The 7Twelve Portfolio

The Benefits of Low Correlation

Craig L. Israelsen, Ph.D.

Brigham Young University

www.7TwelvePortfolio.com
41 slides
1

This document is a research report presenting portfolio research and

analysis.
This document is neither investment advice nor an investment solicitation.
Implementation of the

7Twelve portfolio is no guarantee of

performance.

--------------------------------------------------------------------------------------------This is a copyrighted document, copying for redistribution is

prohibited unless written permission is
obtained from Craig L. Israelsen.

Copyright 2008 Craig L. Israelsen

All rights reserved
2

Presentation Overview
Part

One provides a historical context of

the benefits of a multi-asset, low
correlation portfolio.
Two introduces the 7Twelve
Portfolio, a multi-asset, low correlation
global portfolio.

Part

Part One

Historical Asset Returns

38-Year Period
from 1970-2007

Annualized
Std Dev of
Return (%) Annual Returns

Growth of
$10,000

REIT

12.38

18.45

843,476

Commodities

12.02

23.93

747,183

US Small Stock

11.74

21.68

678,684

US Large Stock

11.08

16.62

542,040

International Stock

10.86

21.54

503,316

8.10

5.39

193,131

Cash

6.29

3.07

101,701

Inflation

4.62

3.08

55,618

Bonds

(Intermediate)

Data

Large-cap US equity represented by the S&P 500 Index.

Small-cap US equity represented by the Ibbotson Small Companies

Index from 1970-1978, and the Russell 2000 Index from 1979-2007.

Non-US equity represented by the MSCI EAFE Index.

Real estate represented by the NAREIT Index from 1970-1977 and

the Dow Jones Wilshire REIT Index from 1978-2007.

Commodities represented by the Goldman Sachs Commodities Index

(GSCI). As of February 6, 2007, the GSCI became the S&P GSCI
Commodity Index.

U.S. intermediate term bonds represented by the Ibbotson

Intermediate Term Bond Index from 1970-73 and the Lehman Brothers
Intermediate Term Government Bond index from 1974-2007.

Cash represented by 3-month Treasury Bills.

6

Historical Upside and Downside

Largest
One-Year
Gain (%)

Worst
One-Year
Loss (%)

Worst
3-Year
Cum Loss (%)

Bonds

25.42

(1.75)

6.43

Cash

15.58

1.05

4.22

Commodities

74.96

(35.75)

(26.06)

REIT

48.99

(23.44)

(28.30)

US Large Stock

37.58

(26.47)

(37.61)

US Small Stock

57.40

(30.90)

(42.22)

International Stock

69.44

(23.45)

(43.32)

1970-2007

Benefit #1
When built correctly,
multi-asset portfolios achieve
low aggregate correlation
among the internal assets.
9

Correlation of Major Asset Classes

(1970-2007)

Large US
Equity

Small US
Equity

Non-US
Equity

US
Bonds

Cash

Small US
Equity

.74

Non-US
Equity

.59

.47

US Bonds

.21

.05

-.11

Cash

.05

.01

-.12

.42

REIT

.39

.71

.25

.00

-.05

Commodities

-.28

-.32

-.14

-.20

.00

Aggregate (Average) Correlation in Equal-Weighted 7-Asset Portfolio =

REIT

-.24

0.12
10

Correlation Matters

Commodities and small US stock had a similar 38-year returnbut blending commodities with large US stock was far
more beneficial because commodities has a lower correlation to large US stock (-0.28) than does small US stock
(0.74).

Grow th of $11 111

,

1111
-

1111

$1 ,000 ,000
$900 ,000
$800 ,000
$700 ,000
$600 ,000

38-Year Returns:
S&P 500 11 .08 %

Correlation:
S&P 500/Small US

Small US 11 74
. %
GSCI
12 02
. %

S&P 500/Commodities =-0 .0 0

= 0. 0 0

$500 ,000
$400 ,000
$300 ,000
$200 ,000
$100 ,000
$0

S&P 500

50% S&P 50 0/ 50% Small US

50% S&P 50 0/ 50% GSC I

11

Performance During
Accumulation Phase
Individual Assets
vs.
Typical Portfolios
vs.
Multi-Asset Portfolio
12

Large US
Equity

Small US
Equity

Non-US
Equity

Intermediate
Term US Bonds

Cash

Real Estate

Commodities

Year

Equally Weighted
Multi-Asset
Portfolio

1970

3.92

(17.40)

(11.66)

