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February 4, 2010

February 4, 2010 1. Do Not Try to Time the Market Flows to Equity Funds Related to Global Stock Price Performance Source: Investment Company Institute The Danger of Trying to Time the Market 15 Year Average Annual Returns (1994-2008) 15 Year Average Annual Return 6.5% 1.9% -3.7 %

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February 4, 2010

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  1. February 4, 2010

  2. 1. Do Not Try to Time the Market Flows to Equity Funds Related to Global Stock Price Performance Source: Investment Company Institute

  3. The Danger of Trying to Time the Market 15 Year Average Annual Returns (1994-2008) 15 Year Average Annual Return 6.5% 1.9% -3.7% -10.0% -14.6% Stayed the course Missed Best 10 Days Missed Best 30 Days Missed Best 60 Days Missed Best 90 Days Investor Profile Source: Standard and Poor’s, Davis Advisors, and Vanguard Investment Strategy Group. The market is represented by the S&P 500Index. Past performance is not a guarantee of future results.

  4. There is Also a Selection Penalty Quarterly Flow into Growth and Value Funds, and the Nasdaq’s Close Nasdaq Net Flow (bil) Total Flow Growth: $363b Value: $96b Source: Strategic Insight

  5. Average Stock Fund Return vs. Average Stock Fund Investor Return (1988-2007) 11.6% Average Annual Return The “Investor Behavior” Penalty 4.5% Source: Quantitative Analysis of Investor Behavior by Dalbar, Inc. (July 2008) computed the “average stock fund investor” returns by using industry cash flow reports from the Investment Company Institute. The “average stock fund return” figures represent the average return for all funds listed in Lipper’s U.S. Diversified Equity fund classification model.

  6. 2. Use Dollar Cost Averaging

  7. The Advice of Warren Buffett A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices on beef? Likewise, if you are going to buy a car from time to time but are not an auto Manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves. But not for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.

  8. 3. Rebalance Yearly During this period, an annually rebalanced portfolio provided lower volatility and higher return

  9. 4. Diversify, Diversify. Diversify • Few Places to Hide During World Wide Recession • But Safe Bonds (e.g. U.S. Treasury Bonds) and Gold Helped • While Correlations Have Risen There Have Been Large Differences in the Returns of Different Asset Classes

  10. Time Varying Stock-Bond Correlation Moving three-year stock-bondreturn correlations Long-term average Data: 10Y Treasury return is calculated from 10Y Treasury yields. Yields are originated from FRB website. Domestic stocks: 1926-1970 S&P 500 Index (monthly reinv); 1971 – 4/22/2005 Dow Jones Wilshire 5000 Index; 4/22/2005 – present MSCI US Broad Market Index

  11. Diversification Into Emerging Markets Helped During the Lost Decade +250% +200 +150 +100 +50 -50 Emerging markets Annual growth rate for the decade: 10.1% Developed markets Growth rate: 0.2% ‘00 ’01 ’02 ‘03 ‘04 ‘05 ’06 ’07 ’08 ‘09 Sources: MSCI and Bloomberg

  12. A Lost Decade? Value of $100,000 invested on January 1, 2000 50% bond, 25% U.S. stock, 25% international stock With $1,000 monthly contributions And annual rebalancing Advantages of Diversification, Rebalancing and Dollar-Cost Averaging $300,000 250,000 200,000 150,000 100,000 50,000 0 S&P 500 index ’00 ‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ’08 ‘09 Source: Vanguard Adjusted for inflation.

  13. 5. Costs Matter Source: Lipper data for all General Equity funds

  14. Costs Matter Actively-Managed mutual funds with low costs outperform funds with high costsDecember 31, 1994 through December 31, 2009 8.66% Net Return to Investors 6.66% Source: Lipper data for all General Equity funds

  15. 6. Use Index Funds • Markets are reasonably efficient • But even if they are not efficient, indexing is an optimal strategy

  16. Distribution of returns Likelihood Better than the market Below the market 6% 10% 8% = Market Performance Investment Performance is a Zero-sum Game

  17. Indexing works Likelihood Below the market Better than the market 6% 7.0% 10% 8% = Market Performance Impact of costs After Costs, Active Management is a Negative-sum Game

  18. Large-cap Equity Funds Versus S&P 500 Index Percentage of large-cap equity funds outperformed by S&P 500 Periods ended December 31, 2008 Sources: Lipper, and Vanguard.Past performance is no guarantee of future results.

  19. The Odds of Success: Returns of Surviving Funds Mutual Funds 1970-2009 Compared with S&P 500 Returns • Number of equity funds • 358 • 2009 119 • Nonsurvivors 239 29 28 Number of equity funds 21 18 14 3 2 2 2 Annualized Returns 1970-2009 Sources: Lipper and Vanguard.

  20. Percentage of Actively Managed Bond Funds Outperformed by the Benchmark 10 years ended December 31, 2008 Source: Morningstar, Barclays Capital and The Vanguard Group.

  21. It’s Down to One Of 14 funds that beat the Standard & Poor’s 500-stock index for nine consecutive years through 2007, only one continued that feat last year. 2008 return (prelim.) -35 M&N Pro Blend Max S S&P 500 (with divs. reinvested) -37 -40 Amer Funds Fundamental A Target Gr Alloc A -40 -41 Lord Abbett Alpha Strat A T. Rowe Price Spect Grth -42 -43 JPMorgan Small Cap Gr A Hartsford Cap App HLS 1A -46 -47 AIM Capital Development A Columbia Acorn Select Z -50 -49 T. Rowe Price New Era Fidelity Select Natural Res -52 -53 Jennison Natural Res B Fidelity Adv Energy T Ivy Global Natural Res A -54 -61 From: The Wall Street Journal, 1/5/09

  22. Satellite 1 Satellite 2 Index core Satellite 3 Potential Advantages of Core-Satellite Approach Core portfolio (indexed investments) Low costs vs. active management Lower risk budget versus active management Diversification (broad indices) Close tracking of benchmark performance Satellite portfolio (active investments) Take “bets” to enhance returns (add alpha) Higher costs versus indexed management Decorrelation Require strong selection skills Can use illiquid assets

  23. Despite Decades of Uncertainty the Long-Run Trend of the Stock Market Has Been Up ? 14000 4,000 2,000 16 Years Billions 25 Years

  24. Valuations Are Moderate Shiller PE Ratio (S&P 500 Real Price/10-Yr Average Real Earnings Source: Robert Shiller website

  25. Median Ten-Year Annual Compound Total Returns from Historic P/E Deciles 1926 to 2008 16.92% 15.99% 15.20% 14.48% 13.86% 11.55% Return (%) 9.32% 8.01% 5.69% 3.27% Stocks Cheap Stocks Expensive

  26. Diversification Again The Home Country Bias U.S. ≈ 40% of World Emerging Markets Are Growing Faster than Developed Markets China‘s Growth Has Been Unprecedented China Likely to Surpass Japan Yuan is Severely Undervalued

  27. China’s GDP as a Percent of World Total* Source: Historical Statistics for the World Economy – Angus Maddison, ISI. *Adjusted for purchasing power parity

  28. China’s Strengths • Underdeveloped Center and Western Regions • Tremendous Human Capital • Educated • Hard Working • Entrepreneurial • Government Policy Promotes Growth • Strong Fiscal Balance

  29. Assessing China Through Low-Cost ETFs • FXI vs. YAO • HAO • Closed-end Funds

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