mer for optimum allocation accross investment alternatives...

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A Two Stage Marginal Efficiency of Investment(MEI) and Marginal Efficiency of Return (MER) Analysis to maximize the selection of an Optimum Investment Portfolio that will beat the S&P 500.A Two Stage Marginal Efficiency of Investment(MEI) and Marginal Efficiency of Return (MER) Analysis to maximize the selection of an Optimum Investment Portfolio that will beat the S&P 500.

Show me The Money!Show me The Money!How to Optimize your Portfolio to beat How to Optimize your Portfolio to beat

the S&P 500the S&P 500

Prepared by

Gary CrosbieJune 2016June 2016

Part-2

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1 1 - - Abstract Abstract ……………………………………………………………………………………………………………………………………….. ..……………………………………………………………………………………………………………………………………….. ..3322- Preface- Preface ……………………………………………………………. ……………………………………………………………. 1313

3-3- Analytic Methodology Analytic Methodology …………………………………………………… 1717

- Proposition 1Proposition 1- - MEI- HOW do you select Best MEI- HOW do you select Best - LC/MC/SC investmentsLC/MC/SC investments

- Proposition 2Proposition 2- MER- How do we allocate our - MER- How do we allocate our Equity percentage of the portfolio across LC/MC/SC. Equity percentage of the portfolio across LC/MC/SC. (e,g, If your risk preference allocation is 70% Equity vs (e,g, If your risk preference allocation is 70% Equity vs 30% Fixed Income , how do you allocate the 70%.)30% Fixed Income , how do you allocate the 70%.)

- Proposition 3Proposition 3-- Comparative Analysis - Compare a Comparative Analysis - Compare a portfolio built by 1 & 2 above with a Base Portfolio of portfolio built by 1 & 2 above with a Base Portfolio of

an S&P 500 Index and Bond Index Fundan S&P 500 Index and Bond Index Fund

Table of ContentsTable of Contents

4 -Analytic Results4 -Analytic Results……………………………….. ……………………………….. 2626

– Proposition - 1 -Proposition - 1 -What are the BEST LC/MC/SC fundsWhat are the BEST LC/MC/SC funds– Proposition –Proposition – 2 - W2 - What is the optimum allocation across LC/MC/SChat is the optimum allocation across LC/MC/SC– Proposition – 3 - Proposition – 3 - How does the optimum portfolio calculated from How does the optimum portfolio calculated from

proposition 1 and 2 compare with a Base Index portfolioproposition 1 and 2 compare with a Base Index portfolio Relative to Relative to

1- Percentage MER difference vs a benchmark Portfolio1- Percentage MER difference vs a benchmark Portfolio 2- MER per unit of risk vs the benchmark portfolio2- MER per unit of risk vs the benchmark portfolio

5.5. – – Recommendations & Comments Recommendations & Comments ......... ......... 5858- Proposition -1Proposition -1- Proposition -2Proposition -2

- Proposition -3- Proposition -3

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Table of ContentsTable of Contents

This paper enhances the previous work done completed in Nov 2013 This paper enhances the previous work done completed in Nov 2013 on he optimum portfolio selection process(attached) by evaluating on he optimum portfolio selection process(attached) by evaluating three propositionsthree propositions::

Proposition 1 -Proposition 1 - Marginal Efficiency of Investment- MEIMarginal Efficiency of Investment- MEI– Identify the model portfolio that contains the optimum LC, MC, SC ,Fixed Income Identify the model portfolio that contains the optimum LC, MC, SC ,Fixed Income

investments . investments . Proposition 2 Proposition 2 - - Marginal Efficiency of Revenue-(MER) Marginal Efficiency of Revenue-(MER)

– Given the identification of the optimum specific Investments (LC,MC,SC) in Given the identification of the optimum specific Investments (LC,MC,SC) in Proposition 1..How do you decide on the optimum allocation of your Investment Proposition 1..How do you decide on the optimum allocation of your Investment dollars across those equity selections(LC,MC,SC) e.g. You have decided based on dollars across those equity selections(LC,MC,SC) e.g. You have decided based on your risk tolerance an Investment allocation of 60% Equities and 40% Fixed Income your risk tolerance an Investment allocation of 60% Equities and 40% Fixed Income (Bonds). How do you decide how to allocate the optimum equity selections derived (Bonds). How do you decide how to allocate the optimum equity selections derived in Proposition 1- across the 60 % of your total equity in Proposition 1- across the 60 % of your total equity calculationcalculation

Proposition 3 Proposition 3 - - Comparative Analysis Comparative Analysis – From Proposition 1&2 above we now have an optimum portfolio that we can compare and

contrast with the baseline portfolio containing the S&P 500 And a Bond Index fund(LAG)

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Abstract:Abstract:

Proposition 1 Proposition 1 -- Marginal Efficiency of Investment- MEI-Marginal Efficiency of Investment- MEI- SEE Ghant Chart- Proposition-1SEE Ghant Chart- Proposition-1

– Identify the model portfolio that contains the optimum LC, MC, SC ,Fixed Income investments . Identify the model portfolio that contains the optimum LC, MC, SC ,Fixed Income investments . – The optimum Portfolio is:The optimum Portfolio is:

Proposition 2 Proposition 2 - - Marginal Efficiency of Revenue-(MER) – Marginal Efficiency of Revenue-(MER) – SSEE Ghant Chart- Proposition-2EE Ghant Chart- Proposition-2

– The optimum allocation across the total equity preference wasThe optimum allocation across the total equity preference was LC= 42%LC= 42% MC=44%MC=44% SC= 14%SC= 14%

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Abstract:Abstract:

StyleStyle InvestmentInvestment

PowerPowerCoefficienCoefficien

tt Comparative IndexComparative IndexLarge

CapVanguard Dividend Growth-VDGFX

6.18 Vanguard Equity Income=VFINX

Mid Cap American Century Value- ACMVX


Small Cap

Fidelity Small Cap Value-FCPVXX


Fixed Income

Metropolitan West Total Return-MWTRX

5.1 SPDR Bond Index-LAG

60% Equity 40% Fixed Income – The allocation WITHIN the 60% equity=60% Equity 40% Fixed Income – The allocation WITHIN the 60% equity=– 42% * 60%= 25%42% * 60%= 25%– 44%* 60%= 26%44%* 60%= 26%– 14%* 60% = 9%14%* 60% = 9%

TOTAL = 60% TOTAL = 60% 50% Equity 50% Fixed Income – The allocation WITHIN the 50% equity=50% Equity 50% Fixed Income – The allocation WITHIN the 50% equity=

– 42% * 50%= 21%42% * 50%= 21%– 44% * 50%= 22%44% * 50%= 22%– 14% * 50% = 7 %14% * 50% = 7 %

TOTAL = 50%TOTAL = 50%

See Exhibit 9….For the above results summarizedSee Exhibit 9….For the above results summarized The percentages calculated above are summarized in Column 1, 2,3 The percentages calculated above are summarized in Column 1, 2,3 The results yield the Dollars greater than the S&P 500 for each % splitThe results yield the Dollars greater than the S&P 500 for each % split

66

Abstract:Abstract:Proposition 2 - Marginal Efficiency of Revenue-(MER) – (Con)SEE Ghant Chart – Proposition-2

Thus: The % equity split for different Equity to fixed Income allocations 70%/30%, 60%/40% and 50%/50% are

• 70% Equity 30% Fixed Income – The allocation WITHIN the 70% equity=

- 42% * 70%= 29%- 44%* 70%= 31%- 14%* 70% = 10% TOTAL = 70%

Proposition 3 Proposition 3 - - Comparative Analysis Comparative Analysis – – See Ghant Chart - Proposition-3 and Exhibit ‘s 10-11-12See Ghant Chart - Proposition-3 and Exhibit ‘s 10-11-12

– From Proposition 1&2 above we now have an optimum portfolio that we can compare and contrast with the baseline portfolio containing the S&P 500 And a Bond Index fund(LAG)

– The following Portfolio ‘s will be analyzed via Monte Carlo simulations to determine investor The following Portfolio ‘s will be analyzed via Monte Carlo simulations to determine investor value/risk vs returnvalue/risk vs return

– 1-Comparatives Economics of Alternative Equity/Debt 1-Comparatives Economics of Alternative Equity/Debt Allocations:Allocations: ToTotal of: % Large Caps + %Midcaps +%Small Caps + %Fixed Income = $1.00tal of: % Large Caps + %Midcaps +%Small Caps + %Fixed Income = $1.00 Total Of S&P 500 baseline =% VFINX(S&P 500 Benchmark) + %LAG(Bond Benchmark)= $1.00Total Of S&P 500 baseline =% VFINX(S&P 500 Benchmark) + %LAG(Bond Benchmark)= $1.00

– 2-70% Equity vs 30% Debt – SEE Ghant Chart & Exhibit-102-70% Equity vs 30% Debt – SEE Ghant Chart & Exhibit-10 Equity AllocationEquity Allocation

– 29% Vanguard Dividend Growth- VDGIF29% Vanguard Dividend Growth- VDGIF– 31% American Century Mid cap Value- ACMVX31% American Century Mid cap Value- ACMVX– 10% Fidelity Small Cap Value- FCPVX10% Fidelity Small Cap Value- FCPVX

Fixed Income(Bond) allocationFixed Income(Bond) allocation– 30% Metropolitan West Total Return- MWTRX30% Metropolitan West Total Return- MWTRX

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Abstract:Abstract:

Results: There is a 59% probability the 70/30 % diversified Portfolio > the S&P 500 and a 30% > $ per unit of risk.

– 3-60% Equity vs 40% Debt – See Ghant Chart & Exhibit -113-60% Equity vs 40% Debt – See Ghant Chart & Exhibit -11 Equity AllocationEquity Allocation



88

Abstract:Abstract:Proposition 3 - Comparative Analysis –

(Con)


- 4-50% Equity vs 50% Debt- See Ghant Chart & Exhibit 12 - Equity Allocation

- 21% Vanguard Dividend Growth- VDGIF - 22% American Century Mid cap Value- ACMVX - 7% Fidelity Small Cap Value- FCPVX

- Fixed Income(Bond) allocation50% Metropolitan West Total Return- MWTRX


The ALPHA’s for the recommended portfolio have high The ALPHA’s for the recommended portfolio have high multiples( 2.7 to 7.2) compared to the S&P 500multiples( 2.7 to 7.2) compared to the S&P 500

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Abstract:Abstract:

lc

MEI/MER Ghant Chart

How to Select Optimum Investments

Select Highest Power Coefficient- See Exhibit -1

Small CapLarge Cap

Mid Cap Small Cap

MEI Power CoeffIcient Calc Algorithum- Page

Morningstar Data base Pull LC, MC SC Funds from Morningstar Data Base

Power Coef = a(1Gr)+b(3 Gr)+c(5 GR) x α (d*Є )+(e* β)+ (F*σ)

Calculate Marginal Efficiency of Investment……MEI

Proposition-1

Vanguard Dividend Growth -VDGFX

American Century Mid Cap Value-ACMVX

Fidelity Small Cap Value-FCPVX

Metropolitan West Total Return-MWTRX

Β= Beta for the investment indicating Β= Beta for the investment indicating correlation over time with the general correlation over time with the general marketmarket

σ = Standard Deviationσ = Standard Deviation α= Measure of performance relative α= Measure of performance relative

to index of equivalent investments. to index of equivalent investments.

