winners and Losers:Winners and Losers:

1. What does this manager do?

2. Does he/she do it well?

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Use the right tools to addressUse the right tools to addressthe 2 central due diligence questions:the 2 central due diligence questions:

TruthsTruths

1. Custom benchmarks best define what a manager does.

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Evaluate Skill, NOT Style

We Have a WinnerWe Have a Winner

02468

10121416 14.4

11.7

Returns for Q1/03 to Q2/07 (4.5 Years)

LargeGrowth

Manager

Russell1000

Growth

7

Asset Allocation24-Month Moving Windows, Computed Monthly

Edgewood Mgmt: Growth Equity

0%

20%

40%

60%

80%

100%

Jun 2004 Mar 2005 Dec 2005 Sep 2006 Jun 2007

Citigroup 3-month T-billRussell Top 200 ValueRussell Top 200 GrowthRussell Midcap ValueRussell Midcap GrowthRussell 2000 ValueRussell 2000 Growth

Asset Allocation24-Month Moving Windows, Computed Monthly

Edgewood Mgmt: Growth Equity

0%

20%

40%

60%

80%

100%

Jun 2004 Mar 2005 Dec 2005 Sep 2006 Jun 2007

Citigroup 3-month T-billSurz US Large ValueSurz US Large GrowthSurz US Small ValueSurz US Small GrowthSurz US Large CoreSurz US Mid ValueSurz US Mid CoreSurz US Mid GrowthSurz US Small Core

Large Growth Large Growth

Small Growth

Russell

Russell and Surz agree manager is NOT Russell 1000 Growthbut disagree on Small Growth Exposure

g y24-Month Moving Windows, Computed Monthly

July 2002 - June 2007

rlgval rlggro

rmidval rmidgro

r2value r2growthSmall

-1

0

1

Large

Value -1 0 1 Growth

SULrgVal SULrgGro

SUMinVal SUMinGro

SULrgCor

SUMidVal SUMidCor SUMidGro

SUMinCorSmall

-1

0

1

arge

Value -1 0 1 Growth

LG Manager

Russell Surz

Russell 1000Growth

Russell 1000 Growth

Russell Surz

Mid

MidMid

Small

Core

LG Manager

8

What this manager does?What this manager does?

Mostly large cap growth, with mid cap growth and other styles added in.

9

Evaluate Skill not StyleEvaluate Skill not Style

0

5

10

15

20

14.411.7

1518.4

LG Manager Russell LCG CustomRussell MCG

Returns for Q1/03 to Q2/07 (4.5 Years)

*

* Custom Determined with Returns-Based Style Analysis10

TruthsTruths

2. Custom benchmarks best define what a manager does. Building blocks (indexes) matter a lot

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Dr. William F. SharpeDr. William F. Sharpe

“It is desirable that the selected asset classes be:

Mutually Exclusive (no class should overlap with another)

Exhaustive (all securities should fit in the set of asset classes) ”

Neither S&P nor Russell Indexes Meet These Criteria

“Determining a Fund’s Effective Asset Mix”, Investment Management Review, December, 1988, pages 59-69.

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Large Middle Small

Value

CoreCore

Growth

SurzSurz Style PureStyle Pure®® IndexesIndexesCore behaves differently than Value and GrowthCore behaves differently than Value and Growth

1986 1997 2010

Surz Morningstar

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2009 Style Quandary 2009 Style Quandary Demonstrates The Importance of :Demonstrates The Importance of :(1) Style Classification Characteristics (P/E (1) Style Classification Characteristics (P/E vsvs P/B), andP/B), and(2) Core, the stuff in between value & growth   (2) Core, the stuff in between value & growth   

21

15

21

3234

2624

0

5

10

15

20

25

30

35

40S&P500                           Russell 200                 Surz Large Cap

VALUE

GROWTH

VALUE

VALUE

GROWTH

GROWTH

CORE

14Forthcoming in the Journal of Investing: Becoming Style Conscious

Lens

The Year 2009The Year 2009

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History History

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AgendaAgenda

The New Trust but VerifyBenchmarks

Statistical SignificanceAttribution

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Winners and LosersWinners and Losers

What does this manager do?Custom Benchmark

Does he/she do it well?

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TruthsTruths

1. Custom benchmarks best define what a manager does. Building blocks (indexes) matter a lot

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2. Statistical significance can be achieved over short periods of time.

CFA Institute CFA Institute Benchmark Committee ReportBenchmark Committee Report

•Be wary of peer groupsClassification, composition & survivor biases

•Use custom benchmarks instead

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The Wait:The Wait:Number of Years to Achieve SignificanceNumber of Years to Achieve SignificanceRegardless of the Benchmark, It Takes Decades to Exhibit StatistRegardless of the Benchmark, It Takes Decades to Exhibit Statistical Significanceical Significance

0

20

40

60

80

100

120

140

160

A Little Skill Good Skill Great Skill

# of years = (1.35/IR)221

Test the Hypothesis “Performance is Good” using Virtual Peer Groups (VPGs): Transforms a Custom Benchmark into a “Peer Group”

Benchmark ConstructionRules

Simulator

PortfolioOpportunities

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Source: PPCA/Cainsoft, A Joint Software Development Venture

Pure Style Peer Groups for the Decade of the 2000s

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Style Quandary for the DecadeStyle Quandary for the Decade

S&P 500 Russell 3000 Surz Style Pure Value 1 3 7Growth -3 -3 -8Core 1

-10-8-6-4-202468

Ann

ualiz

ed R

etur

nsSurz Style Pure® Indexes are Rebalanced Quarterly

Lens

Winners and LosersWinners and Losers

What does this manager do?Custom Benchmark

Does he/she do it well?Hypothesis Test.