16.90

6.80

(4.00)

15.17

1.39

1971

14.30

16.50

29.59

8.70

4.53

15.52

21.08

15.75

1972

19.00

4.40

36.35

5.20

4.24

8.01

42.43

17.09

1973

(14.69)

(30.90)

(14.92)

4.60

7.46

(15.52)

74.96

1.57

1974

(26.47)

(19.90)

(23.16)

7.03

8.35

(21.42)

39.51

(5.15)

1975

37.23

52.80

35.39

8.33

6.08

19.29

(17.22)

20.27

1976

23.93

57.40

2.54

11.74

5.23

47.56

(11.92)

19.50

1977

(7.16)

25.40

18.06

3.00

5.52

22.43

10.37

11.09

1978

6.57

23.50

32.62

2.23

7.67

10.98

31.61

16.45

1979

18.61

43.07

4.75

6.59

10.86

48.99

33.81

23.81

1980

32.50

38.60

22.58

6.65

12.71

33.12

11.08

22.46

1981

(4.92)

2.03

(2.28)

10.79

15.58

17.88

(23.01)

2.30

1982

21.55

24.95

(1.86)

25.42

11.66

20.91

11.56

16.31

1983

22.56

29.13

23.69

8.22

9.24

32.17

16.26

20.18

1984

6.27

(7.30)

7.38

14.29

10.33

21.89

1.05

7.70

1985

31.73

31.05

56.16

18.00

7.97

6.50

10.01

23.06

1986

18.67

5.68

69.44

13.06

6.29

19.75

2.05

19.28

1987

5.25

(8.80)

24.63

3.61

6.13

(6.59)

23.77

6.86

1988

16.61

25.02

28.27

6.40

7.06

17.48

27.94

18.40

1989

31.69

16.26

10.54

12.68

8.67

2.72

38.28

17.26

1990

(3.10)

(19.48)

(23.45)

9.56

7.99

(23.44)

29.08

(3.26)

13

Large US
Equity

Small US
Equity

Non-US
Equity

Intermediate
Term US Govt
Bonds

Cash

Real Estate

Commodities

Year

Equally Weighted
Multi-Asset
Portfolio

1991

30.47

46.04

12.13

14.11

5.68

23.84

(6.13)

18.02

1992

7.62

18.41

(12.17)

6.93

3.59

15.13

4.42

6.28

1993

10.08

18.88

32.56

8.17

3.12

15.14

(12.33)

10.80

1994

1.32

(1.82)

7.78

(1.75)

4.45

2.66

5.29

2.56

1995

37.58

28.45

11.21

14.41

5.79

12.24

20.33

18.57

1996

22.96

16.49

6.05

4.06

5.26

37.05

33.92

17.97

1997

33.36

22.36

1.78

7.72

5.31

19.66

(14.07)

10.87

1998

28.58

(2.55)

19.93

8.49

5.02

(17.01)

(35.75)

0.96

1999

21.04

21.26

27.03

0.49

4.87

(2.58)

40.92

16.15

2000

(9.10)

(3.02)

(14.17)

10.47

6.32

31.04

49.74

10.18

2001

(11.89)

2.49

(21.44)

8.42

3.67

12.35

(31.93)

(5.48)

2002

(22.10)

(20.48)

(15.94)

9.64

1.68

3.58

32.07

(1.65)

2003

28.69

47.25

38.59

2.29

1.05

36.18

20.72

24.97

2004

10.88

18.33

20.25

2.33

1.43

33.16

17.28

14.81

2005

4.91

4.55

13.54

1.68

3.34

13.82

25.55

9.63

2006

15.79

18.37

26.34

3.84

5.07

35.97

(15.09)

12.90

2007

5.49

(1.57)

11.17

8.47

4.77

(17.56)

32.67

6.21 14

Benefit #2
When built correctly,
multi-asset portfolios
achieve equity-like returns
with bond-like risk.
15

Multi-Asset Portfolio vs. Single

Assets
Large US
Equity

Small US
Equity

Non-US
Equity

US
Bonds

Cash

Real
Estate

Commodities

Equally
Weighted
7-Asset
Portfolio

38-Year Average
Annualized %
Return

11.08

11.74

10.86

8.10

6.29

12.38

12.02

11.41

38-Year Standard
Deviation of
Annual Returns

16.62

21.68

21.54

5.39

3.07

18.45

23.93

8.60

Number of Years
with Negative
Returns

11

10

Worst One-Year
% Return

(26.47)

(30.90)

(23.45)

(1.75)

1.05

(23.44)

(35.75)

(5.48)

Worst Three-Year
Cumulative %
Return

(37.61)

(42.22)

(43.32)

6.43

4.22

(28.30)

(26.06)

2.43

1970-2007

16

Whats Different in 2008?