Fixed Income

11111111

Proposition-2: Derive the Optimum % allocation across Styles(LC,MC,SC)-MER

Monte Carlo Simulations

Calculate Asset Allocation of Equities –LC,MC,SC

MER Power Coef per unit of Risk (LC, MC, SC) = (W*X * Y*) Z

W= From the Monte Carlo Simulation for each style. The Probability that particular style(LC,MC,SC) exceeds the S&P 500. x= Mean MEI Power Coefficient for LC, MC, SCY= Dollars > S&P 500- 10 year revenue Growth > S&P 500Z= Standard Deviation – A measure of Risk for Each LC, MC, SC simulation

MER Algorithum

Vanguard Dividend Growth VDGFX

American Century Mid Cap Value-ACMVX Fidelity Small Cap Value-FCPVX

Fidelity Small Cap Value-FCPVXVanguard Dividend Growth VDGFX

American Century Mid Cap Value-ACMVX

MER Power Coef (LC, MC, SC) = (W*X * Y*) Z

MER Power Coef (LC, MC, SC) = (W*X * Y*) Z

44%-ACMVX

MEI/MER Ghant ChartProposition-2- % Equity Allocation

FCPVX%

Use MER to Calculate % Equities Allocation

42%- VDGFX 1-What is the Optimum EQUITY Allocations-See Exhibit-6


70/30% - Equity /Bond Allocation

70% S&P-VFINX

70/30% S&P 500 /LAG Bond

30% LAG Bond

Equity Fixed Income Fixed IncomeEquity

The Mean of the 70/30% Optimum Equity Allocation is $5.26 which is 16% greater than the S&P allocated portfolio of $4.55. The probability is 59% that the 70/30% Optimum equity allocation will exceed the S&P 500 mean. Further, the 70/30% allocation yield a 30% better Return per unit of risk than the benchmark S&P 500 portfolio


31% ACMVX

29%-VDGFX

10%-FCPVX 30%-MWTRX

Proposition-3- Compare the Optimum Portfolio Allocations with an S&P 500 Portfolio

Large Cap Mid Cap Small Cap

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Compare the Optimum Portfolio Allocations with an S&P 500 Portfolio

50/50% - Equity /BondAllocation 50/50% S&P 500 /LAG Bond

Equity Fixed Income Fixed IncomeEquity

Proposition-3


Proposition-3 Results

MEI/MER Ghant Chart

The Mean of the 50/50% Optimum Equity Allocation is $4.88 which is 3.3% greater than the S&P allocated portfolio of $4.72. The probability is 53% that the 70/30% Optimum equity allocation will exceed the S&P 500 mean. Further, the 50/50% allocation yield a 6% better Return per unit of risk than the benchmark S&P 500 portfolio

22%21% 7% 50% 50% LAG Bond 50% S&P-VFINX


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This Section Defines the Issues:This Section Defines the Issues: Propositions of Interest: Propositions of Interest: Is there a methodology that allows the Investor to beat the S&P 500 ? There are three Is there a methodology that allows the Investor to beat the S&P 500 ? There are three

propositions of significance in the investment community:propositions of significance in the investment community:

– Proposition 1-Proposition 1- Marginal Efficiency of Investment- MEMarginal Efficiency of Investment- MEII Identify the model portfolio that contains the optimum LC, MC, SC ,Fixed Income Identify the model portfolio that contains the optimum LC, MC, SC ,Fixed Income

investments . investments . Given previous research completed in 2011, that Midcaps(vs large Caps and Small Given previous research completed in 2011, that Midcaps(vs large Caps and Small

Caps) have the best value per unit of risk , does the results from the periods following Caps) have the best value per unit of risk , does the results from the periods following the financial crisis (2007- 2012) continue to support those results. the financial crisis (2007- 2012) continue to support those results. That analysis was That analysis was completed in 2014 and is included as an attachment For your review and informationcompleted in 2014 and is included as an attachment For your review and information. .

In 2016In 2016…..The process from that analysis has been used to …..The process from that analysis has been used to UPDATEUPDATE the selection of the selection of the Optimum Equites by style(LC,MC,SC, Fixed Income) and serves as the foundation the Optimum Equites by style(LC,MC,SC, Fixed Income) and serves as the foundation for the followingfor the following

..

Section-1- Preface:Section-1- Preface:

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Section-1- Section-1- Preface:Preface:Proposition 2Proposition 2- - Marginal Efficiency of Revenue-(MER) Marginal Efficiency of Revenue-(MER)

– Given the identification of the optimum specific Investments (LC,MC,SC) in Proposition Given the identification of the optimum specific Investments (LC,MC,SC) in Proposition 1..How do you decide on the optimum allocation of your Investment dollars across 1..How do you decide on the optimum allocation of your Investment dollars across those equity selections(LC,MC,SC) e.g. You have decided based on your risk tolerance those equity selections(LC,MC,SC) e.g. You have decided based on your risk tolerance an Investment allocation of 60% Equities and 40% Fixed Income (Bonds). How do you an Investment allocation of 60% Equities and 40% Fixed Income (Bonds). How do you decide how to allocate the optimum equity selections derived in Proposition 1- across decide how to allocate the optimum equity selections derived in Proposition 1- across the 60 % of your total equity calculationthe 60 % of your total equity calculation. .

– The previous analysis done in 2014 (Attached) allocated percentages across investment types by a weighted Power Coefficient approach.oach.

– This analysis investigates a weighting based on Marginal return(10 year revenue growth diff from S&P) on investment vs the S&P 500. Is there an Optimum alternative Is there an Optimum alternative investment process (allocation /Mix of Investments in Large Cap, Midcap , Small Cap investment process (allocation /Mix of Investments in Large Cap, Midcap , Small Cap and Fixed Income Styles) that maximizes the marginal return of Revenue per unit of and Fixed Income Styles) that maximizes the marginal return of Revenue per unit of risk .risk .

– A-Style(LC vs MC vs SC): A-Style(LC vs MC vs SC): The previous analysis used The previous analysis used Monte Carlo Simulations based on power Coefficients for Monte Carlo Simulations based on power Coefficients for each style . This analysis adds to that result by adding each style . This analysis adds to that result by adding another variable…10 yr Revenue performance to fine another variable…10 yr Revenue performance to fine tune this result.tune this result.

– B- Asset Allocation across styleB- Asset Allocation across style. . Maximize the allocation Maximize the allocation based on Revenue per Unit of Risk across equity based on Revenue per Unit of Risk across equity styles(e.g. 35% LC, 45% Midcap, 20% SC) that provide styles(e.g. 35% LC, 45% Midcap, 20% SC) that provide better results than simply a weighted average of the MEI better results than simply a weighted average of the MEI power coefficients (Used in the previous analysis)power coefficients (Used in the previous analysis)

– This analysis This analysis UPDATESUPDATES proposition 1 and focuses proposition 1 and focuses more detail on Proposition 2 and 3more detail on Proposition 2 and 3

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Proposition 2- Marginal Efficiency of Revenue-(MER)

Section-1- Preface:Section-1- Preface:

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Section-1- Preface:Section-1- Preface:-Proposition 3- Compare and Contrast the economic results of the following:

1-A portfolio utilizing the results of proposition 1 with the Marginal Efficiency of Investment (MEI) methodology to select the optimum equity and bond Investments across Large Cap, Mid Cap, Small Cap and fixed income styles.

2-Given (1) above, the identification of the Best investments by style, use Proposition 2, Marginal Efficiency of Revenue model , to derive the optimum allocation % for each style (LC, MC, SC & Fixed Investment.

3- From Proposition 1&2 above we now have an optimum portfolio that we can compare and contrast with the baseline portfolio containing the S&P 500 And a Bond Index fund(LAG)

Section 2- Section 2- Analytical MethodologyAnalytical Methodology

This section will discuss The following:This section will discuss The following:

1- Process1- Process• Filtering InvestmentsFiltering Investments

2- Proposition - 1- Modeling- Marginal Efficiency of 2- Proposition - 1- Modeling- Marginal Efficiency of Investment(MEI)Investment(MEI)

• MEI- Power CoefficientMEI- Power Coefficient• Proposition -1Proposition -1

• -Best Investments Ranked by MEI power Coefficient-Best Investments Ranked by MEI power Coefficient3- Proposition - 2- Modeling- Marginal Efficiency of Revenue(MER)3- Proposition - 2- Modeling- Marginal Efficiency of Revenue(MER)

• MER- Power CoefficientMER- Power Coefficient• Proposition 2- Proposition 2-

• Monte Carlo SimulationsMonte Carlo Simulations• Optimum % Equity Allocation across Styles(LC, MC, SC)Optimum % Equity Allocation across Styles(LC, MC, SC)

3- Proposition – 3- Modeling- Analytic Comparatives3- Proposition – 3- Modeling- Analytic Comparatives• Use MEI & MER- Power Use MEI & MER- Power Coefficient ResultsCoefficient Results• Proposition 3- Proposition 3-

• Monte Carlo SimulationsMonte Carlo Simulations• Analytic ComparativesAnalytic Comparatives• Optimum Diversified Portfolio derived from proposition 1 & 2Optimum Diversified Portfolio derived from proposition 1 & 2• Above analytically compared to an Index portfolio of the S&P Above analytically compared to an Index portfolio of the S&P

500(VFINX) & a Bond SPYDR Index (LAG)500(VFINX) & a Bond SPYDR Index (LAG)

2020

Proposition 1-Proposition 1-Two Step Process: Two Step Process: Marginal of Investment-MEI- (See Marginal Efficiency of Investment- Marginal of Investment-MEI- (See Marginal Efficiency of Investment- Attached)Attached)Step One: Using the MEI methodology identified above and reviewed Step One: Using the MEI methodology identified above and reviewed below:below:

– Initially filter with Morningstar Fund/ETF screening process.Initially filter with Morningstar Fund/ETF screening process.– Choose top 3-5 investments in each style..Large Cap, Mid Cap, Small Choose top 3-5 investments in each style..Large Cap, Mid Cap, Small

Cap, ..Value, Blend and Growth with the highest Power CoefficientsCap, ..Value, Blend and Growth with the highest Power Coefficients– Choose top 3-5 investments in Fixed income-Bonds. Choose top 3-5 investments in Fixed income-Bonds.