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AgendaAgenda

The New Trust but VerifyBenchmarksStatistical Significance

Attribution

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ItIt’’s all about the Futures all about the Future

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TruthsTruths

1. Custom benchmarks best define what a manager does. Building blocks (indexes) matter a lot

2. Statistical significance can be achieved over short periods of time.

3. Knowing why (attribution) is the key, but if the benchmark is wrong all of the analytics are wrong.

28

Attribution: Sources of ReturnAttribution: Sources of Return

Evaluate Skill: Not Style, Not Luck

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Custom AttributionCustom Attribution

Sample Fund

Fund Return

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Lg Growth

LgValue

Core

Sector Opportunities in 2009: S&P500 ranked against Total Market

Source: PPCA/Cainsoft, A Joint Software Development Venture 31

-4.57

Attribution for S&P in 2009Attribution for S&P in 2009

32Source: PPCA/Cainsoft, A Joint Software Development Venture

By Sector

By Style

INTEGRATE INTEGRATE

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Allocating (Indexes)to Skillful Managers (Benchmarks)

Coordination is the KeyCoordination is the KeyCORE is the LocksmithCORE is the Locksmith

1. Find Skill by Looking Everywhere, not Just Style Corners.

2. Allocate to Skill to Maintain Diversification (Optimize).

CORE

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The Folly of Common PracticeThe Folly of Common Practice

Common practice sometimes defies common sense.35

Everyone U

ses

Brand Index

es

& Peer Grou

ps

TruthsTruths

1) Custom benchmarks best define what a manager does. Building blocks (indexes) matter a lot

2) Statistical significance can be achieved over short periods of time. Hypothesis test using simulations.

3) Knowing why (attribution) is the key, but if the benchmark is wrong, all of the analytics are wrong.

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That’s Hard !!Every noble work is at first impossible.

- Thomas Carlyle

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You have to use theright tools for the job!

#One

AgendaAgenda

The New Trust but VerifyBenchmarksStatistical SignificanceAttribution

Target Date FundsFiduciary ConsiderationsGlide Paths

39

Fiduciary Best Practices inFiduciary Best Practices inTarget Date FundsTarget Date Funds

It’s All About the Beneficiaries

2008 Has Been a Safety Test2008 Has Been a Safety TestShould Investors be Better Protected?Should Investors be Better Protected?

‐40

‐35

‐30

‐25

‐20

‐15

‐10

‐5

0Current 2010 2020 2030 2040

One

Yea

r A

nnua

l Ret

urn

(S&P Return: -37%)

2010 Funds Are the Focus Of SEC & DoL HearingsAverage Equity Allocation 

= 45%

Fund companies assure all is OK

Who wins?Who wins?

Closed architecture using proprietary products

High equity allocation (high fees), especially near the target date

Most Most TDFsTDFs are are ““ThroughThrough”” FundsFundsand this is a BIG mistake and this is a BIG mistake

Designed to Miss Their Target Date on Purpose

Because They Target Death

The Purpose Cannot Be Served Because:

1. Retirees Exitthe Fund atTarget Date

AND

2. Longevity riskcannot be

managed with aGlidepath

Fiduciary ChoicesFiduciary ChoicesSee See ““Target Date FixTarget Date Fix””, 2/10 , 2/10 Financial Planning Financial Planning

1. Type of Qualified Default Investment Alternative (QDIA)

Target Date FundBalanced Fund

Managed Account

2. Type of Target Date Fund

To: Ends at target dateThrough: Continues beyond target date

3. Type of “To” Fund

Zero equities at target because it actually ends at target dateFlat equity exposure at target date and beyond because it’s a fake “To” fund

4. Glide Path of “To” fund that ends at zero equities

Financially engineered Safe Landing Glide Path™No model: simple equity reduction through time

RecordkeepersRecordkeepers Keep Records.Keep Records.Financial Engineers Design Safe Glide Paths.Financial Engineers Design Safe Glide Paths.

The “Capital Market Line.”Dr. William F. Sharpe won a Nobel Prize for it. Liability Driven Investing (LDI) guides the allocation along the line. It is the Safe Landing Glide Path™. The Risky Portfolio is

extremely well‐diversified:World Portfolio moves EfficientFrontier up & to the left. Dr. Harry Markowitz won the Nobel Prize for the EfficientFrontier.

The Reserve Asset protects against losses,both absolute & against inflation:TIPS and Treasury Bills 

60

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Glide Paths: Equity Allocations ofGlide Paths: Equity Allocations of““TOTO”” versus versus ““THROUGHTHROUGH””

SimilarRisk

S&P Target date index is an industry average of all target date funds.SLGP is our Safe Landing Glide Path™ – a “TO” Fund

Objective transitions from growth to preservation,with BIG difference near target date

Benefits of The Best Glide Path Benefits of The Best Glide Path

++

= Safe Landing Glide Path™+

The Proof of the PuddingThe Proof of the Pudding

48

BibliographyBibliography

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http://www.ppca‐inc.com/WhitePapers/white_papers.htm

http://www.ppca‐inc.com/Commentaries/Commentaries.htm

http://www.targetdatesolutions.com/fiduciary‐corner.html