Investment Strategy Webinar. October 17, 2012

Transcription

1 Investment Strategy Webinar October 17, 2012

2 Presenters Steve Cummings, President & CEO Phone: Tapan Datta, Principal Global Asset Allocation Phone: tapan.datta@aonhewitt.com Lou Kahl, Associate Partner Phone: louis.kahl@aonhewitt.com Eric Friedman, Senior Consultant Phone: eric.friedman@aonhewitt.com 2

3 Discussion Topics Opening Remarks Market Update and Outlook Hedge Fund Strategy Update Fixed Income Research Update Q&A Session 3

4 Market Update Tapan Datta

5 US Fiscal Condition a Weak Link 65 US doing much better here (US versus Eurozone PMI Indices) Expanding US Manufacturing Eurozone manufacturing 30 Oct- 06 Apr- 07 Oct- 07 Apr- 08 Oct- 08 Apr- 09 Oct- 09 Apr- 10 Oct- 10 Apr- 11 Oct- 11 Apr but not so well here (Ratio of government debt to GDP) Source: IMF Fiscal Monitor October US Eurozone US finances in total in worse shape than Eurozone

6 US Bond Yields Have Not Felt Any Impact 1 The US has continued to pay little to service its Treasury debt (Real yield (%) on 20 yr constant maturity TIPS) Oct11 Nov11 Dec11 Jan12 Feb12 Mar12 Apr12 May12 Jun12 Jul12 Aug12 Sep and inflation concerns are also not evident (Break-even inflation, 20 years) 2.5 Fed activity and Eurozone crisis has helped yields stay contained but for how long? Oct11 Nov11 Dec11 Jan12 Feb12 Mar12 Apr12 May12 Jun12 Jul12 Aug12 Sep12 6

7 Fewer Reasons Now to Prefer US Growth IT Profit Margins Remain Ahead of Financials but the Gap has Narrowed (IT / Financials Profit Margins) 4x 3x 2x Higher IT Margins Information Technology s profitability advantage over the Financial sector has shrunk 1x Average Margins for IT / Financials Apple Now Makes up 9% of Growth Index (Top 5 Holding of Russell 100 Growth Index, % Market Value) 0x % 9% 8% 7% Apple - 9% Microsoft - 3.6% International Bus.Mchs % Google 'A' - 2.6% Coca Cola - 2.4% 6% 5%.and the dependence on Apple for the entire Growth style is unhealthy 4% 3% 2% 1% 0%

8 Summary of Medium-Term Market Views Equities Cautious on medium-term view, but prefer to bonds Favor large cap Rebalance to neutral within growth-value Favor non-us markets on any rebalancing Bonds Ultra low yields make bonds vulnerable Favor credit over government bonds Favor intermediate to long duration Favor Investment grade and secured loans to high yield Alternative Asset Classes Favor real estate, hedge funds, infrastucture and selected private equity investments 8

9 Hedge Fund Strategy Update Lou Kahl

10 Hedge Fund Industry Trends Investor flows have been strong and steady Hedge fund assets exceed $2 trillion Positive flows of $20 billion in H Inflows continue to favor large firms 70% of all funds experienced net outflows in Q We continue to see institutional investors develop new and expand existing hedge fund programs With volatile equity markets and low bond yields, no indications of that changing We expect fund of hedge fund (FoHF) flows to continue to lag as institutional investors, and public funds in particular, have been transitioning more toward direct mandates However, FoHFs are likely to remain a popular option to investors with smaller plan assets and limited staff resources; and for introductory allocations to hedge funds, as well as for larger plans with strategic and niche market initiatives Source: Hedge Fund Research. HFR Global Hedge Fund Industry Report:: Second Quarter

11 HEK Client Trends We have seen a distinct shift in preference for direct hedge funds vs fund of hedge funds, where size of allocation, tolerance for single manager risk and governance considerations allow 80% of client searches so far this year are for direct funds (60% in 2011) Funds of Funds continue to be an important area of focus despite recent client trends Client interest is in the following areas Multi strategy fund of hedge funds for smaller plans Direct multi strategy funds Discretionary global macro funds Credit long / short funds Commodities 11