Step Two:Step Two:– Use the Power Coefficient defined in the next section to rank Use the Power Coefficient defined in the next section to rank

investments based on personal investor preferencesinvestments based on personal investor preferences

2-Analytic Methodology: 2-Analytic Methodology: Proposition 1- Step 1 Proposition 1- Step 1

MEI-ProcessMEI-Process

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Definition: Definition: The MEI Power Coefficient: The MEI Power Coefficient: – A derivative of 10 variables A derivative of 10 variables – Define the short and long run viability of a Define the short and long run viability of a

particular Fund or ETF.particular Fund or ETF.– The variables are weighted based on individual The variables are weighted based on individual

investor preferences to encapsulate :investor preferences to encapsulate : Tolerance for riskTolerance for risk Investment time horizonsInvestment time horizons VolatilityVolatility Rates of Return at different time horizons(1,3,5 yr)Rates of Return at different time horizons(1,3,5 yr)

2-Analytic Methodology: 2-Analytic Methodology: Proposition 1-Step 2 – Proposition 1-Step 2 –

MEI-ModelingMEI-Modeling

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Marginal Efficiency of Investment (MEI)Model Marginal Efficiency of Investment (MEI)Model Algorithm:Algorithm:

– Generated from the following equation:Generated from the following equation:– Equation:Equation: Power coefficient generated by the Power coefficient generated by the

following:following:

MEI Power CoefMEI Power Coef = = a(1Gr)+b(3 Gr)+c(5 GRa(1Gr)+b(3 Gr)+c(5 GR) x ) x αα

(d*(d*ЄЄ )+(e* )+(e* ββ)+)+ (F*(F*σσ))

2-Analytic Methodology: 2-Analytic Methodology: Proposition 1- Proposition 1-

Step 2 –MEI-ModelingStep 2 –MEI-Modeling

2323

– Where:Where: a= Percentage weight for 1 year growth ratea= Percentage weight for 1 year growth rate B= Percentage weight for 3 year growth rateB= Percentage weight for 3 year growth rate c= Percentage weight for 5 year growth ratec= Percentage weight for 5 year growth rate D= Percentage weight for Expense RatioD= Percentage weight for Expense Ratio E= Percentage weight for BetaE= Percentage weight for Beta F= Percentage weight for Standard deviationF= Percentage weight for Standard deviation 1GR= 1 year growth rate1GR= 1 year growth rate 3GR= 3 year growth rate3GR= 3 year growth rate 5GR= 5 year growth rate5GR= 5 year growth rate Є= Expense ratioЄ= Expense ratio ΒΒ= Beta for the investment indicating correlation over time with the general market= Beta for the investment indicating correlation over time with the general market σ σ = Standard Deviation= Standard Deviation α= Measure of performance relative to index of equivalent investments.



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Power Coefficients generated for each fund should be used to rank Power Coefficients generated for each fund should be used to rank funds in ascending order for each Style:funds in ascending order for each Style:– Large Cap Picks:Large Cap Picks:– Mid Cap Picks:Mid Cap Picks:– Small Cap picks:Small Cap picks:– Fixed Income Picks:Fixed Income Picks:

The spread sheet to do the power coefficient calculations and The spread sheet to do the power coefficient calculations and Rank them in order is included as an attachment.Rank them in order is included as an attachment.

Otherwise you may want to look at the following Otherwise you may want to look at the following “Quik Calc” “Quik Calc” method:method:

– See Page 12 in Attachment: Back of the “Match See Page 12 in Attachment: Back of the “Match book Cover” Calculation of a power Coeff.book Cover” Calculation of a power Coeff.



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Step 2 –MER-ModelingStep 2 –MER-ModelingProposition 2Proposition 2Marginal Efficiency of Revenue (MER) : Marginal Efficiency of Revenue (MER) : From each of the LC, MC and SC Funds extract the:From each of the LC, MC and SC Funds extract the:

– Mean MEI Power CoefficientMean MEI Power Coefficient– Standard Deviation Standard Deviation – Probability the respective Style(equity) > S&P 500Probability the respective Style(equity) > S&P 500

Use in the following:Use in the following:

Marginal Efficiency of Revenue (MER)Model AlgorithmMarginal Efficiency of Revenue (MER)Model Algorithm::– Generated from the following equation:Generated from the following equation:– Equation:Equation: MER MER Power coefficient generated by the following for each of Power coefficient generated by the following for each of

the optimum LC, Mid Cap, Small Cap- SEE page 9 and 10the optimum LC, Mid Cap, Small Cap- SEE page 9 and 10 MER Power Coef (LC, MC, SC)MER Power Coef (LC, MC, SC) = = (W*X * Y*)(W*X * Y*)

ZZ

– Where: From the Simulation StochasticsWhere: From the Simulation Stochastics W= From the Monte Carlo Simulation for each style. The W= From the Monte Carlo Simulation for each style. The

Probability that particular style(LC,MC,SC) exceeds the Probability that particular style(LC,MC,SC) exceeds the S&P 500. S&P 500.

x= Mean MEI Power Coefficient for LC, MC, SC from x= Mean MEI Power Coefficient for LC, MC, SC from the simulationthe simulation

Y= Dollars > S&P 500- 10 year revenue Growth > S&P Y= Dollars > S&P 500- 10 year revenue Growth > S&P 500500

Z= Standard Deviation – A measure of Risk for Each Z= Standard Deviation – A measure of Risk for Each LC, MC, SC simulationLC, MC, SC simulation

– MER= The Marginal Efficiency of Revenue /Return is MER= The Marginal Efficiency of Revenue /Return is therefore a methodology to weight Investment therefore a methodology to weight Investment Revenue generation per Unit of RiskRevenue generation per Unit of Risk

2626


Step 2 –MER-ModelingStep 2 –MER-Modeling

2727

-Proposition 3-Proposition 3- - Compare and Contrast the economic results Compare and Contrast the economic results of the following:of the following:

1-A portfolio utilizing the MEI /MER results of proposition 1&2 and a Bond Index 1-A portfolio utilizing the MEI /MER results of proposition 1&2 and a Bond Index with with

2- A portfolio containing the S&P 500 And a Bond Index fund(LAG)2- A portfolio containing the S&P 500 And a Bond Index fund(LAG)

–Methodology:Methodology: Given a $1.00 investment, generate a portfolio allocated according to the power coefficients Given a $1.00 investment, generate a portfolio allocated according to the power coefficients

for each style: Large Caps, Midcaps, Small caps & Fixed Income. for each style: Large Caps, Midcaps, Small caps & Fixed Income. The allocation of a portfolio between debt and equity is the decision of the individual investor The allocation of a portfolio between debt and equity is the decision of the individual investor

driven by their tolerance for risk. The average portfolio allocation is 50-65% Equity ,35% to driven by their tolerance for risk. The average portfolio allocation is 50-65% Equity ,35% to 50% Fixed Income. For the purpose of this analysis a Mid point allocation was assumed. 50% Fixed Income. For the purpose of this analysis a Mid point allocation was assumed.

– That is 60% equity, 40% Fixed IncomeThat is 60% equity, 40% Fixed Income The following will address the MER methodology to determiine an optimum, % allocation The following will address the MER methodology to determiine an optimum, % allocation

across styles(LC,MC,SC) WITHIN the equity portion of the portfolio across styles(LC,MC,SC) WITHIN the equity portion of the portfolio

2-Analytic Methodology: 2-Analytic Methodology: Proposition-3 Proposition-3

Step 2– Monte Carlo Simulations for Step 2– Monte Carlo Simulations for Comparative PortfolioComparative Portfolio

Section-3 Section-3 Results Results

This section This section discusses the results of the discusses the results of the methodology discussed in section 2 to methodology discussed in section 2 to the three propositionsthe three propositionsProposition 1-MEI-AnalyticsProposition 1-MEI-Analytics::

– Is there an alternative investment process (Mix of Is there an alternative investment process (Mix of Mutual funds in Large Cap, Midcap , Small Cap and Fixed Mutual funds in Large Cap, Midcap , Small Cap and Fixed Income Styles) chosen by the highest Power Coef’s that Income Styles) chosen by the highest Power Coef’s that provide better results than simply a Mutual fund that provide better results than simply a Mutual fund that duplicates the S&P 500?duplicates the S&P 500?

– What are those investments?What are those investments?Proposition 2- MER AnalyticsProposition 2- MER Analytics - - What is the optimum % allocation of InvestmenstWhat is the optimum % allocation of Investmenst

in 1 above (e.g. %LC/MC/SC)in 1 above (e.g. %LC/MC/SC)Proposition 3- Comparative Portfolio AnalysisProposition 3- Comparative Portfolio Analysis - How does the Optimum Portfolio selected in - How does the Optimum Portfolio selected in Proposition 1 Proposition 1 & 2 with a baseline index fund & 2 with a baseline index fund (LAG) above compare to a (LAG) above compare to a baseline portfolio of baseline portfolio of a n Index Fund(Vanguard Index-a n Index Fund(Vanguard Index- VFINX) and a VFINX) and a baseline Bond Fund(LAG)baseline Bond Fund(LAG)

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MEI- Analytic Modeling-See Exhibit-1MEI- Analytic Modeling-See Exhibit-1Power Coefficient Picks: (Using Model on Page 9)Power Coefficient Picks: (Using Model on Page 9)

– Large Cap: Large Cap: 1.1. Vanguard LC Dividend Growth-VDIGXVanguard LC Dividend Growth-VDIGX- - (Highest power Coef(Highest power Coef))

– Mid Cap: Mid Cap: 1.1. American Century MC Value-ACMVX (Highest power CoefAmerican Century MC Value-ACMVX (Highest power Coef))

– Small Cap: Small Cap: 1.1. Fidelity Small Cap Value- FCPVX=(Highest power CoeffFidelity Small Cap Value- FCPVX=(Highest power Coeff))

– Fixed income- BondsFixed income- Bonds- - 1.1. Metropolitan West Total Return-MWTRX (Highest power Coef)Metropolitan West Total Return-MWTRX (Highest power Coef)

3-Results: MEI 3-Results: MEI Proposition 1: Proposition 1:

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Results: MEI Power Coefficients > S&P 500Results: MEI Power Coefficients > S&P 500

Exhibit-1Exhibit-13-Results: MEI Proposition 1: 3-Results: MEI Proposition 1:

SECTOR- Power Coefficient AnalysisSummary- Sector ETF Fund Ratings >S&P 500

Power Rating SECTOR9.0 S&P- consumer staples-XLP

7.8 S&P -Technology-XLK

7.7 S&P - Cyclicals-XLY

7.0 S&P- Utilitities- XLU

6.2 S&P - healthcare-XLV

5.2 S & P 500 -VFINX

MUTUAL Fund Power Coefficient AnalysisSMALL CAP FUND MEI-Power Coefficient Analysis

Summary- Funds GREATER THAN the S&P 500 Power Rating Rating Fund

5.15 S & P 500 -VFINX

4.38 Silver fidelity SC Value-FCPVX

MUTUAL Fund Power Coefficient Analysis LARGE CAP FUND MEI-Power Coefficient Analysis

Summary- Funds GREATER THAN the S&P 500Power Rating Rating Fund

6.78 Gold Vanguard LC Dividend Growth-VDIGX6.02 Gold Parnassus Core LC Equity Invest-PRBLX

5.67 Silver T.Rowe Price LC Div Grwth-PRDGX

5.15 S & P 500 -VFINX

MUTUAL Fund Power Coefficient Analysis MID CAP FUND MEI-Power Coefficient Analysis

Summary- Funds GREATER THAN the S&P 500 Power Rating Rating Fund

5.85 Gold American Century MC-Value-ACMVX5.15 S & P 500 -VFINX

3131

Exhibit-1Exhibit-13-Results: MEI Proposition 1: 3-Results: MEI Proposition 1:

Results: MEI Power Coefficients > S&P Results: MEI Power Coefficients > S&P

500500 BONDS- Marginal Efficiency of Investments-Power Coefficient AnalysisSummary- BOND FUND Ratings > Aggegate Bond Index-LAG

