About Passive Portfolio Management

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• About Passive Portfolio Management

11-06-98
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• Active Management vs.
• Passive Management
• Active Management
• The process of managing investment portfolios by
  attempting to time the market and/or select
  undervalued stocks to buy and overvalued
  stocks to sell based upon company research,
  investigation and analysis
• Passive Management
• The process of managing investment portfolios by
  trying to match the performance of an index or
  asset class of securities as closely as possible
  by holding all or a representative sample of the
  securities in the index or asset class
• Does not use market timing or stock selection
  strategies

03-10-03
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Investment Decision Matrix Where Do You Fit In?
1.
2.

• Market Timers and Stock Selectors
• Where the common crowd hangs out
• Preference of active management, high-cost
  gurus
• Heavy on investment hype

• Stock Selectors
• Preference of stockbrokers and many financial
  advisors
• High cost, high turnover, high taxes

3.
4.

• The Informed Investor
• Based on academic research and data
• As much as 40 of institutional invested dollars
• The prudent investors
• Receive market returns
• Where YOU should be (and where we are)

• Market Timers
• Tactical analysis (with no proven results)
• Tax inefficient
• Short-term outlook

Source Financial Planning Magazine, December
1997, page 110
01-25-00
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• Asset Class Investing
• Stocks and Bonds
• US and International
• Large Cap and Small Cap
• Growth and Value
• Short-Term and Long-Term Maturity

02-16-99
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• Why Use Passive Asset Class Investing?
• Lower portfolio turnover
• Lower operating expenses
• Lower transaction costs
• Greater tax-efficiency
• Long-term perspective
• Broad diversification/risk reduction
• Control of asset allocation
• Passive asset class funds capture separate
  dimensions
  of worldwide returns

07-22-99
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• The Four Major Tenets of Modern Portfolio Theory
• Markets process information so rapidly when
  determining security prices, that it is extremely
  difficult to gain a competitive edge by
  exploiting market anomalies.
• Over time, riskier assets provide higher expected
  returns as compensation to investors for
  accepting greater risk.
• Adding high risk, low-correlating asset classes
  to a portfolio can actually reduce volatility and
  increase expected rates of return.
• Passive asset class fund portfolios can be
  designed with the expectation of delivering over
  time the highest returns for a chosen level of
  risk.

03-31-99
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• Asset Class Selection
• Asset Class Selection is the most important
  determinant of portfolio performance

• Asset Class SelectionHow assets are allocated in
  a portfolio
• Market TimingShifting portfolio assets in and
  out of the market or between asset classes
• Security Selection Finding underpriced
  companies or industries

Market Timing 2
Asset Class Selection 94
Security Selection 4
The vast majority of a portfolios returns
variance is determined by asset class selection.
Only a small portion is determined by market
timing and security selection.
Source Study of 91 large pension plans over 10
year period. Gary P. Brinson, L. Randolph Hood
and Gilbert L. Beebower, Determinants of
Portfolio Performance, Financial Analysts
Journal, July-August 1986, pp. 39-44 and Gary
P. Brinson, Brian D. Singer and Gilbert L.
Beebower, Revisiting Determinants of Portfolio
Performance An Update, 1990, Working Paper.
Information from sources deemed reliable, but its
accuracy cannot be guaranteed.
02-17-99
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• The 5 Solution
• The Hurdles of Active Management
• 1 Operating Expenses1
• 1 Cost of Cash
• 1 Transaction Costs2
• 1 Market Impact Costs3
• 1 Taxes4
• 5 Hurdle of Active Management

1John Bogle, Common Sense on Mutual Funds, p.
206 2Charles Ellis, Winning the Losers Game 3New
York Times, July 11, 1999 4John Bogle, Common
Sense on Mutual Funds, p. 286
07-19-99
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• Distinct Asset Classes Provide Distinct Return
  Profiles

Small Cap ValueCombined risk
factors provide powerful premium
returns Large Cap Value Recognizable premium
return Small CapHigher risk, greater return
Large CapBumpy ride, but
wealth-creating (SP 500)
Long-Term BondsPoor risk/reward tradeoff
T-BillsNo growth after taxes and inflation
26,675
4,611
3,830
1,592
56.04
16.86
10.29 Inflation
Log Scale
Growth of 1
Source Dimensional Fund Advisors, Inc.
Performance is historical and does not guarantee
future results. Information from sources deemed
reliable and current, but its accuracy cannot be
guaranteed. See Sources and Descriptions of
Data at the end of this booklet.
03-06-03
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The Fallacy of Past Performance as A Predictor of
Future Performance

• Percentage of Lipper Funds Performing in the Top
  25 That Repeated in the Top 25 the Following
  Year