12 Performance 9 months to Sept 30, 2012 Year-to-date Returns Ending Sep 2012 HFRI FoF Composite Index HFRI Equity Hedge Index HFRI Equity Market Neutral Index HFRI Event- Driven Index HFRI Macro Index HFRI Macro: Systematic Divers Index HFRI Relative Value Index S&P 500 MSCI ACWI IMI Barclays Agg 3.3% 5.5% 2.1% 5.0% 0.6% 0.0% 8.1% 16.4% 13.0% 4.0% S&P 500 MSCI ACWI IMI HFRI Relative Value Index HFRI Equity Hedge Index HFRI Event-Driven Index Barclays Agg HFRI FoF Composite Index HFRI Equity Market Neutral Index HFRI Macro Index HFRI Macro: Systematic Divers Index 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 12

13 Regulatory Update Dodd-Frank and other areas of Regulator focus SEC Hedge Fund registration - Mandatory registration occurred March 31, 2012 Form PF - Managers are now required to complete an extensive regulatory filing designed to allow the SEC and others to determine the systemic risks a hedge fund or group of hedge funds may pose Volcker Rule Banks continue to migrate away from proprietary activities and alternative asset managers continue to benefit Systemic Risk - Hedge funds are generally deemed not to be systemically important, however there are certain thresholds whereby specific institutions may be deemed systemically important Resolution Authority - 9 U.S. banks filed initial resolution plans (on FDIC website); some market participants have noted the arbitrary conditions in which these living wills could be applied, and potentially distort established bankruptcy procedures CFTC - Final Rule on Position Limits was vacated in a decision by the U.S. District Court for D.C. The Federal Reserve Bank approved notices of rulemaking provisions that apply most of Basel III capital requirements to U.S. banks JOBS Act many in the hedge fund industry interpret this as an open door to lifting marketing restrictions Legal advisors urge caution as new options may run afoul of other restrictions, and certain limits are unclear Regulators have struggled to meet Dodd-Frank requirements As of October 1 st, just 32% of rules have been finalized and 63% of deadlines have been missed Despite slow progress and certain obstacles, many hedge fund firms view Dodd-Frank as providing significant market advantages 13

14 Strategy Outlook Equity Long / Short: While Equity L/S managers struggle compared to broad equity markets, they run at about 75% of market Beta. However, returns have been strong as correlations come down. Lower correlations should benefit equity L/S managers, but stimulus efforts seem to reinforce correlations. Event-Driven: Environment is fairly healthy as Credit becomes less Beta-oriented and Merger / Corporate Catalyst landscape improves. Despite low default levels Credit markets present meaningful opportunities for L/S Credit managers. Additionally, long-run opportunity sets appear attractive as Dodd-Frank, Basel III and other regulatory initiatives have dramatically changed the environment Wall Street balance sheets have fallen well below historical levels and corporate security inventories have collapsed. Structured Credit continues to benefit from altered industry dynamics. Macro: Unrelenting Monetary and Fiscal measures continue to create distortions; Rapid reversals on policy announcements favor Discretionary managers over trend following Managed Futures. Relative Value / Multi-Strategy: Relative Value managers should continue to benefit, in part due to many of the Macro pressures creating pricing distortions or structural opportunities. Managers with a long-volatility bias or outright tail protection may continue to find difficulty as volatility is compressed. Managers with strong ability to allocate opportunistically throughout capital structures globally benefit. Funds of Hedge Funds: We see opportunities in niche strategies, such as credit oriented and seed / emerging manager funds. 14

15 Fixed Income Research Update Eric Friedman

16 HEK is Updating its Framework for Fixed Income to Address Key Questions How can investors align their fixed income managers benchmarks and guidelines with their styles and strengths? How can investors align the strategic fixed income exposures with the needs of the portfolio? How can investors implement better fixed income portfolios in light of the issues above? What are style-appropriate benchmarks to evaluate manager performance? How should guidelines be customized to reflect a manager s skills? What is the preferred duration exposure? How much credit risk should be taken? With what credit qualities? When and how much exposure to securitized sectors is desirable? How should complementary managers be put together? How should market conditions affect the allocation among fixed income managers and These questions will be addressed in a three-part white paper series to be published over the next few months 16