Power Rating …… Fund5.1 Metroipolitan West Total Return-MWTRX

4.9 Dodge and Cox Income-DODIX

4.6 Fidelity GNMA-FGMNX

4.2 Janus Flexible Bond-JAFIX

4.2 Category Average(SPDR US bond Index)-LAG

INTERNATIONAL- Power Coefficient AnalysisSummary- International FUND Ratings

Power Rating >International Index-ACWX

6.7 Artisian Global Value Investor-ARTGX

S & P 500 -VFINX

Using the algorithm identified on page 9 the highest Power Using the algorithm identified on page 9 the highest Power Coefficients in each style generated the following:Coefficients in each style generated the following:– See EXHIBIT-1See EXHIBIT-1– Large Cap…… = 6.78 = Vanguard Dividend Growth- VDIGXLarge Cap…… = 6.78 = Vanguard Dividend Growth- VDIGX– Mid Cap ……….= 6.11 = American Century MC Value- ACMVXMid Cap ……….= 6.11 = American Century MC Value- ACMVX– Small Cap …….= 4.38 = Fidelity Small Cap Value- FCPVXSmall Cap …….= 4.38 = Fidelity Small Cap Value- FCPVX– Fixed Income...= 5.1 = Metropolitan West Total Return = MWTRXFixed Income...= 5.1 = Metropolitan West Total Return = MWTRX– NOTE: The Highest Small Cap Investment PC was close but did not exceed the NOTE: The Highest Small Cap Investment PC was close but did not exceed the

S&P 500. However, as you will see in Proposition 2- when a 10 year planning S&P 500. However, as you will see in Proposition 2- when a 10 year planning horizon is evaluated the revenue per unit of risk is higher than the S&P and horizon is evaluated the revenue per unit of risk is higher than the S&P and thus an appropriate allocation of 7-10% is recommended for diversitythus an appropriate allocation of 7-10% is recommended for diversity . .

Than weights are derived as a result of proposition 2 . Than weights are derived as a result of proposition 2 . – The previous analysis (attached) used a weighting of the power coefficients to The previous analysis (attached) used a weighting of the power coefficients to

allocate across styles. allocate across styles. – The purpose of this analysisThe purpose of this analysis outside of an update on the fund selection outside of an update on the fund selection

process was to provide more input based on the process was to provide more input based on the analysis of revenues analysis of revenues per unit of risk thus providing a more accurate portrayal of the per unit of risk thus providing a more accurate portrayal of the allocation across the equity styles(LC,MC,SC)allocation across the equity styles(LC,MC,SC)

3232

3-Results: MEI 3-Results: MEI Proposition 1: Proposition 1:

3333

MER- Asset allocation (%LC, %MC, %SC) Evaluation MER- Asset allocation (%LC, %MC, %SC) Evaluation ProcessProcess– Proposition – 2- Proposition – 2- SSeeee Exhibit -2-3-4-5 Exhibit -2-3-4-5

Methodology to determine the optimum % between LC,MC,SC% within the total equity allocation(e.g. in a 70% Equity to 30 %

Fixed Income portfolio how should the % be allocated across the 3 styles)

1000 interactions were used in the simulation:1000 interactions were used in the simulation: Generate Monte Carlo Simulations for each style which will generate :Generate Monte Carlo Simulations for each style which will generate :

– a -Mean MEI power coefficient for each of the MEI selected stylesa -Mean MEI power coefficient for each of the MEI selected styles LC=LC=Vanguard Dividend Growth- VDGIX= $6.26Vanguard Dividend Growth- VDGIX= $6.26 MC=MC= American Century Value- ACMVX= $5.85 American Century Value- ACMVX= $5.85 SC=SC=Fidelity Small Cap Value- FCPVX= $4.32Fidelity Small Cap Value- FCPVX= $4.32

3- Results : Proposition 2 3- Results : Proposition 2 ––MER-ModelingMER-Modeling

MER- Asset allocation (%LC, %MC, %SC) MER- Asset allocation (%LC, %MC, %SC) Evaluation ProcessEvaluation Process– Proposition – 2(con)Proposition – 2(con)

– b-The probability by Style (LC,MC,SC) > S&P b-The probability by Style (LC,MC,SC) > S&P 500 500

– c-The Standard deviation of each style c-The Standard deviation of each style probability distributionprobability distribution

– d- Marginal 10 year Revenue > S&P 500d- Marginal 10 year Revenue > S&P 500

Exhibit 6 –Column E Exhibit 6 –Column E reflects the Monte Carlo reflects the Monte Carlo Simulation MER calculations Yielding the % Simulation MER calculations Yielding the % allocation by Style.allocation by Style.

3434

3- Results : Proposition 3- Results : Proposition 2 2

–MER-Modeling–MER-Modeling

The Baseline Index The Baseline Index Power Coefficient .Power Coefficient .

S&P 500S&P 500– Vanguard Index: VFINXVanguard Index: VFINX

$1.00 Investment$1.00 Investment Mean Value for the S&P Mean Value for the S&P

500 = $4.79500 = $4.79 The standard deviation = The standard deviation =

11.53. 11.53.

3535

Implication: The S&P 500 index –VFINX is the baseline for comparison used to Select specific Style choices (Proposition-1-LC,MC,SC) . In this section Proposition -2..How to define the allocation %’s between the respective style choices (e.g. Given the individuals assumption of risk –Equity to debt 70/30, 60/40, 50/50 etc , how do you define the allocation of LC.MC.SC within the assumed % equity allocation. )

Exhibit-2Exhibit-23-Results: Proposition-2- What is the 3-Results: Proposition-2- What is the Optimum %Allocation across styles(LC, Optimum %Allocation across styles(LC,

MC, SC)MC, SC)

3636

Power Coefficient Large Cap PortfolioPower Coefficient Large Cap Portfolio

Large CapsLarge Caps– Vanguard Dividend Growth VDIGXVanguard Dividend Growth VDIGX

$1.00 Investment$1.00 Investment Mean Value for the S&P 500 = $4.79Mean Value for the S&P 500 = $4.79 Mean Value from the VDIGX simulation = Mean Value from the VDIGX simulation =

6.266.26 The VDIGX portfolio yielded a $1.47The VDIGX portfolio yielded a $1.47 Difference than the baseline S&P 500 Difference than the baseline S&P 500 portfolio.portfolio.

Implication: The 100% Large Cap portfolio with a dollar invested generated a 31% higher Power Coefficient result of $6.26 vs $4.79 for the S&P portfolio. The Large Cap portfolio had a 55% probability of exceeding the S&P 500 index Portfolio

Exhibit-3Exhibit-3 3 Results: Proposition-2- What is 3 Results: Proposition-2- What is

the Optimum %Allocation across the Optimum %Allocation across styles(LC, MC, SC)styles(LC, MC, SC)

3737

Power Coefficient Mid Cap Power Coefficient Mid Cap PortfolioPortfolio

MidcapsMidcaps– American Century value American Century value

ACMVXACMVX

$1.00 Investment$1.00 Investment The mean of the S&P 500 = The mean of the S&P 500 =

$4.79$4.79 Mean Value from the ACMVX Mean Value from the ACMVX

simulation was $6.00.simulation was $6.00.

Implication: The 100% Mid Cap portfolio with a dollar invested generated a 25% higher Power Coefficient result of $6.00 versus $4.79 of the S&P 500 portfolio. The 100% Midcap portfolio had a 55% probability exceeding the S&P 500 port of 4.79

Exhibit-4Exhibit-43- Exhibit-2 Results: Proposition-2- What 3- Exhibit-2 Results: Proposition-2- What

is the Optimum %Allocation across is the Optimum %Allocation across styles(LC, MC, SC)styles(LC, MC, SC)

3838

-Power Coefficient -Power Coefficient PortfolioPortfolio

Small CapsSmall Caps– Fidelity Small Cap Value- Fidelity Small Cap Value-

FCPVXFCPVX $1.00 Investment$1.00 Investment The mean of the S&P 500 The mean of the S&P 500

=$4.70=$4.70 Mean Value from the FCPVX Mean Value from the FCPVX

simulation was $3.57 . simulation was $3.57 . The probability of exceeding the The probability of exceeding the

S&P 500 of 4.79 was 40% S&P 500 of 4.79 was 40% Implication: The above 100% Small Cap portfolio has a 40% probability of exceeding the S&P 500 Index Portfolio . While the Mean for the Small Cap is marginally lower than the S&P 500 this Style is included to broaden diversification for the long term.

Exhibit-5Exhibit-5 3-Results: Proposition-2- What is the 3-Results: Proposition-2- What is the Optimum %Allocation across styles(LC, Optimum %Allocation across styles(LC,

MC, SC)MC, SC)

- Given the statistics from each simulation..Specif\cally- Given the statistics from each simulation..Specif\cally– Mean for each style From the Monte Carlo Simulation (LC,MC,SC)Mean for each style From the Monte Carlo Simulation (LC,MC,SC)

LC=LC= $ 6.26 – Exhibit-3 $ 6.26 – Exhibit-3 SC=SC= $6.00 – Exhibit-4 $6.00 – Exhibit-4 SC=SC= $3.57 – Exhibit-5 $3.57 – Exhibit-5

– Standard Deviation From the Monte Carlo Simulation (LC,MC,SC)Standard Deviation From the Monte Carlo Simulation (LC,MC,SC) LC=LC= 13.36- Exhibit-3 13.36- Exhibit-3 MC=MC=12.99- Exhibit-412.99- Exhibit-4 SC=SC= 9.99- Exhibit- 5 9.99- Exhibit- 5

– Power coefficient from the Monte Carlo Simulation for each stylePower coefficient from the Monte Carlo Simulation for each style LC=LC=$6.78 –Exhibit-1$6.78 –Exhibit-1 MC=MC=$6.11- Exhibit-1$6.11- Exhibit-1 SC=SC=$3.57- Exhibit-1$3.57- Exhibit-1

– 10 year revenue greater than the S&P 500- See Exhibit-610 year revenue greater than the S&P 500- See Exhibit-6 LC= $3848- Exhibit-6LC= $3848- Exhibit-6 MC=MC=$$4,523- Exhibit-64,523- Exhibit-6 SC=$2,337 – Exhibit-6SC=$2,337 – Exhibit-6

3939

3-Results: Proposition-2- What is the Optimum %Allocation 3-Results: Proposition-2- What is the Optimum %Allocation across styles(LC, MC, SC)across styles(LC, MC, SC)

Than use the following formula from Section 2 PageThan use the following formula from Section 2 Page Equation:Equation: MER MER Power coefficient generated by the following for each of the Power coefficient generated by the following for each of the

optimum LC, Mid Cap, Small Cap- SEE page 9 and 10optimum LC, Mid Cap, Small Cap- SEE page 9 and 10

MER Power Coef (LC, MC, SC) = MER Power Coef (LC, MC, SC) = (W*X * Y*)(W*X * Y*)

ZZ Where: From the Simulation StochasticsWhere: From the Simulation Stochastics W= From the Monte Carlo Simulation for each style. The Probability that particular W= From the Monte Carlo Simulation for each style. The Probability that particular

style(LC,MC,SC) exceeds the S&P 500. style(LC,MC,SC) exceeds the S&P 500. x= Mean MEI Power Coefficient for LC, MC, SCx= Mean MEI Power Coefficient for LC, MC, SC Y= Dollars > S&P 500- 10 year revenue Growth > S&P 500Y= Dollars > S&P 500- 10 year revenue Growth > S&P 500 Z= Standard Deviation – A measure of Risk for Each LC, MC, SC simulationZ= Standard Deviation – A measure of Risk for Each LC, MC, SC simulation

4040

3-Results: Proposition-2- What 3-Results: Proposition-2- What is the Optimum %Allocation is the Optimum %Allocation

across styles(LC, MC, SC)across styles(LC, MC, SC)

))

Per this equation , MER= is therefore a Per this equation , MER= is therefore a methodology to weight Investment methodology to weight Investment Revenue generation per Unit of RiskRevenue generation per Unit of Risk

Results reflected in the following ChartResults reflected in the following Chart– See the See the MER column MER column (Exhibit -6) (Exhibit -6) which is which is

reflective of the Calculations in the formula reflective of the Calculations in the formula specified.specified.

