PORTFOLIO MANAGEMENT

Managing Individual Investor PortfolioBy

Shoaib Chatta

Client Profile

Mr. & Mrs. Johnson

Politically and financially stable country

GDP 8%, Inflation 3%, Flat-tax rate 35%, Avg. age 65

Mark Johnson 37, Susan Johnson 35

Combined salary $225,000

Inheritance $7.9 million, savings acct. balance $200,00

Client Profile (Contd.)

Porsche $52,000, Lexus $33,000, Condominium $300,000

Can take calculated risk, interested in high return especially in alternative assets and emerging market classes

Want to see return in pre-retirement & post-retirement basis

Objectives

Return:

A return that should replace 80% of their combined salary, should offset inflation impact, translate into an inflation adjusted pre-tax ROR of 10.32%, risk adjusted ROR of 8.9% and inflation adjusted post-tax ROR of 6.71% before retirement

Risk:

Ability to absorb moderate volatility, willing to take calculated risk

Constraints

Internal:

Liquidity requirements include $20,000 for recreation, $38,000 for 529-A education plan for their kids, $10,000 for IRA, $15,000 rainy day and $25,000 emergency in post-retirement arena and 80% of combined salary in pre-retirement period

Time horizon is 30 years both pre and post-retirement

Due to their unique experience with use of options to hedge interest rate risk and stock market risk, they propose to consider it

Constraints (Contd.)

External:

Want to stay in 35% flat-tax bracket

Want retirement savings account to be managed in compliance with prevalence fiduciary standards for diversification and prudence

Not interested in South Asian market due to child labor problem and tobacco market due to health hazard concerns

Investment Policy Statement

Written records & minutes of all decisions will be maintained pertaining to choice & monitoring of investment funds

Investment option will based upon diversification and to cover a wide risk/return spectrum to maximize returns within reasonable and prudent levels of risk to provide returns comparable to returns for similar investment options and to control administrative and management costs to the plan and participants.

Investment Policy Statement (Contd.)

The investment selection criterion will take into consideration the investment option’s volatility and performance relative to benchmarks

It’s demonstrated adherence to stated investment objectives competitiveness of fees and expense ratios

It will be compared to similar investments, the organization’s size, structure, and history; management profile and investment philosophy

Investment Policy Statement (Contd.)

The investment committee will reevaluate each asset class and investment vehicle based upon the foregoing criteria, no less frequently than annually, in order to determine the continuing suitability of each such option under the plan.

The benchmarks that will be pursued to meet risk, return and rating objectives of different asset classes will be S&P 500 index, Moody’s, Russell 2000 and MSCIA

Capital Market Expectations

Bonds and Private Equity 30 year US treasuries predicted to yield 4.95%

and 10 year US treasuries to yield 4.25% in 2010

High yield bonds expected to provide a return of 10% with a standard deviation of

The corporate default rate is predicted to reach 4.5 to 6%

5 year private equity’s annualized return was nearly 12%

The slow growth of the economy and the lock-in period makes PE a “no go”

Capital Market Expectations

Equities Analyst have predicted the bull market to continue

in 2010 with large cap stocks outperforming the small cap

Equity return is expected to be around 10% in 2010

The healthcare sector is expected to provide better returns in 2010

The technology stocks will be the first to take advantage of the bull market

The mid cap and the small cap is expected to provide a return of 7.43% and 8.8%

Capital Market Expectations

Real Estate Housing prices will be low or further decrease

due to the high unemployment rate

The current housing prices are still above the 2000 level

Supply is way above the demand for the commercial sector

With the increase in companies spending commercial real estate will be a good investment in the future

Capital Market Expectations Absolute-Return Strategies

Performance in 2009

In 2009 Hedge Funds generated the best returns in the recent history

In 2009, Markets Normalizing, Uncertain events and Mergers, Uncertainty in Markets, Technical Factors Correcting, Global Economy recovering, Global Economy exiting the recession.

Returned were driven by Alpha

In 2009, Tremont Hedge Funds Index returned 19%

In 2009, HFRI Index returned around 20%

Capital Market ExpectationsThe Best Performers

Fixed-Income Convertible Arbitrage returning 60% with Standard Deviation 9.57%

Emerging Markets returning 40.38% with the Standard Deviation of 11.80%

Distressed Securities returning 28.18% with the Standard Deviation of 6.51%

Event Driven returning 25.19 % with the Standard Deviation of 5.64%

Relative Value Arbitrage returning 25.94% with the Standard Deviation of 3.62%

Equity Hedge returning 24.60% with the Standard Deviation of 1.78%

Merger Arbitrage returning 11.79% with the Standard Deviation of 1.80%.

Capital Market Expectations Absolute-Return Strategies

Going Forward

Still above normal returns, although lower than in 2009.

Today the markets are a lot more predictable and many opportunities are exhausted.