Commodities and real estate are not helping as much as in prior

downturns.
Year

Large US
Equity

Small US
Equity

Non-US
Equity

Intermediate

Cash

Real Estate

1973

(14.69)

(30.90)

(14.92)

4.60

7.46

(15.52)

74.96

1.57

1974

(26.47)

(19.90)

(23.16)

7.03

8.35

(21.42)

39.51

(5.15)

2000

(9.10)

(3.02)

(14.17)

10.47

6.32

31.04

49.74

10.18

2001

(11.89)

2.49

(21.44)

8.42

3.67

12.35

(31.93)

(5.48)

2002

(22.10)

(20.48)

(15.94)

9.64

1.68

3.58

32.07

(1.65)

YTD
Oct 31
2008

(32.9)

(29.1)

(42.0)

4.8

1.5

(30.5)

(28.3)

(22.34)

US Govt
Bonds

Commodities Equally Weighted

Multi-Asset
Portfolio

17

Typical Multi-Asset Portfolios

Portfolio Large US Small US
(Equity/
Stock
Stock

Fixed Income)

Non-US
Stock

Bonds

Cash

60/40

30%

15%

15%

30%

10%

40/60

20%

10%

10%

50%

10%

18

19

Performance in Post-Retirement
Distribution Phase
Various Portfolios
vs.
Multi-Asset Portfolio

20

Benefit #3
When built correctly, multi-asset
portfolios are durable during the
post-retirement distribution phase.
Durable = Growth + Downside
Resistance
21

Distribution Portfolio (1970-2007)

Internal Rate of Return (1970-2007)

12%

11%

10%

$500,000 Initial Portfolio Value

5% withdraw rate
3% inflation rate of annual
withdrawal

EW

6
5

CW
40/60

60/40
4

9%
3

8%
2
1

7%

6%
10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

Frequency of Loss
(as measured by % Change in Year-to-Year Account Value)
1 = One-asset portfolio (100% Cash)
2 = Two-asset portfolio (50% each Bonds, Cash)
3 = Three-asset portfolio (33% each Cash, Bonds, Large US Stock)
4 = Four-asset portfolio (25% each Cash, Bonds, Large US Stock, Small US Stock)
5 = Five-asset portfolio (20% each Cash, Bonds, Large US Stock, Small US Stock, Non-US Stock)
6 = Six-asset portfolio (16.7% each Cash, Bonds, Large US Stock, Small US Stock, Non-US Stock, REIT)
EW = Seven-asset equal-weighted portfolio (14.3% each Cash, Bonds, Large US Stock, Small US Stock, Non-US Stock, REIT, Commodities)
CW = Seven-asset custom-weighted portfolio (12% Large US, 8% Small US, 10% Non-US, 5% REIT, 5% Commodities, 40% Bond, 20% Cash)
60/40 = 30% Large US, 15% Small US, 15% Non-US, 30% Bond, 10% Cash

22

 Minimizing

frequency of loss and size of

portfolio loss while generating robust
performance are distinct benefits of low
correlation portfoliosprovided that each
asset is assigned a meaningful allocation.

Recovering

from large losses is more difficult

in distribution portfolios--when money is being
systematically withdrawn.

23

Portfolio Loss

Needed Average Annual % Return to Restore Original Portfolio Balance

WITHDRAWAL Portfolio
First Year Withdrawal of 5% of initial balance, 3% increase of annual withdrawal

Within 1
Year

Within
2 Years

Within
3 Years

Within
4 Years

Within 5 Years

-5%

16.8%

11.1%

9.3%

8.4%

8.0%

-10%

23.7%

14.4%

11.5%

10.1%

9.4%

-15%

31.4%

18.0%

13.9%

12.0%

10.9%

-20%

40.2%

22.0%

16.5%

14.0%

12.5%

-25%

50.2%

26.4%

19.4%

16.1%

14.3%

Portfolio Loss

BUY-and-HOLD Portfolio
Within
1 Year

Within
2 Years

Within
3 Years

Within
4 Years

Within
5 Years

-5%

5.3%

2.6%

1.7%

1.3%

1.0%

-10%

11.1%

5.4%

3.6%

2.7%

2.1%

-15%

17.6%

8.5%

5.6%

4.1%

3.3%

-20%

25.0%

11.8%

7.7%

5.7%

4.6%

-25%

33.3%

15.5%

10.1%

7.5%

5.9%
24

Example Distribution Portfolios

Portfolio Large US Small US
(Equity/
Stock
Stock

Fixed Income)