– The results are a $ per unit of risk for each of The results are a $ per unit of risk for each of the respective investments in the far left the respective investments in the far left column derived from Proposition 1.column derived from Proposition 1.

4141

3-Results: Proposition-2- What 3-Results: Proposition-2- What is the Optimum %Allocation is the Optimum %Allocation

across styles(LC, MC, SCacross styles(LC, MC, SC

– The MER calculation (The MER calculation (MER Column-Exhibit-6)MER Column-Exhibit-6)yields a 10 year revenue per yields a 10 year revenue per unit of risk per each designated style (00’s)unit of risk per each designated style (00’s)

Large Cap Large Cap –Vanguard Dividend Growth-VFGIX………$1074–Vanguard Dividend Growth-VFGIX………$1074 Mid Cap- Mid Cap- American Century Value-ACMCX ……………$1119American Century Value-ACMCX ……………$1119 Small Cap- Small Cap- Fidelity Small Cap Value- FCPVX………….. Fidelity Small Cap Value- FCPVX………….. $367$367 Total $2560 Total $2560

– According to the According to the Exhibit-6 –MER % Exhibit-6 –MER % Column reflects the MER allocations Column reflects the MER allocations across the Equity & allocation in the portfolio are:across the Equity & allocation in the portfolio are:

LC=LC= $1074 / $2560 ….= 42% $1074 / $2560 ….= 42% MC=MC= $1119 / $2560….= 44% $1119 / $2560….= 44% SC=SC= $357 / $2560……=14% $357 / $2560……=14%

4242

3-Results: Proposition-2- What is the 3-Results: Proposition-2- What is the Optimum %Allocation across styles(LC, Optimum %Allocation across styles(LC,

MC, SCMC, SC

4343

Exhibit-6Exhibit-6 MER Equity Asset Allocation

MER Power Coef (LC, MC, SC) =E= (B*C* D*) A

MER MER%A B C D (B*C*D)/A E

Results for -MER- Defines % allocation of Equity % in Portfolio

Equity Investment

Standard Deviation(%) frm Monte Carlo

Simulation

Total 10 year Dollar Diff from S&P 500

Prob Greater than the S&P 500(%) From

Monte Carlo Simulation

Power Coef from Monte Carlo Simulation

10 Yr -Multivariate $ per Unit of Risk(00's)

MER- Multivariate Equity Style Allocation

Vanguard LC Dividend Growth-

VDIGX13.36% $3,848 55% 6.78 $1,074 42%

American Century MC-Value-ACMVX 13.00% $4,523 55% 5.85 $1,119 44%

Fidelity SC Value-FCPVX 10.00% $2,337 44% 3.57 $367 14%

Total $10,708 $2,560 100%

5

4444

MER% G H I J

E F E*70% F*G E*60% F*H E*55% F*I E*50% F*J

Percent of Portfolio

Allocated to Equities

Total Equity

allocation- MER AVG

at 70%



Total Equity allocation- MER AVG

at 60%



Total Equity allocation- MER AVG

at 55%



Total Equity allocation-

MER AVG at 50%

MER- Multivariate Equity Style Allocation

Total 10 year Dollar Diff from S&P

50070%

Dollars greater than the

S&P 500 in year 10 at

70%

60%

Dollars greater than the S&P 500 in year 10 at

60%

55%Dollars

greater than the S&P 500 in year 10 at

55%

50%

Dollars greater than the S&P 500 in year 10at

50%

42% $3,848 29% $1,130 25% $969 23% $888 21% $807

44% $4,523 31% $1,384 26% $1,186 24% $1,087 22% $988

14% $2,337 10% $235 9% $201 8% $184 7% $168

100% $10,708 70% $2,748 60% $2,356 55% $2,159 50% $1,963

Exhibit-7 Exhibit-7 MERMER Equity Asset Allocation Equity Asset Allocation

MER %

This is than the optimum allocation across the designated investment styles.This is than the optimum allocation across the designated investment styles. This percent for each Investment style will be applied to the % of total This percent for each Investment style will be applied to the % of total

equity in various portfolios to be analyzed in the Next section Proposition 3.equity in various portfolios to be analyzed in the Next section Proposition 3. Thus refer to Thus refer to Exhibit-8 -column 1, 2, 3 Exhibit-8 -column 1, 2, 3 in the next chart.in the next chart. Given the 42%, 44% and 14% allocated across the three designated LC,MC Given the 42%, 44% and 14% allocated across the three designated LC,MC

and SC styles for various portfolio’s :and SC styles for various portfolio’s :– 70% Equity 30% Fixed Income – The allocation WITHIN the 70% 70% Equity 30% Fixed Income – The allocation WITHIN the 70%

equity=equity= 42% * 70%= 29%42% * 70%= 29% 44%* 70%= 31%44%* 70%= 31% 14%* 70% = 14%* 70% = 10%10%

TOTAL = 70% TOTAL = 70% – The % equity split for different % Equity to fixed income portfolio The % equity split for different % Equity to fixed income portfolio

allocations are similarly calculated multiplying 42%, 44%, 14% by the % allocations are similarly calculated multiplying 42%, 44%, 14% by the % equity …60% and %50% respectively.equity …60% and %50% respectively.

–

4545


MC, SCMC, SC

Thus: Thus: See Exhibit-8- See Exhibit-8- The % equity split for different Equity to The % equity split for different Equity to fixed Income allocations 60%/40% and 50%/50% arefixed Income allocations 60%/40% and 50%/50% are– 60% Equity 40% Fixed Income – The allocation WITHIN the 60% equity=60% Equity 40% Fixed Income – The allocation WITHIN the 60% equity=

42% * 60%= 25%42% * 60%= 25% 44%* 60%= 26%44%* 60%= 26% 14%* 60% = 14%* 60% = 9%9%

TOTAL = 60% TOTAL = 60% – 50% Equity 50% Fixed Income – The allocation WITHIN the 50% equity=50% Equity 50% Fixed Income – The allocation WITHIN the 50% equity=

42% * 50%= 21%42% * 50%= 21% 44% * 50%= 22%44% * 50%= 22% 14% * 50% = 14% * 50% = 7 %7 %

TOTAL = 50% TOTAL = 50%

– See Exhibit 9….For the above results summarizedSee Exhibit 9….For the above results summarized– The percentages calculated above are summarized in Column 1, 2,3 The percentages calculated above are summarized in Column 1, 2,3 – The results yield the Dollars greater than the S&P 500 for each % splitThe results yield the Dollars greater than the S&P 500 for each % split

4646


MC, SCMC, SC

Exhibit-8Exhibit-8 MERMER Equity Asset AllocationEquity Asset Allocation

at Various Equity to Debt at Various Equity to Debt Ratio’s Ratio’s

4747

Stop

1-Percent of Portfolio


Total Equity allocation- MER

AVG at 70%




AVG at 60%




AVG at 50%

Equity Investment 70%

Dollars greater than the S&P 500 in year 10 at 70%

60%Dollars greater

than the S&P 500 in year 10 at 60%

50%Dollars greater than the S&P 500 in year

10at 50%

Vanguard LC Dividend Growth-

VDIGX29% $1,130 25% $969 21% $807

American Century MC-Value-ACMVX 31% $1,384 26% $1,186 22% $988

Fidelity SC Value-FCPVX 10% $235 9% $201 7% $168

Total 70% $2,748 60% $2,356 50% $1,963

4848

Thus: See Exhibit-9 & 10 The % and $ Revenue ContributionsBy Equity Allocation for different Equity to fixed Income allocations 70 %./30% ,60%/40% and 50%/50% are

70% Equity 30% Fixed Income – The allocation WITHIN the 70% equity=42% * 70%= 29%44%* 70%= 31%14%* 70% = 10%

TOTAL = 70% 10 yr dollars > S&P 500 = $2,748 – Exhibit-910 % diff > S&P 500…… = 28% - Exhibit-10

60% Equity 40% Fixed Income – The allocation WITHIN the 60% equity=42% * 60%= 25%44%* 60%= 26%14%* 60% = 9%

TOTAL = 60% 10 yr dollars > S&P 500= $2,356– Exhibit-910 % diff > S&P 500…… = 23% - Exhibit-10

50% Equity 50% Fixed Income – The allocation WITHIN the 50% equity=42% * 50%= 21%44% * 50%= 22%14% * 50% = 7 %

TOTAL = 50% 10 yr dollars > S&P 500= $2,1963– Exhibit-910 % diff > S&P 500…… = 14% - Exhibit-10

See Exhibit 9 and 10….For the above results summarized

3-Results: Proposition-2- The % and $ Revenue 3-Results: Proposition-2- The % and $ Revenue Contributions by Equity Allocation for Different Contributions by Equity Allocation for Different

Equity to Fixed Income Allocations Equity to Fixed Income Allocations

49494949

-Exhibit-9Exhibit-9Revenue Contributions by Equity Allocation > S&P 500

Equity Allocation Style % Split 10 years % > S&P 500

10 years $ > S&P 500

70%- 30% Allocated Portfolio

29%-LC-31%MC-10%SC-30% Bond 28% $2,748

60-40% Fully Allocated Portfolio

25%LC-26%MC-9%SC-40% Bonds 23% $2,356


21%LC-22%MC-7%SC-50% Bond 14% $1,963

5050

-Exhibit-10Exhibit-10Revenue Contributions by Equity Allocation > S&P 500

Equity Allocation Style % Split 10 years % > S&P 500

10 years $ > S&P 500

70%- 30% Allocated Portfolio

29%-LC-31%MC-10%SC-30% Bond 28% $2,748


25%LC-26%MC-9%SC-40% Bonds 23% $2,356


21%LC-22%MC-7%SC-50% Bond 14% $1,963

– The following will evaluate a diversified portfolio using The following will evaluate a diversified portfolio using The results from the MEI analysis, Proposition 1 identifies the best The results from the MEI analysis, Proposition 1 identifies the best

styles (LC,MC,SC, Bond) styles (LC,MC,SC, Bond) The specific LC, MC, SC equities are allocated across Equities via The specific LC, MC, SC equities are allocated across Equities via

Proposition 2 and than Proposition 2 and than Proposition 3 analyzed the resulting optimum portfolio vs a Proposition 3 analyzed the resulting optimum portfolio vs a

benchmark Portfolio using various risk assumptions(% equity vs % benchmark Portfolio using various risk assumptions(% equity vs % Debt) : ThusDebt) : Thus

