During the last several weeks, world equity markets have coupled and, in general, have moved downwards. Although the magnitude of decline is well within the expected probability distribution of stock prices, nevertheless, some investors may become disconcerted because of a natural human tendency to extrapolate current events into an indefinite future.

One of the basic principles of investing is that the future return on a portfolio of risky assets is a random variable – i.e., not knowable. Over many long planning horizons, under some simplifying assumptions, actual portfolio return converges towards a number that is greater than the risk-free rate available through U.S. Treasuries or bank CDs. Likewise, over a single life’s long-term planning horizon, it is also reasonable to expect that a portfolio of risky assets will outperform a risk-free investment.

Patrick Collins, Ph.D, CLU, CFA has released a working paper on the topic of Multifactor Asset Pricing Models and the Rationale for Investing in Value Stocks.

This article summarizes academic research into multifactor asset pricing models, with specific emphasis on growth and value stocks. The article notes that empirical studies observe that value stocks typically generate superior risk-adjusted returns relative to growth stocks, and addresses implications for the Efficient Market Hypothesis if value stocks, in fact, represent an improperly priced risk factor.

Patrick Collins, Ph.D, CLU, CFA has released a working paper on the topic of The Decision to Replace Trust Owned Life Insurance Policies. Reprinted from the November / December 2005 issue of The Banking Law Journal

There may be many valid reasons to consider life insurance policy replacement. However, the focus in this article is on replacing an existing life insurance contract with a new contract that provides superior financial results. The trustee takes replacement action based on the expectation that the new policy offers a financial instrument better suited to the terms, purposes, distribution requirements, and other circumstances of the trust — a prudent decision-making process. It also addresses the quantitative nature of the analysis (and difficulties therein) and provides an approach which allows the trustee to demonstrate the requisite levels of care, skill, and caution.

Patrick Collins, Ph.D, CLU, CFA, and Josh Stampfli MS (EESOR), have released a working paper on the topic of portfolio rebalancing. The paper begins with an overview of the surprisingly extensive research on the topic, including a survey of various rebalancing strategies and results from several empirical and mathematical studies. The authors go on to explain exactly how portfolio rebalancing can either enhance returns, control risk, or both. In the process they touch on issues both practical, such as taxes, and cerebral, as in Utility Theory. To gain further insight into the economic consequences of rebalance elections, Collins & Stampfli developed a simulation model with which they test nine different rebalance strategies under both portfolio accumulation and decumulation conditions. The results are instructive.

In the second quarter edition of Investment Quarterly we focus on two critical questions investors face when planning for financial security in retirement:

• What level of monthly income can be systematically withdrawn from the retirement portfolio, without incurring too great a risk of depleting the portfolio completely?

• How should the portfolio be invested?

Our lead article explains the challenges investors face in answering these questions and describes an advanced form of analysis that yields particularly insightful results.

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As a companion to our article “Planning for Retirement Income”, the second quarter edition of Investment Quarterly offers a piece on inflation indexed bonds (TIPS). The structure of TIPS makes them a potentially useful asset for producing retirement income, but much depends on the investor’s specific goals and objectives.

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From Balancing Act, by Donald Jay Korn, September 2003 Financial Planning magazine.

“A total return trust operates without the safety net of enforced conservatism,” notes Patrick Collins, a financial analyst in San Francisco who has written extensively about such trusts. “Therefore, it is vital to shape carefully the language of distribution provisions, lest the corpus run out of money prior to the end of the planning horizon. Distribution provisions both reflect and govern reasonable spending expectations, which in turn provide the targeted return for asset allocation and asset management decisions. Grantors and beneficiaries must determine a suitable balance between growth expectations [reward], failure rates [distributions below an acceptable dollar amount], and bankruptcy risk [portfolio value approaching zero].”

Monitoring Passively Managed Mutual Funds
Patrick J. Collins, CFA
Journal of Investing
vol. 8, no. 4 (Winter 1999) pages 49 to 61

Summarized by Roger Ignatius, CFA

The author notes that passively managed structured-asset-class funds are not indexes. They require ongoing monitoring and review. He analyzes an equity index mutual fund and a structured-asset-class equity mutual fund and finds that compared with the index fund, the structured fund has a larger tracking error and shows evidence of providing added value.

CFA Institute members can download Fiduciary Duty to Monitor and Review Passively Managed Mutual Funds