Non-US
Stock

Bonds

Cash

60/40

30%

15%

15%

30%

10%

40/60

20%

10%

10%

50%

10%

20/80

10%

5%

5%

60%

20%

0/100

0%

0%

0%

70%

30%
25

Final Outcomes Are Very Dependent on Timing of

Returns
Final Account Value During Each 20-Year Period
$4,500,000
$4,000,000
$3,500,000
$3,000,000

DISTRIBUTION PORTFOLIO
$500,000 Initial Portfolio Value
5% withdraw rate
3% inflation rate of annual
withdrawal

1975-1994

60/40

40/60

$2,500,000

20/80

$2,000,000

0/100

$1,500,000
$1,000,000
$500,000
$0

1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

20-Year Period Ending in...

60% Equity/40% Fixed Income

40% Equity/60% Fixed Income

20% Equity/80% Fixed Income

100% Fixed Income

26

Distribution Portfolio Goals

Stabilize Returns to Minimize Timing Dependence

Maintain Robust Performance to Increase Portfolio Longevity
25

3-Year Annualized Rolling Returns

1970-2007
20

15

10

0
Ave. 3-Yr Return

Ave. 3-Yr

40/ 60

Equal-Weighted 7 Asset Portfolio

2007

2006

2005

2004

2003

2002

2001

2000

4.4%

1999

1998

1997

1996

1995

1994

11.7%

1993

1992

1991

1990

1989

9.8%
1988

1987

1986

1985

1984

1983

1982

1981

1980

1979

1978

1977

40 Equity/60 Fixed Income

4.3%
7-Asset EW Portfolio
1976

1975

1974

1973

(5)

1972

Std Dev

27

Part Two

28

Building a Multiple-Asset
Low Correlation Portfolio
The

7Twelve Portfolio

7 Core Asset Classes

with
12 Underlying Funds

29

The 7Twelve Portfolio

A Multiple-Asset Global Portfolio

Approximately 60% of the Portfolio Allocation

in Equity and Diversifying Assets

Approximately 40% of the Portfolio

Allocation in Bonds and Cash

US
Equity

Non-US
Equity

Real
Estate

Resources

US
Bonds

Non-US
Bonds

Cash

Large
Companies

Developed
Markets

Global
Real Estate

Natural
Resources

US
Aggregate
Bonds

International
Bonds

US Money
Market

Mediumsized
Companies

Emerging
Markets

Commodities

Inflation
Protected
Bonds

Small
Companies

30

7Twelve

Correlation

Aggregate Correlation = 0.09

Using annual returns from 1998-2007

Large
US

Mid
US

Small
US

Non-US
Developed

Non-US
Emerging

Global Real
Natural
Estate
Resources

Commodities

US
Aggregate
Bonds

Inflation
Protected
Bonds

Mid US

0.58

Small US

0.88

0.38

Non-US
Developed

0.65

0.16

0.48

Non-US
Emerging

0.50

(0.18)

0.50

0.74

Global Real
Estate

0.70

0.46

0.74

0.19

0.17

Natural
Resources

0.47

0.37

0.48

0.53

0.69

0.35

Commodities

0.14

0.25

0.12

0.09

0.34

0.35

0.59

US Aggregate
Bonds

(0.39)

0.05

(0.17)

(0.68)

(0.83)

0.05

(0.61)

(0.24)

Inflation
Protected
Bonds

(0.47)

0.01

(0.27)

(0.54)

(0.42)

(0.02)

(0.08)

0.38

0.63

Non-US Bonds

(0.20)

(0.20)

(0.10)

0.25

(0.09)

(0.11)

(0.17)

(0.09)

0.36

0.42

US Money
Market

(0.13)

0.29

(0.24)

(0.35)

(0.32)

(0.35)

(0.15)

(0.22)

0.08

(0.22)

Non-US
Bonds

(0.50)
31

7Twelve Portfolio
40%

Red dot is 7Twelve portfolio

10-Year Annualized Return

30%
20%
10%

0%
-10%
1,979 distinct mutual funds with at least 10
years of performance as of December 31,
2007