– Proposition 1- Proposition 1- Large Cap= Large Cap= Vanguard Dividend Growth-VDIGXVanguard Dividend Growth-VDIGX MidCap= MidCap= American Century Mid Cap Value- ACMVXAmerican Century Mid Cap Value- ACMVX Small Cap= Small Cap= Fidelity Small Cap Value- FCPVXFidelity Small Cap Value- FCPVX Fixed Income= Fixed Income= Metropolitan West Total Return- MWTRXMetropolitan West Total Return- MWTRX

5151

3-Results – Proposition 3: – Monte Carlo 3-Results – Proposition 3: – Monte Carlo Simulations for a Comparative Portfolio Simulations for a Comparative Portfolio derived from Proposition 1&2 Compared derived from Proposition 1&2 Compared to a Benchmark Portfolio of the S&P 500 to a Benchmark Portfolio of the S&P 500

Proposition 2- Proposition 2- – The MER allocation within the Equity segmentationThe MER allocation within the Equity segmentation– 42% LC….44% MC………14% SC42% LC….44% MC………14% SC

Proposition 3-Proposition 3-– The following Portfolio ‘s will be analyzed via Monte Carlo simulations to The following Portfolio ‘s will be analyzed via Monte Carlo simulations to

determine investor valuedetermine investor value– 70% Equity vs 30% Debt- 70% Equity vs 30% Debt- See Exhibit -10See Exhibit -10

Equity AllocationEquity Allocation– 29% Vanguard Dividend Growth- VDGIF29% Vanguard Dividend Growth- VDGIF– 31% American Century Mid cap Value- ACMVX31% American Century Mid cap Value- ACMVX– 10% Fidelity Small Cap Value- FCPVX10% Fidelity Small Cap Value- FCPVX


5252

3-Results : – Proposition 3: – Monte Carlo 3-Results : – Proposition 3: – Monte Carlo Simulations for a Comparative Portfolio Simulations for a Comparative Portfolio derived from Proposition 1&2 Compared derived from Proposition 1&2 Compared to a Benchmark Portfolio of the S&P 500 to a Benchmark Portfolio of the S&P 500

Proposition 3-(con)Proposition 3-(con)– 60% Equity vs 40% Debt - 60% Equity vs 40% Debt - See Exhibit -11See Exhibit -11

Equity AllocationEquity Allocation– 25% Vanguard Dividend Growth- VDGIF25% Vanguard Dividend Growth- VDGIF– 26% American Century Mid cap Value- ACMVX26% American Century Mid cap Value- ACMVX– 19% Fidelity Small Cap Value- FCPVX19% Fidelity Small Cap Value- FCPVX


– 50% Equity vs 50% Debt- 50% Equity vs 50% Debt- See Exhibit -12See Exhibit -12 Equity AllocationEquity Allocation



5353

3-Results : – Proposition 3: – Monte Carlo 3-Results : – Proposition 3: – Monte Carlo Simulations for a Comparative Portfolio Simulations for a Comparative Portfolio derived from Proposition 1&2 Compared derived from Proposition 1&2 Compared to a Benchmark Portfolio of the S&P 500 to a Benchmark Portfolio of the S&P 500

5454

Baseline S&P Portfolio-Baseline S&P Portfolio-VFINXVFINX

$1.00 Investment$1.00 Investment 100% Invested in S&P 100% Invested in S&P

Fund- VFINXFund- VFINX Mean Value from the Mean Value from the

simulation was $ $4.55simulation was $ $4.55 The measure of Risk or The measure of Risk or

Standard deviation was Standard deviation was 9.729.72 Implication: The above $1.00 investment in The S&P 500 Fund yielded a Mean Power Coefficient of $4.55 with a standard deviation of 9.73

Exhibit-10Exhibit-103-Results – Proposition 3: : – Monte Carlo 3-Results – Proposition 3: : – Monte Carlo Simulations for a Comparative Portfolio Simulations for a Comparative Portfolio

derived from Proposition 1&2 Compared to a derived from Proposition 1&2 Compared to a Benchmark Portfolio of the S&P 500 Benchmark Portfolio of the S&P 500

70% Equity/30% Debt70% Equity/30% Debt

5555

Power Coefficient PortfolioPower Coefficient Portfolio $1.00 Investment$1.00 Investment 29% Large Cap, 31% Mid Cap, 29% Large Cap, 31% Mid Cap,

10% Small Cap, 40% Fixed 10% Small Cap, 40% Fixed IncomeIncome

The Mean Value from The Diversified The Mean Value from The Diversified Portfolio simulation was 16% Portfolio simulation was 16% higher -$5.26 vs $4.55 for the S&P higher -$5.26 vs $4.55 for the S&P 500 Portfolio 500 Portfolio

The Standard Deviation or Risk of the The Standard Deviation or Risk of the 70/30 asset allocation portfolio is 70/30 asset allocation portfolio is

8.72 8.72 12% lower in risk vs the S&P 500 12% lower in risk vs the S&P 500

BenchBench mark portfolio of 9.73mark portfolio of 9.73 59% probability the Div ersified Port59% probability the Div ersified Port > Than the S&P 500 > Than the S&P 500 Implication: A 70/30% asset allocation portfolio gives the investor a $.61 versus $.47 dollar return per unit of risk. This represents a 30% better return per unit of risk over the S&P benchmark Portfo;io

Exhibit-10Exhibit-10 3-Results – Proposition 3 : – Monte Carlo Simulations 3-Results – Proposition 3 : – Monte Carlo Simulations for a Comparative Portfolio derived from Proposition for a Comparative Portfolio derived from Proposition 1&2 Compared to a Benchmark Portfolio of the S&P 1&2 Compared to a Benchmark Portfolio of the S&P

500 500 70% Equity/30% Debt70% Equity/30% Debt

5656

Exhibit-11Exhibit-11 3-Results : – Proposition 3: – Monte Carlo 3-Results : – Proposition 3: – Monte Carlo Simulations for a Comparative Portfolio Simulations for a Comparative Portfolio


60% Equity/40% Debt60% Equity/40% Debt Baseline S&P Portfolio-Baseline S&P Portfolio-

VFINXVFINX $1.00 Investment$1.00 Investment 100% Invested in S&P 100% Invested in S&P

Fund- VFINXFund- VFINX Mean Value from the Mean Value from the



5757

Exhibit-11Exhibit-113-Results – Proposition 3: – Monte Carlo 3-Results – Proposition 3: – Monte Carlo Simulations for a Comparative Portfolio Simulations for a Comparative Portfolio


60% Equity/40% Debt60% Equity/40% Debt Power Coefficient PortfolioPower Coefficient Portfolio $1.00 Investment$1.00 Investment 29% Large Cap, 31% Mid Cap, 10% 29% Large Cap, 31% Mid Cap, 10%

Small Cap, 40% Fixed IncomeSmall Cap, 40% Fixed Income The Mean Value from The Diversified The Mean Value from The Diversified

Portfolio simulation was 6.3% higher -Portfolio simulation was 6.3% higher -$5.09 vs $4.79 for the S&P 500 $5.09 vs $4.79 for the S&P 500 Portfolio Portfolio

The Standard Deviation or Risk of the The Standard Deviation or Risk of the 70/30 asset allocation portfolio is 8.5 70/30 asset allocation portfolio is 8.5

14% lower in risk vs the S&P 500 Bench14% lower in risk vs the S&P 500 Bench mark portfolio of 9.71mark portfolio of 9.71 54% probability the Diversified Port54% probability the Diversified Port > Than the S&P 500 > Than the S&P 500

Implication: A 60/40% asset allocation portfolio gives the investor a $.60 versus $.47 dollar return per unit of risk . This represents a 27% better rerturn per unit of risk over the S&P benchmark Portfo;io

5858

Exhibit-12Exhibit-123-Results – Proposition 3: – Monte Carlo Simulations 3-Results – Proposition 3: – Monte Carlo Simulations

for a Comparative Portfolio derived from for a Comparative Portfolio derived from Proposition 1&2 Compared to a Benchmark Portfolio Proposition 1&2 Compared to a Benchmark Portfolio

of the S&P 500 of the S&P 500 50% Equity/50% Debt50% Equity/50% Debt

Baseline S&P Portfolio-Baseline S&P Portfolio-VFINXVFINX

$1.00 Investment$1.00 Investment 100% Invested in S&P Fund- 100% Invested in S&P Fund-

VFINXVFINX Mean Value from the Mean Value from the



5959

Exhibit-12Exhibit-123-Results – Proposition 3 : – Monte Carlo 3-Results – Proposition 3 : – Monte Carlo

Simulations for a Comparative Portfolio derived Simulations for a Comparative Portfolio derived from Proposition 1&2 Compared to a Benchmark from Proposition 1&2 Compared to a Benchmark

Portfolio of the S&P 500 Portfolio of the S&P 500 50% Equity/50% Debt50% Equity/50% Debt

Power Coefficient PortfolioPower Coefficient Portfolio $1.00 Investment$1.00 Investment 29% Large Cap, 31% Mid Cap, 10% 29% Large Cap, 31% Mid Cap, 10%

Small Cap, 40% Fixed IncomeSmall Cap, 40% Fixed Income The Mean Value from The Diversified Portfolio The Mean Value from The Diversified Portfolio

simulation was 3.3% higher -$4.88 vs simulation was 3.3% higher -$4.88 vs $4.72 for the S&P 500 Portfolio $4.72 for the S&P 500 Portfolio

The Standard Deviation or Risk of the The Standard Deviation or Risk of the 70/30 asset allocation portfolio is 9.08 70/30 asset allocation portfolio is 9.08

2% lower in risk vs the S&P 500 Bench2% lower in risk vs the S&P 500 Bench mark portfolio of 9.24mark portfolio of 9.24 53% probability the Diversified Port53% probability the Diversified Port > Than the S&P 500 > Than the S&P 500

Implication: A 50/50% asset allocation portfolio gives the investor a $.54 versus $.51 dollar per unit of risk a 6% better rerturn per unit of risk over the S&P benchmark Portfo;io

CChapter 4- hapter 4- RecommendationsRecommendations

6060

This Section Outlines Conclusions:

– Proposition 1- Best Styles(LC.MC,SC, FI) Additional Comments:

– Proposition 2- Optimum Diversified Portfolio: Additional Comments

– Proposition 3- Comparative Analysis- Recommended Model Portfolio vs Baseline Index Equity and bond Portfolio

Additional Remarks

Proposition -1Proposition -1-- Marginal Efficiency of Investment- MEIMarginal Efficiency of Investment- MEI– What are the best investments per unit of risk by style.(LC.MC.SC)What are the best investments per unit of risk by style.(LC.MC.SC)

Based on the MEI power Coefficient and Monte Carlo simulation analysis Based on the MEI power Coefficient and Monte Carlo simulation analysis all the all the styles except Small Caps reflected a power coefficient higher than the styles except Small Caps reflected a power coefficient higher than the S&P.S&P.