Source Lipper Analytical Services, Inc.Funds
included in the Lipper Growth Universe normally
invest in companies whose long-term earnings are
expected to grow significantly faster than the
earnings of the stocks represented in the major
unmanaged indices. Funds included in the Lipper
Small Universe limit their investments to
companies on the basis of the size of the
company. Performance is historical and does not
guarantee future results. Information derived
from sources deemed to be reliable, but its
accuracy cannot be guaranteed.
02-23-99
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• Even the Best Cant Win

• Companies (In alphabetical order)
• Allete
• Alltel Corp
• Bellsouth Corp
• Conectiv Inc
• Ethyl Corp
• Ingersoll-Rand Co
• Intl Flavors Fragrances
• Jefferson-Pilot Corp
• McGraw-Hill Companies
• Merck Co
• Nacco Industries
• NL Industries
• Northrop Grumman Corp
• Progress Energy Inc
• Sears Roebuck Co
• Snap-On Inc
• Sprint Corp
• SPS Technologies Inc

Annualized Returns (1987-2001)
Basic 60/40 is 60 SP 500 and 40 Lehman Bros.
Intermediate Government/Credit Bond
Index. Source FutureMetrics, LLC all companies
with fiscal year ending December, with complete
data from 1987-2001. / Dimensional Fund Advisors,
Inc.
Performance is historical and
does not guarantee future results. Information
from sources deemed reliable, but its accuracy
cannot be guaranteed.
03-04-03
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• Trend Toward Passive Asset Class Investing
• Restatement of the Prudent Investor Rule
• Constant flow of academic studies
• Trustees abandoning active for passive strategies
• Growth in passive fund investing
• Fifteen years ago, 1 billion invested in passive
  funds
• Today, over 2 trillion3 (as much as 40 of
  institutional funds)
• 37.6 of all net new money is being invested in
  index funds4
• Trend isnt greater because Wall Street doesnt
  want investors to know
• Major pension plans
• Intel fires all of their active money managers1
• Phillip Morris ends use of active managers for
  nearly 8 billion in pension plan assets due to
  poor and inconsistent performance2
• Exxon moves nearly all of 13.2 billion in
  retirement assets to indexing2

1Wall Street Journal, August 24, 1995. 2New York
Times, August 29, 1999. 3Pensions Investments,
September 6, 1999. 4Wall Street Journal, October
4, 1999.
10-28-99
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• Trend Toward
• Passive Asset Class Investing
• Indexing is a marvelous technique. I wasnt a
  true believer. I was just an ignoramus. Now I
  am a convert. Indexing is an extraordinary
  sophisticated thing to do. If people want
  excitement, they should go to the racetrack or
  play the lottery.
• Douglas Dial, Portfolio Manager of the
  CREF Stock Account Fund
• Few managers consistently outperform the SP
  500. Thus, in the eyes of the plan sponsor, it
  is paying an excessive amount of the upside to
  the manager while still bearing substantial risk
  that its investments will achieve sub-par
  returns. Slowly, many large pension funds have
  shared our experience and have moved toward
  indexing more domestic equity assets.1
• Goldman Sachs

1Philip Halpern, Financial Analysts Journal,
July/August 1996
04-08-99
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• Trend Toward Passive Asset Class Investing
• Peter Lynch Most investors would be better off
  in an index fund.1
• Warren Buffet Most investors, both
  institutional and individual, will find that the
  best way to own common stocks is through an index
  fund that charges minimal fees. Those following
  this path are sure to beat the net results (after
  expenses and fees) delivered by the great
  majority of investment professionals.2
• Jean Baptiste Colbert, Louis XIV Finance
  Minister The art of taxation consists in so
  plucking the goose as to obtain the largest
  possible amount of feathers with the least
  possible amount of hissing.
• Larry Swedroe The purveyors of active
  management want to keep plucking large fees from
  the pockets of individual investors with the
  least possible amount of hissing. To continue
  doing so, they must keep alive the myth that
  active management works.

1Barrons, April 2, 1990. 21997 annual letter to
shareholders of Berkshire Hathaway.
04-08-99
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• If Markets Are So Efficient, How Do Lynch and
  Buffett Succeed?
• With tens of thousands of professional managers
  trying to beat the market, why dont more
  succeed?
• If the market were truly inefficient, there would
  be far more Lynches and Buffetts than actually
  exist
• In fact, far fewer succeed than randomly expected
• Even before expenses, performance by active
  managers is no better than randomly expected
• Twenty years from now, there will be a new Lynch
  and new Buffett. The problem is we cant identify
  today who they will be

10-20-98
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Sources and Descriptions of Data
Company logo or name here
01-27-03
Sources and Descriptions of Data supplied by
Dimensional Fund Advisors, Inc.
Information from sources deemed reliable but its
accuracy cannot be guaranteed.
17
Sources and Descriptions of Data
Company logo or name here
01-27-03
Sources and Descriptions of Data supplied by
Dimensional Fund Advisors, Inc.
Information from sources deemed reliable but its
accuracy cannot be guaranteed.