17 Broad Benchmark-Driven Strategies are Not Best for All Investors The benchmark exposures may not have the risk exposures most appropriate to complement the rest of the portfolio. Investors may want exposures that are different than the benchmark Duration Securitized sectors Credit (amount and type) U.S. Universal Index Duration Adjusted Excess Return 7/88-6/12 MBS Corporate Government IG Corporate Securitized Corp High Yield 144A ex Agg Other Average (bp) Std. Dev. (bp) Ret./s.d Corr. w/ S&P

18 Some Managers Have Excess Returns that are More Based on Style than Skill: Over-weighting Credit For several fixed income managers, we compared excess returns to that based on a passive portfolio that over-weights spread sectors in all environments 10% 8% 5% 3% 0% -3% -5% -8% -10% 1/1/2002 1/1/2003 1/1/2004 1/1/2005 1/1/2006 1/1/2007 1/1/2008 1/1/2009 1/1/2010 1/1/2011 1/1/2012 Over-weight Credit Manager 1 Manager 2 10% 8% 5% -3% 0% 3% -10% -8% -5% 1/1/2002 1/1/2003 1/1/2004 1/1/2005 1/1/2006 1/1/2007 1/1/2008 1/1/2009 Over-weight Credit Manager 3 Manager 4 Manager 5 Manager 6 1/1/2010 1/1/2011 1/1/2012 The excess returns for Managers 1 and 2 have low correlations with the portfolio that over-weights credit, while Managers 3, 4, 5 and 6 have excess returns with high correlations to the portfolio that over-weights credit. The managers with high correlations have excess performance based more on style (over-weighting spreads) that skill (rotating between sectors, or choosing the best securities within a sector) 18

19 Some Managers Have Excess Returns that are More Based on Style than Skill: Over-weighting Securitized Sectors For the same fixed income managers, we looked at the over-weights to securitized sectors 50% 40% 30% 20% 10% 0% 1/1/2002 1/1/2003 1/1/2004 1/1/2005 1/1/2006 1/1/2007 1/1/2008 1/1/2009 1/1/2010 1/1/2011 1/1/2012 Manager 2 clearly stands out as one that significantly over-weights the securitized sector in all economic environments. Its performance is highly dependent on the performance of the beta in that sector. 19 Manager 1 Manager 2 Manager 3 Manager 4 Manager 5 Manager 6

20 Using Managers with Specialized Styles and Skills Skilled, specialized managers with style biases can add value Bond-pickers who can identify the best bets in credit Specialists in the securitized sectors Bottom-up managers that may have more depth in certain parts of the market Giving standardized benchmarks to specialized managers can cause problems Allows managers to game the system by over-allocating to spread sectors or not taking responsibility for results ( our style was just out of favor ) Causes an inability to differentiate between alpha and beta exposures Investors should consider customizing benchmarks and guidelines to some managers styles and strengths 20

21 Customizing Benchmarks and Guidelines Benchmarks Bond-pickers may have a benchmark without Treasuries, as their skill cannot add value in that sector Specialists in the securitized sectors may have benchmarks over-weighting those areas Bottom-up managers may have customized benchmarks reflecting their universe Guidelines Bond-pickers may have the ability to have issuer concentration Sector rotators may have broad ability to over- and under-weight sectors Guidelines may be tighter in areas outside a manager s strengths When using customized benchmarks and guidelines, multiple managers with different benchmarks can be structured to make sure the overall portfolio s strategic exposures are in-line with the investor s preferences 21

22 Thank you. Question & Answer Questions may be submitted at any time during the web seminar by typing the question in the "Ask a Question" text field and clicking "Submit." Questions will be answered live as time permits during the question and answer sessions. 22

23 Our next investment strategy update call is scheduled for Wednesday, November 14th, at 10 a.m. CST. 23