The MEI results by style are:The MEI results by style are:– Large Cap- Large Cap- Vanguard Dividend Growth-VDGIXVanguard Dividend Growth-VDGIX– Mid Cap-Mid Cap- American Century MC Value-ACMVX American Century MC Value-ACMVX– Small Cap- Small Cap- Fidelity Small Cap Value-FCVPXFidelity Small Cap Value-FCVPX– Bonds –Bonds – Metropolitan West Total return- MWTRX- Metropolitan West Total return- MWTRX-

Allocating your investment portfolio with the above LC,MC,SC , Bond choices will give you Allocating your investment portfolio with the above LC,MC,SC , Bond choices will give you The optimum Architectural efficient segmentation.The optimum Architectural efficient segmentation.

Thus these investments were used to develop the portfolio used in the 2 Thus these investments were used to develop the portfolio used in the 2 Proposition.Proposition.

ChapterChapter 4- Recommendations:4- Recommendations:Proposition-1Proposition-1

Proposition -1- Additional Remarks :Proposition -1- Additional Remarks :

Research compleResearch completed in 2011 suggested that of the three styles LC,MC,SC …ted in 2011 suggested that of the three styles LC,MC,SC …that that midcap investments over 50 years of data provided the best value return midcap investments over 50 years of data provided the best value return per unit of risk. Including 2011 thru 2013 into the historical timeline does per unit of risk. Including 2011 thru 2013 into the historical timeline does NOT change the long term results.NOT change the long term results.

However in the short term, Given the 8 years 2007 thru 1However in the short term, Given the 8 years 2007 thru 1stst QTR 2016 , following QTR 2016 , following the financial crisis , it is of interest to verify the validity of this hypothesis given the financial crisis , it is of interest to verify the validity of this hypothesis given significant changes in exogenous variables such as extremely low interest rates, significant changes in exogenous variables such as extremely low interest rates, stimulative Fed Policy , Global Slow down and Global Central Bank policy(e.g. stimulative Fed Policy , Global Slow down and Global Central Bank policy(e.g. negative interest rates) that have a significant effect on savings and investment.negative interest rates) that have a significant effect on savings and investment.

The results of The results of Proposition 1-Proposition 1-indicate that, indicate that, during this period of very low during this period of very low interest rates, Large Caps (had a marginally better return value per unit interest rates, Large Caps (had a marginally better return value per unit of risk over Mid Caps and Small Caps as evidenced by the higher power of risk over Mid Caps and Small Caps as evidenced by the higher power coefficientscoefficients..

6262


So what changed to mitigate the previous results. Primarily it has to do with the Federal So what changed to mitigate the previous results. Primarily it has to do with the Federal Reserves manipulation of the yield curve to uncharacteristically low rates . The result has Reserves manipulation of the yield curve to uncharacteristically low rates . The result has caused a predictable misallocation of investor resources to Large Cap Value stocks. The caused a predictable misallocation of investor resources to Large Cap Value stocks. The reason is with the short end of the yield curve at uncharacteristically low levels(10 year reason is with the short end of the yield curve at uncharacteristically low levels(10 year bond rate at 1.7-2.0 percent) investors who need a monthly return to maintain there bond rate at 1.7-2.0 percent) investors who need a monthly return to maintain there standard of living moved to proxy bond investments with dividend paying large Cap Value standard of living moved to proxy bond investments with dividend paying large Cap Value stocks. So with a dividend rate of 3-4% and a growth factor of 1-3% , investors sold their stocks. So with a dividend rate of 3-4% and a growth factor of 1-3% , investors sold their bonds for proxy Large Cap Value stocks and forced a large volume move in in this vehicle. bonds for proxy Large Cap Value stocks and forced a large volume move in in this vehicle. The primary driver to this mass movement to proxy bonds thru the purchase of Large Cap The primary driver to this mass movement to proxy bonds thru the purchase of Large Cap dividend paying value investments was further exacerbated by the simultaneous Federal dividend paying value investments was further exacerbated by the simultaneous Federal reserve policy to implement the massive buying of mortgage back securities (QE1,2,3 2009 reserve policy to implement the massive buying of mortgage back securities (QE1,2,3 2009 -2013) to the tune of 85 billion a month..This forced Bond prices up and yields down at the -2013) to the tune of 85 billion a month..This forced Bond prices up and yields down at the shorter end of the yield curve driving even more investors to stocks.shorter end of the yield curve driving even more investors to stocks.

This was the main contributing factor to the temporary 5 year (2010-2015)slight advantage This was the main contributing factor to the temporary 5 year (2010-2015)slight advantage of large Caps over Midcaps. Once the yield curve assumes a more normal trajectory (10 of large Caps over Midcaps. Once the yield curve assumes a more normal trajectory (10 year at 4.- 5%) , income based risk averse investors will return the appropriate balance of year at 4.- 5%) , income based risk averse investors will return the appropriate balance of there portfolio’s to fixed income investments . there portfolio’s to fixed income investments .

When this will happen remains to be seen. When this will happen remains to be seen.

6363

Proposition -1- Additional Remarks (con):


Proposition -1- Additional Remarks : (Con)Proposition -1- Additional Remarks : (Con) The key will be when(timing) the Bond Market decides that there is not enough The key will be when(timing) the Bond Market decides that there is not enough

risk built into the yield curve to appropriately account for more GDP growth risk built into the yield curve to appropriately account for more GDP growth (currently1.8- 2% vs the long term trend of 3- 3.5%) and or Inflation( aprox 1.5 - (currently1.8- 2% vs the long term trend of 3- 3.5%) and or Inflation( aprox 1.5 - 2% which averages 2.5 to 3% ) such that the Federal Reserve begins to 2% which averages 2.5 to 3% ) such that the Federal Reserve begins to regurally increase the discount rate . regurally increase the discount rate .

Further there is a global slow down in international economies . The global central Further there is a global slow down in international economies . The global central banks in the EU and Japan have responded with fiscal policy to enhance growth banks in the EU and Japan have responded with fiscal policy to enhance growth with negative interest rates . When you are charging a penalty to save (negative with negative interest rates . When you are charging a penalty to save (negative interest rates) this has the compound effect of putting even more pressure on our interest rates) this has the compound effect of putting even more pressure on our bond market(flight to higher returns) through more demand by further pushing bond market(flight to higher returns) through more demand by further pushing prices up and yields down.prices up and yields down.

To this date (June 2016) , due to extremely low growth (1To this date (June 2016) , due to extremely low growth (1stst Qtr GDP .8%) the Fed Qtr GDP .8%) the Fed has had only one increase(Dec-2015) of 25 basis points in the discount rate to a has had only one increase(Dec-2015) of 25 basis points in the discount rate to a total of 50 basis points (.5) total of 50 basis points (.5)

The Fed has implied the intention to have 1-2 more rate increases this year The Fed has implied the intention to have 1-2 more rate increases this year following by 3-4 increases in 2017. following by 3-4 increases in 2017.

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ChapterChapter 4- 4- Recommendations:Recommendations:

Proposition-1Proposition-1

Proposition -1- Additional Remarks : (Con)Proposition -1- Additional Remarks : (Con) It should be noted It should be noted The statistical data model to calculate the MEI power coefficients (Proposition 1) to The statistical data model to calculate the MEI power coefficients (Proposition 1) to

determine the best Investments by style(LC,MC,SC, Fixed Income) were based on the latest 5 year data determine the best Investments by style(LC,MC,SC, Fixed Income) were based on the latest 5 year data inputs. Thus for this analysis the 5 year data periods were 2010-2015 and the Power Coefficient inputs. Thus for this analysis the 5 year data periods were 2010-2015 and the Power Coefficient calculation is based on data(growth rates, Standard deviation, expense ratio’s , Alpha and Beta) over a 5 calculation is based on data(growth rates, Standard deviation, expense ratio’s , Alpha and Beta) over a 5 year period. Further the growth rates or performance statistics were given a weighting of 70%. This year period. Further the growth rates or performance statistics were given a weighting of 70%. This appears to be an appropriate statistical model for defining the Best equity investments for each style(LC, appears to be an appropriate statistical model for defining the Best equity investments for each style(LC, MC,SC) .MC,SC) .

However, the primary interest in this additional research was to provide a better performance However, the primary interest in this additional research was to provide a better performance measure to identify how you should allocate investment dollars between the different measure to identify how you should allocate investment dollars between the different LC.MC,SC styles to provide maximum revenue return gain/unit of risk over say a 10 year LC.MC,SC styles to provide maximum revenue return gain/unit of risk over say a 10 year period of time.period of time.

Strategic planning horizons are different depending on the statistical goal. Identification of specific Strategic planning horizons are different depending on the statistical goal. Identification of specific investments by style(LC,MC,SC) probably have a life of 3-5 years. You may keep them…but you will re-investments by style(LC,MC,SC) probably have a life of 3-5 years. You may keep them…but you will re-evaluate annually within that time horizon. evaluate annually within that time horizon.

Asset allocation however is more dependent on your status within your long term planning horizon…Asset allocation however is more dependent on your status within your long term planning horizon… Your asset allocation will most likely change every 5-10 years driven by normal business, monetary and Your asset allocation will most likely change every 5-10 years driven by normal business, monetary and

fiscal cycles (recessions, recoveries , Fed Reserve etc) and personal risk assumptions . (age versus asset fiscal cycles (recessions, recoveries , Fed Reserve etc) and personal risk assumptions . (age versus asset accumulation and retirement)accumulation and retirement)

6565


--Thus an attempt was made to provide an appropriate time Thus an attempt was made to provide an appropriate time horizon For performance evaluation of different asset horizon For performance evaluation of different asset allocations to changes in Preference for risk. E.g. so in the the allocations to changes in Preference for risk. E.g. so in the the early stages of your first 10 years you might assume a 80% early stages of your first 10 years you might assume a 80% equity 20% bond allocation.equity 20% bond allocation. Risk Allocation SegmentationRisk Allocation Segmentation

6666

Proposition -1- Additional Remarks : (Con)



Segmentation AllocationFrom %

ToAllocation %

1-10 Years 70/30 80/20 11-20 Years 60/40 70/30 21-30 Years 55/45 60/40 31 and beyond 50/50 55/45

NOTENOTE: The Highest Small Cap Investment PC was close but did not : The Highest Small Cap Investment PC was close but did not exceed the S&P 500. However, as you will see in Proposition 2- exceed the S&P 500. However, as you will see in Proposition 2- when a 10 year planning horizon is evaluated the revenue per unit when a 10 year planning horizon is evaluated the revenue per unit of risk is higher than the S&P and thus an appropriate allocation of risk is higher than the S&P and thus an appropriate allocation of 7-10% is recommended for portfolio diversification.of 7-10% is recommended for portfolio diversification. 2-Other Recommendations with high Power Coeff:2-Other Recommendations with high Power Coeff:Large CapsLarge Caps–Parnassus Core LC Equity Investment- PRBLXParnassus Core LC Equity Investment- PRBLX–T Rowe Price LC Dividend Growth- PRDGXT Rowe Price LC Dividend Growth- PRDGXFixed IncomFixed Incomee–Dodge and Cox Income- DODIXDodge and Cox Income- DODIX–Fidelity GNMA- FGMNXFidelity GNMA- FGMNX–Janus Flexible Bond- JAFIXJanus Flexible Bond- JAFIX

6767


6868

Sector – Analysis- High to LowSector – Analysis- High to Low- - The Following Sector ETF’s warrants consideration based on Power Coef‘s The Following Sector ETF’s warrants consideration based on Power Coef‘s Greater than the S&P 500. Note the high power coefficient for Consumer Greater than the S&P 500. Note the high power coefficient for Consumer

Staples is due in some respect to the substitution effect of Staples is due in some respect to the substitution effect of dissallusioned bond investors seeking a lower risk alternative (relative dissallusioned bond investors seeking a lower risk alternative (relative to alternative Equity Sectors) with 3 to 4% dividend income plus 2 to to alternative Equity Sectors) with 3 to 4% dividend income plus 2 to 3% growth vs a 1 to 2 % yield in fixed income investments.3% growth vs a 1 to 2 % yield in fixed income investments.