Many Opportunities Global, Economy is still recovering, Many uncertain events.

Capital Market ExpectationsThe Best Future Performers

Energy/Basic Materials Sector 13%

Distressed Securities returning around 12%

Merger Arbitrage returning around 11%.

Capital Market Expectations Emerging Markets

In 2009 MSCI returned 79% Standard Deviation 32%

Demand for Products by developed nations

Increased domestic consumption

The global demand for commodities

Currently Emerging Markets are Fairly valued when compared to the historical P/E ratios

Future Expectations are positive as markets will continue to recover

Future Expectations for Emerging Markets

MSCI will return around 12-18%

The Best Performers will be

Brazil: expected return 19% Std Dev 40.19%

South Korea: expected return 18% Std Dev 39%

South Africa: expected return 15% Std Dev 30.17%

Risk ManagementRisky Assets

Ability and willingness to take risk of the investor

Default risk of company’s issuing High Yielding Bonds

Interest rate risk in Bonds

Exchange rate risk in Emerging market Investments

Risk Management Bonds and Equities

Managers of Bonds and Equities will be asked to maintain a “Snake Tunnel”

Upper limit 4% and lower limit 2.5%

High Yielding Bond default risk to be hedged using “Credit Default SWAPS”

Calendar Rebalancing and constant mix strategy will be implemented every six months

Hedging Interest rate risk through repurchase agreements or futures

Risk Management Absolute-Returns

Only Invest In Specified Strategies

Control of exposure to any one strategy

Limit exposure to a single entity

Must match the historical performance

Diversification

We will invest in index to limit exposure to a single manager

Risk Management Emerging Markets

Diversification

Only invest in specified markets

Limit exposure to a single entity

Control amount at risk

Do not attempt to outperform the market

Follow the performance of the specified Index or Market

Asset AllocationMedium Risk (Selected

portfolio)Asset Return MR Return Std Dev MR Risk

High Yield Bonds 14 12% 1.68% 10.00% 1.40%

Corporate Bonds 10 7% 0.68% 5% 0.50%

Technology Stocks 11 16.80% 1.85% 16% 1.76%

Healthcare 14 4.80% 0.67% 10% 1.40%

Mid cap 12 7.43% 0.89% 12.25 0.75%

Small cap 9 8.80% 0.79% 18% 1.62%

HFRI EH: Sector - Energy/Basic Materials Index 10 13.00% 1.30% 12.05% 1.21%

HFRI ED: Distressed/Restructuring Index 7 12.00% 0.84% 6.51% 0.46%

HFRI ED: Merger Arbitrage Index 8 11.00% 0.88% 1.80% 0.14%

MSCI Emerging Markets EM Index 3 15.00% 0.45% 28.00% 0.84%

MSCI Brazil Index 0 19.00% 0.00% 40.19% 0.00%

MSCI South Korea Index Fund 0 18.00% 0.00% 39.00% 0.00%

MSCI South Africa Index 2 15.00% 0.30% 30.17% 0.60%Total     10.33%   9.20%

[C] Conservative Portfolio and[HR] High Risk Portfolio

Asset C weights C return C Risk HR Weights HR Return HR Risk

High Yield Bonds 10% 1.20% 1.00% 10% 1.20% 1.00%

Corporate Bonds 35% 2.380% 1.75% 5% 0.34% 0.25%

Technology Stocks 5% 0.8400% 0.80% 30% 5.04% 4.80%

Healthcare 12% 0.5760% 1.20%

Mid cap 10% 0.74% 0.015

Small cap 5% 0.44% 0.90%

HFRI EH: Sector - Energy/Basic Materials Index 0.00% 10% 1.30% 1.21%

HFRI ED: Distressed/Restructuring Index 9% 1.0800% 0.59% 5% 0.60% 0.33%

HFRI ED: Merger Arbitrage Index 29% 3.1900% 0.52% 0.00%

MSCI Emerging Markets EM Index 10% 1.50% 2.80%

MSCI Brazil Index 10% 1.90% 4.02%

MSCI South Korea Index Fund 5% 0.90% 1.95%

MSCI South Africa Index

Total   9.27% 5.86%   13.96% 18.75%

Performance January 1 2010 – March 31 2010

Asset Actual Return

High Yield Bonds 7%

Corporate Bonds 5%

Technology Stocks 5.8%

Healthcare 1.24%

Mid cap 8.9%

Small cap 7.5%

HFRI EH: Sector - Energy/Basic Materials Index 1.86%

HFRI ED: Distressed/Restructuring Index 5.70%

HFRI ED: Merger Arbitrage Index 1.86%

MSCI Emerging Markets EM Index 2.40%

MSCI Brazil Index -0.12%

MSCI South Korea Index Fund 3.75%

MSCI South Africa Index 4.57%

Total  4.97%