Download Northern`s Advantages

Risk Management Strategies
In Today’s Economic Environment
September 11, 2007
Michael Leon
Senior Vice President
© 2007 Northern Trust Corporation
Gary M. Kramer
CFA Vice President
northerntrust.com
Client Profile
 Private


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Sold business to publicly traded companies
in stock for stock deals
Corporate Executives


Business Owners
Stock and stock options
Investors

Private equity and Venture Capital distributions

IPO’s

Strategic investments
The Northern Experience
Investment Concentrations

What Constitutes a Concentration?

Determined by Facts and Circumstances
Size of Account
Size of Holding
Outside Assets

Exclusions
 U.S.
Treasury and Agency Securities
 Mutual
Funds, Common Funds
 Personal
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The Northern Experience
Residence
Risk
However good our stock market research may be, we shall
never be able to escape from the ultimate dilemma that all
of our knowledge is about the past, and all of our decisions
are about the future.
Ian Wilson, American Risk Strategy Consultant
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The Northern Experience
Why Clients Should Diversify

To reduce overall portfolio volatility
 Increase
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risk adjusted rates of return

Decrease risk of a stock disaster

The average single stock has about twice the volatility
as a well diversified portfolio such as the S&P 500
The Northern Experience
The Forbes 400
145 Names
Dropped Off
because of Death,
Shifting Assets
50 Names Still on
List
13%
36%
51%
205 Names
Dropped Off
Forbes Magazine, October 11, 2004
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The Northern Experience
High Volatility Reduces Returns
Stocks can have equal arithmetic rates of return, but
differ markedly in their real or compounded rates of
return depending on how they fluctuate in price.
Stock Returns
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Beginning
Price
Year
One
Year
Two
Year
Three
Arithmetic
Return
Compound
Return
Ending
Price
Stock A
$100
10%
10%
10%
10%
10.0%
$133.3
Stock B
$100
35%
-20%
15%
10%
7.49%
$124.2
Stock C
$100
40%
20%
-30%
10%
5.50%
$117.6
The Northern Experience
Monte Carlo Analysis
Starting Value:
$10MM
Distribution of Final Value at end
for 20 Years, No Liquidation
Chance of Ending with:
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(A) Initial Holdings
(B) Index Fund
Less than $5.0MM
0.70%
0.00%
Less than $10.0MM
5.10%
0.70%
Less than $20.0 MM
17.90%
10.00%
More than $100.0 MM
16.90%
7.70%
The Northern Experience
Modern Portfolio Theory
Most important lesson one learns from modern
portfolio theory is to…
DIVERSIFY!
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The Northern Experience
Concerns About Diversification

Adverse Income Tax Consequences

Unfamiliarity with Other Asset Classes

Loss of Control

Performance Expectations

Legacy Holdings
 Impact

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The Northern Experience
Fees
on Portfolio Yield
Evaluating Exposure Management Strategies
Hold
Options / Derivatives
Planned Giving
Exchange Funds
Sell
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The Northern Experience
Developing Best Practices

Financial Planning / Investment Policy
 Focus:

Asset Allocation
 Focus:

Goals, not Performance
“The R word” (and it’s not “Return”)
Implementation
 Evaluate

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The Northern Experience
all possible strategies
Monitoring and Periodic Re-evaluation
Northern’s Advantages
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The Northern Experience

Access to Best in Class Products

Competitive Pricing

Best Practices ― Fiduciary Culture
Aligns Interest with our Clients
Parting Thoughts
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
Investors are generally overconfident. Studies show that investors
often overestimate the future performance of their stock, and
almost always overestimate their ability to predict performance.

Even sophisticated investors have trouble identifying and
understanding risk. Investors tend to myopically focus on returns
and regularly assume significant degrees of diversifiable risk.

Psychological or emotional factors often drive short-term investing
decisions rather than objective planning.
The Northern Experience
Interest Rate Risk Management
© 2007 Northern Trust Corporation
northerntrust.com
Interest Rate Forecasts
Economists
Financial Futures Markets
Crystal
Balls
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The Northern Experience
Where Are Interest Rates Headed?


The Economists Say ―

The current average forecast of 60 economists surveyed by the Wall Street
Journal for 10 Year Treasury Rates at year end is 5.16%

The range of forecasts for 10 Year Treasury Rates at year end is 4.14% - 6.20%.
Financial Futures Markets Say ―


Crystal Ball Says ―

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“Turmoil in credit and stock markets had prompted Wall Street traders as recently
as Monday to place odds of a rate cut in September at 70%. The Fed dashed
those expectations, though, and the odds plunged to 25% yesterday, as indicated
by futures-contracts pricing.”*
― Wall Street Journal, Wednesday 8/8/07
“Rates tomorrow will be different than today”
The Northern Experience
Interest Rate Risk – What is it?

Risk posed by unexpected changes in interest rates

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Changes relative to economic forecasts, implied
financial futures forecasts, crystal ball forecasts
The Northern Experience
Interest Rate Risk

Risk to unexpected changes in Cash Flows

Risk to unexpected changes in Valuation
How Do We Manage This Risk?
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The Northern Experience
Interest Rate Risk Management – What it is not!
Interest Rate Risk Management is
NOT a Strategy or Series of Strategies
Which Tries to Forecast and Take Advantage
of the Highs and Lows in Interest Rates!
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The Northern Experience
Interest Rate Risk Management
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The Northern Experience

Identifying the Risks

Establishing Tolerances

Evaluating Strategies

Implementing Solutions

Monitoring Environment
Northern Trust’s Interest Rate Risk Management Expertise
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
Northern can assist in identifying and quantifying risk

Northern can then customize a solution that matches
client needs with the most appropriate instruments,
working within client objectives by discussing alternative
hedging strategies and their benefits and costs
The Northern Experience
Examples of Customized Solutions
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
Loan Refinancing

Fixed rate loan with “liquidity crisis kicker”

Modification of amortization schedule AND aversion of
prepayment penalty AND providing a lower rate to borrower
The Northern Experience