The mix of stocks and bonds drives investors’ risk-adjusted success over time. Tom Pappenfus shows how a Morningstar portfolio snapshot can help track that mix.

Joel Dresang: Tom, when you meet with clients, you’ll have these Morningstar portfolio snapshots. What do you use them for?

Tom Pappenfus: Well, the portfolio snapshot that is provided by Morningstar is an aggregate overview analysis of our client’s account. So they’re not only beneficial for our clients to understand how their money is really invested, but they’re a very valuable tool for us as advisors to manage their portfolios.

Joel: So this snapshot is very colorful, has lots of information on it. Let’s go through some of the highlights. What do you focus on first?

Tom: What’s most important to our clients’ portfolios and how we manage them is really the right stock-to-bond mix. And what we see here in this first illustration is the pie chart, which breaks down the allocation between stocks, bonds and even further goes into non-U.S. stocks, a category for “other,” which would be non-traditional investments, and also cash.

The main driver of portfolios’ returns is really getting the right mix of stocks to bonds, and this is what we focus on first and foremost when we’re looking at portfolios.

Joel: And then next to that is that style box for the types of equity holdings?

Tom: Correct. Just to the right is the Equity Investment Style. It’s a nine-box matrix, which highlights two pieces of information: Not only how large the individual companies are that you’re investing in, but also what’s their investment methodology? Are these companies that are built for growth? Are they value? Or are they kind of a mix or in the core category?

Joel: So Morningstar takes all of your investments and breaks down all of the different kinds of equity holdings?

Tom: Absolutely. It’s not just broken down by the individual mutual funds. It’s broken down to their core components, which would be the individual stocks of the companies.

Joel: And they do that also for the bonds or the fixed-income holdings?

Tom: Absolutely. It’s down to the individual bonds holdings themselves. So Fixed-Income Investment Style is another, again, nine-box matrix based on the maturities of the bonds. And then the other piece of information they’re divided by is the credit quality, or your risk of default in those bonds.

Joel: So that’s another reminder to investors that even in their bonds, they’re taking degrees of risk.

Tom: They’re certainly exposed to risk. And another way we look at the risk in their bonds is on the second page, in the upper right-hand corner, for what the average maturity of their bonds is, as well as the duration or the measure of interest-rate sensitivity.

Joel: There’s all sorts of performance data on here, but you were saying you like to look at performance measured against risk.

Tom: As our clients may know, it’s not so much about what the overall performance of your portfolio is but how well are you rewarded for the risk that you’re taking? It becomes very important to measure what that risk-to-reward tradeoff really looks like.

Some of the measures that we look at would be the standard deviation, the mean. More importantly would be the Sharpe Ratio, which would be the risk-reward tradeoff, as well as the alpha and the beta measure.

Joel: We actually have other videos* that help explain some of those terms, but I wanted to ask you how does it help you as an advisor to be able to look at a portfolio in aggregate like this?

Tom: Well, a portfolio has a lot of variables and a lot of different moving parts. And this is the one single piece – statistical and analytical information – that lets us put it all together. It allows us to understand if we’re doing our job well as far as diversification and managing risk.

Tom Pappenfus is an investment advisor at Landaas & Company.

Joel Dresang is vice president-communications at Landaas & Company.

Money Talk Video by Peter May

*Learn more from these Money Talk Videos:

(initially posted June 26, 2015)

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