-20%
-30%
0%

20%

40%

60%

80%

10-Year Standard Deviation of Return

100%

120%
32

Calendar Year
Total % Return

7Twelve
Portfolio

American
Funds Capital
Income
Builder

Fidelity
Global
Balanced

S&P 500
Index

1998

0.10

17.75

13.90

28.62

1999

15.47

23.03

7.96

21.07

2000

12.26

(5.97)

5.60

(9.06)

2001

2.17

(8.15)

(2.49)

(12.02)

2002

2.31

(6.15)

(7.74)

(22.15)

2003

28.61

29.90

24.38

28.50

2004

17.46

13.67

12.55

10.74

2005

12.31

9.00

6.44

4.77

2006

15.13

13.70

11.92

15.64

2007

12.46

13.77

7.70

5.39

10-Year
Annualized Return

11.54

9.35

7.69

5.83

Correlation to
S&P 500 Index

.50

.94

.89

1.00
33

Accumulation 7Twelve Portfolio

34

Distribution 7Twelve Portfolio

$100,000 Initial Account Value, 5% Initial Withdrawal, 3% Annual Increase in Withdrawal

35

Age of Investor

Portfolio Mix

Under
Age 50
100%
7Twelve

Age
50-60

Age
60-70

Over
Age 70

80%
60%
40%
7Twelve 7Twelve 7Twelve
10% TIPS 20% TIPS 30% TIPS
10% Cash 20% Cash 30% Cash

Comparison Funds

American
Funds
Capital
Income
Builder A
(CAIBX)

Fidelity
Global
Balanced
(FGBLX)

Accumulation Portfolio (1998 2007)

10-Year Average
Annualized Return
(%)

11.54

10.40

9.23

8.03

10.06

9.35

Worst One-Year %
Loss

0.10

0.99

1.88

2.77

(2.78)

(8.15)

Distribution Portfolio (1998 2007)

($100,000 initial value, 5% annual withdrawal, 3% annual increase in withdrawal)

Internal Rate of
Return (%)
Worst One-Year
Portfolio Loss

10.24

9.28

8.30

7.29

($4,899) ($4,010) ($3,122) ($2,233)

8.90

8.46

($8,118) ($15,267)

Correlation (1998 2007)

Correlation to S&P
500

0.50

0.45

0.37

0.19

0.44

0.94 36

As of October 31, 2008

Master 7TwelveTM Portfolios

100% 7Twelve
80% 7Twelve, 10% TIPS, 10%
Cash
60% 7Twelve, 20% TIPS, 20%
Cash
40% 7Twelve, 30% TIPS, 30%
Cash

Year-to-Date

10-Year

Total % Return as of
October 31, 2008

Annualized % Return
as of October 31, 2008

(27.72)
(22.72)

8.19
7.69

(17.73)

7.08

(12.74)

6.39

(30.15)

5.48

(24.57)

5.38

(27.77)

3.57

(21.37)

2.98

(32.87)

0.32

Comparison Funds
American Funds Capital Income
Builder
(CAIBX)
Fidelity Global Balanced
(FGBLX)
T. Rowe Price Personal Strategy
Balanced
(TRPBX)
Vanguard Balanced
(VBINX)
Vanguard 500 Index

37

38

DJIA hit all-time high on Oct 9, 2007

365 days later(Thursday Oct 9, 2008)
Trailing 1-year Return as of Oct 9, 2008

DJIA
S&P

-39.4%
-40.6%

500

100%

7Twelve
40/30/30 7Twelve

-25.9%
-10.4%

* 40% 7Twelve, 30% TIPS, 30% Cash

39

7Twelve Portfolio
1) Portfolio logistics are very straight-forward:
Equally-weighted, annually rebalanced.
Using cash flows to accomplish rebalance increases tax efficiency.
2) No reliance upon tactical skill or timing.
3) Represents the core module of any portfolio pre or post retirement.
Examples: 80% 7Twelve, 20% individual stocks
60% 7Twelve, 20% TIPS, 20% cash
50% 7Twelve, 30% fixed annuity, 20% cash
4) Can be built using actively managed funds, passively managed index
funds, ETFs, ETNs, or CTFs (collective trust funds).
5) Sets upper and lower boundaries for number of portfolio holdings:
(7 asset classes employing 12 underlying funds)
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The 7Twelve Portfolio

The Benefits of Low Correlation

Craig L. Israelsen, Ph.D.

Brigham Young University

Email: craig@7TwelvePortfolio.com
Web: www.7TwelvePortfolio.com
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