See EXHIBIT-1…. page 18See EXHIBIT-1…. page 18

– Consumer Staples- XLP- Highest Power CoefficientConsumer Staples- XLP- Highest Power Coefficient– Technology-PTFTechnology-PTF– Cyclicals- XLYCyclicals- XLY– Utilities- XLUUtilities- XLU– Healthcare- XLVHealthcare- XLV



Proposition -1- Additional Remarks : (Con)Proposition -1- Additional Remarks : (Con)::– Note: TNote: There are no international recommendations at this time.here are no international recommendations at this time.– The reason is……….. international investments (all except Artisan Global Value The reason is……….. international investments (all except Artisan Global Value

Investor-ARTGX) reflect lower power coefficients relative to domestic opportunities. Investor-ARTGX) reflect lower power coefficients relative to domestic opportunities. This is primarily because growth in Europe(less than 1%) and the BRICS is lower This is primarily because growth in Europe(less than 1%) and the BRICS is lower (tending toward deflation) than the States. The ECB has moved to lower interest (tending toward deflation) than the States. The ECB has moved to lower interest rates to stimulate investment and improve growth. Continual reductions have led to rates to stimulate investment and improve growth. Continual reductions have led to negative interest rates which has had little to no monetary effect on total negative interest rates which has had little to no monetary effect on total investment, velocity of money and thus GDP Growth.investment, velocity of money and thus GDP Growth.

– The results of this excessively tight monetary policy leads to foreign investments re-The results of this excessively tight monetary policy leads to foreign investments re-allocated to higher growth opportunities in the states which adds to higher asset allocated to higher growth opportunities in the states which adds to higher asset pricing and more growth in earnings and markets.pricing and more growth in earnings and markets.

– Monitor global markets and when European Central Bank rates turn positive and Monitor global markets and when European Central Bank rates turn positive and look to INCREASE rates two to three times in a calander year (indicating look to INCREASE rates two to three times in a calander year (indicating accelerating growth in GDP ) add moderate exposure of 5% of the total Bond accelerating growth in GDP ) add moderate exposure of 5% of the total Bond allocation percentage to allocation percentage to Artisan Global Value Investor- ARTGXArtisan Global Value Investor- ARTGX. .

6969



This is another reason for short to middle term optimism about Stocks. This is another reason for short to middle term optimism about Stocks. Until the economic climate changes , overseas investors see more Until the economic climate changes , overseas investors see more opportunity here. opportunity here.

Note further when the fed decides to continue to tighten…or even Note further when the fed decides to continue to tighten…or even implications thru interpretation of release transcripts of fed meeting implications thru interpretation of release transcripts of fed meeting minutes, the market is likely to drop , in the short run 5-15%. The minutes, the market is likely to drop , in the short run 5-15%. The driver to tightening would be greater GDP growth > =3% or inflation driver to tightening would be greater GDP growth > =3% or inflation >=1.9-2% . The Fed has increased rates once( Dec 2015.) and thru >=1.9-2% . The Fed has increased rates once( Dec 2015.) and thru Fed Reserve Meetings suggests possibly 1 to two Additional rate Fed Reserve Meetings suggests possibly 1 to two Additional rate increases in 2016 and 2-4 more in 2017.increases in 2016 and 2-4 more in 2017.

Finally….when choosing an investment or group of investments, it is Finally….when choosing an investment or group of investments, it is important to select that which invests in growth sectors. One of the important to select that which invests in growth sectors. One of the reasons this portfolio has positive results(per high Alpha’s discussed reasons this portfolio has positive results(per high Alpha’s discussed earlier) earlier) is the correct sector diversification in is the correct sector diversification in iiConsumer Consumer Staples, Technology, Cyclicals and Health cäreStaples, Technology, Cyclicals and Health cäre

Proposition -1- Additional Remarks : (Con)



Propositin -2-Additional RemarksPropositin -2-Additional Remarks– ForFor the calculation of the MER(Marginal Efficiency of Rev Return) to the calculation of the MER(Marginal Efficiency of Rev Return) to

determine the percent allocation to be used between styles a 10 year planning determine the percent allocation to be used between styles a 10 year planning horizon was used. This analytic provides a better horizon was used. This analytic provides a better LONG TERM View of LONG TERM View of return/revenue potential per unit of Risk and more appropriate for return/revenue potential per unit of Risk and more appropriate for determining an allocation strategy between equity styles(LC, MC, SC)determining an allocation strategy between equity styles(LC, MC, SC)

– Is there an optimum allocation to be used to allocate among equity Is there an optimum allocation to be used to allocate among equity alternatives that will beat the S&P 500alternatives that will beat the S&P 500..

– Yes…Using the Identification of Equity alternatives across (LC, MC,SC) –Yes…Using the Identification of Equity alternatives across (LC, MC,SC) –Proposition 1 Proposition 1

– The following is the % allocation from the results of MER analysis , Proposition The following is the % allocation from the results of MER analysis , Proposition 2 . The following portfolio is defined as the optimum allocation (see page 19 2 . The following portfolio is defined as the optimum allocation (see page 19 and 20) and 20)

ChapterChapter 4- 4- Recommendations:Recommendations: Proposition-2 Proposition-2

Proposition -2-Additional Remarks(con)Proposition -2-Additional Remarks(con)1.1. Large Caps- Large Caps- 42% of equity allocation42% of equity allocation

1.1. The best of the Large caps = The best of the Large caps = Vanguard Dividend Growth- Vanguard Dividend Growth- 2.2. VDGFX= 31% higher Power Coefficient than the S&P 500 and a VDGFX= 31% higher Power Coefficient than the S&P 500 and a

55% probability of exceeding the s&P 50055% probability of exceeding the s&P 5002.2. Mid Caps- Mid Caps- 44% of equity allocation44% of equity allocation

n The best of the Midcaps =The best of the Midcaps =American Century Value-ACMVXAmerican Century Value-ACMVXn VDGFX= 25% higher Power Coefficient than the S&P 500 and a VDGFX= 25% higher Power Coefficient than the S&P 500 and a

55% probability of exceeding the s&P 50055% probability of exceeding the s&P 5003.3. Small Caps- Small Caps- 14% of equity allocation14% of equity allocation

1. 1. The best of the small caps=The best of the small caps=Fidelity Small Cap Value –FCPVXFidelity Small Cap Value –FCPVX 2- 2- VDGFX= 40% probability of exceeding the S&P 500VDGFX= 40% probability of exceeding the S&P 500

4 . 4 . Fixed Income- Bonds- Fixed Income- Bonds- 1.Metropolitan West Total Return – MWTRX-

7272

ChapterChapter 4- 4- Recommendations:Recommendations: Propos Proposition-2ition-2

7373

Proposition -2-Additional Remarks(con)Proposition -2-Additional Remarks(con) 1- Recommended Model Portfolio1- Recommended Model Portfolio::

• Large Caps: Large Caps: – Vanguard Dividend Growth- VDGIXVanguard Dividend Growth- VDGIX– % allocation- % allocation- – 70/30 - 29%70/30 - 29%– 60/40 - 25%60/40 - 25%- 50/40 - 21%- 50/40 - 21%– Future Allocation: As Fed tightens…Decrease allocation by 3% per Future Allocation: As Fed tightens…Decrease allocation by 3% per

allocation .allocation .

• Mid Caps:Mid Caps:– American Century Midcap Value- ACMVXAmerican Century Midcap Value- ACMVX– % allocation- % allocation- – 70/30 - 31%70/30 - 31%– 60/40 - 26%60/40 - 26%– 50/40 - 22%50/40 - 22%– Future Allocation; As Fed tightens…increase allocation by 3% per Future Allocation; As Fed tightens…increase allocation by 3% per

allocation allocation


7474

• Small Caps:Small Caps:– Fidelity Small Cap Value- FCPVXFidelity Small Cap Value- FCPVX– % allocation- % allocation- - 70/30 - 10%- 70/30 - 10%– 60/40 - 9%60/40 - 9%– 50/40 - 7%50/40 - 7%– Future Allocation; - as Fed tightens…Maintain –Future Allocation; - as Fed tightens…Maintain –

Fixed IncomeFixed Income– Metropolitan West Total Return-MWTWXMetropolitan West Total Return-MWTWX– % Allocation- 40%...Bond durations should be < = 5 % Allocation- 40%...Bond durations should be < = 5

YearsYears– Monitor…for every 100 basis point increase in 10 Bond Monitor…for every 100 basis point increase in 10 Bond

rate rate year results in 5% decrease in yield(valueyear results in 5% decrease in yield(value))


Proposition -2-Additional Remarks(con)

Proposition 3- Additional Remarks;(con) Proposition 3- Additional Remarks;(con) – The following Portfolio ‘s will be analyzed via Monte Carlo simulations to The following Portfolio ‘s will be analyzed via Monte Carlo simulations to

determine investor valuedetermine investor value– 1-Comparatives Economics of Alternative Equity/Debt 1-Comparatives Economics of Alternative Equity/Debt Allocations:Allocations:

ToTotal of: % Large Caps + %Midcaps +%Small Caps + %Fixed Income = $1.00tal of: % Large Caps + %Midcaps +%Small Caps + %Fixed Income = $1.00 Total Of S&P 500 baseline Total Of S&P 500 baseline % VFINX(S7P 500 Benchmark) + %LAG(Bond Benchmark)= $1.00% VFINX(S7P 500 Benchmark) + %LAG(Bond Benchmark)= $1.00

– 2-70% Equity vs 30% Debt2-70% Equity vs 30% Debt Equity AllocationEquity Allocation



59% probability the 70/30 % diversified Portfolio > the S&P 50059% probability the 70/30 % diversified Portfolio > the S&P 500

7575





54% probability the 60/40 % diversified Portfolio > the S&P 50054% probability the 60/40 % diversified Portfolio > the S&P 500




53% probability the 50/50 % diversified Portfolio > the S&P 50053% probability the 50/50 % diversified Portfolio > the S&P 500 --

7676

Proposition 3- Additional Remarks; (con)


– The ALPHA’s for the recommended portfolio The ALPHA’s for the recommended portfolio have high multiples( 2.7 to 7.2) compared to have high multiples( 2.7 to 7.2) compared to the S&P 500the S&P 500

– NOTE:NOTE: When GDP growth has 2 consecutive When GDP growth has 2 consecutive quarters quarters

of 4-4.5% growth increase the allocation of of 4-4.5% growth increase the allocation of Small Caps Small Caps

3-5% and Midcaps 3-5% and subtract the 6 – 3-5% and Midcaps 3-5% and subtract the 6 – 10% from10% from

the Large Cap allocation.the Large Cap allocation.7777

Proposition 3- Additional Remarks (con)


mer for optimum allocation accross investment alternatives...

Economy & Finance