Investment Risk Management Presentation To. Mark R. Connors Chief Strategist

Transcription

1 Asset Allocating in the New Paradigm July 15 th 2013 Investment Risk Management Presentation To State Pension By Mark R. Connors Chief Strategist risk dimensions LLC risk dimensions

2 Asset Allocating in the New Paradigm Presentation Overview Current Thesis Macro Factors will remain driver of risk & reward through 2014 Structural Elements 10k View Evolving Landscape - Credit, Economic and Market Methodology Feedback loop Among Short term signals, Credit Intermediaries & Economic Factors Conclusion Our integrative approach to Asset Allocation and Risk Management improves return symmetry risk dimensions

3 Asset Allocating in the New Paradigm June 28th 2013 Macro Markets Drive Investment Returns and more in 2013 A long way from the Buttonwood Tree A key tenet of free market operation lies in the assumption that market participants determine the clearing price of assets. For the most part, that is how modern U.S. and global liquid markets have operated since a group of U.S. merchants formed the 1792 Buttonwood Agreement in downtown Manhattan. With a set of clear parameters for investor, merchant and supplier to work with, investment and commerce (GDP) grew as capital was pulled from the profligate and flowed to the efficient. Today, Central Bank policy lays waste to market-based mechanisms as unlimited asset purchases and a zero-rate policy drive uneconomic demand for risk assets forcing capital into the efficient and inefficient enterprise without distinction. Risk-On/ Risk-Off Dynamic dominates returns Through the great swap of 2009 developed market (G-10) sovereigns assumed the risk of their money center banks through programs and schemes including direct investment and letters of credit to favorable monetary policy. While most programs were successful in stabilizing the markets and have run their course, the scope, scale and tenor of Monetary Policy appears to grow daily. Below is a graph of the correlation of daily returns since 1962 between the S&P 500 and the US 10Y Treasury - assets we respectively assign as risk-on and risk-off proxies. For these reasons among others, monetary and to a lesser extent fiscal policy have been and will continue to be the number one driver(s) of investment risk and opportunity for years to come as uncertainty stymies investment and channels global flows into either risk-on or risk-off gyrations. We invite you to review our blog where we discuss approaches to Asset Allocation, and enterprise risk management including counterparty credit, liquidity and regulatory risk management that will benefit your enterprise during this period of exceptional market intervention. Sincerely, Mark R. Connors Founder / Chief Strategist Risk Dimensions LLC risk dimensions

4 10K View Global GDP Global GDP * US v Europe * Japan v China * Growth Expectations 4

5 10K View The Euro Zone Spread Dispersion * Core v Periphery Failed Expectations & The Inevitable Break up of THE EURO The EU experiment started out with alignment of interests, similar risk profiles and an expectation of reporting and adherance to EU fiscal standards. Since 2010, the factors listed above have all-but disintegrated as demonstrated by the graphs below showing the massive increase in dispersion of credit spreads since 2005 (ex-greece). 5Y CDS Spread CDS Spread (BPs) EU Sovereign CDS Levels and Variance: March 2005, Average = 3.5BPs, StDev = 0.8BPs (1.0) (0.5) (1.0) Sov Spread's differnce from mean (BPs) (150) (100) (50) Sov Spread's differnce from mean (BPs) CDS Spread (BPs) EU Sovereign CDS Levels and Variance Today Sovereign 6/28/2013 3/4/ In March 2005, the CDS spreads Finland 23 2 of the representative sampling to the Germany 32 5 right averaged just 3BPs. Denmark 32 4 Netherlands 57 4 Spreads were low, and more Austria 39 2 importantly, dispersion was low, France 80 3 implying UNIFORM credit profiles Belgium 73 3 across the region Ireland Italy Spain Portugal Average StDev The 11 Soverreigns listed above are a sample of the current 17 sovereigns that make up the core of the EU monetary union. Greece was excluded owing to its outsized volatility. 2. Today: spreads are 38x wider, 133BPs on average vs. 3BPs. & the dispersion 165x greater, 130BPs vs. 0.8BPs, than in CDS Spread (BPs) EU Sovereign CDS Levels and Variance: Today vs (2005 dispersion virtually indistinguishable owing to differences in scale) (150) (100) (50) (100) (200) 3. Combining the two periods on one graph demonstates the scale of the change in spread and dispersion from the sample. The blue trend line represents current spread and dispersion. The green triangle represents the spread and dispersion of the same 11 sovereigns in (300) Conclusion: Initial conditions supporting a (400) common monetary union linked through a Sov Spread's differnce from mean (BPs) singled currency and central banking system no longer exist. This leaves us to question the long term benefits of the proposed banking union given fiscal / monetary dis-union. 5

6 Weekly Focus Equities * Credit * Rates * Currencies * Commodities * Risk 6

7 10K View-Hedge Funds Equities * Credit * Rates * Currencies * Commodities * Risk 7

8 Returns Across Global Assets Equities * Credit* Rates * Currencies * Commodities Asset Allocating in the New Paradigm 6/14/2013 Returns by Asset Class (Global) 20% 15.2% US EUR YTD TRR (loc) 10% 0% -10% -20% 6.0% 5.3% 3.4% 1.1% 1.2% 6/14/2013 Equity Credit (HY) -1.8% Rates-0.7% COMDTY (MTLS/AG) Currencies (DXY/EUR -11.8% -17.3% Global Equity Indices (loc) % 1 5.0% -5.0% S&P 500 (US) DAX (GDR) FTSE (UK) IBEX (SPA) FTSE (ITA) HANG SENG (CH) Global Credit (loc) YTD (loc) 6.0% 4.0% 2.0% -2.0% -4.0% -6.0% -8.0% 5D 21D 63D S&P 500 (US) Euro STOXX HANG SENG (CH) DAX (GDR) FTSE (UK) IBEX (SPA) FTSE (ITA) 6.0% YTD (loc) 3.0% 5D 21D 63D 5.0% 2.0% 4.0% 3.0% 2.0% 1.0% CDX.IG CDX.HY Bk Loans ITRX_XOVR 1.0% -1.0% -2.0% -3.0% CDX.IG CDX.HY Bk Loans ITRX_XOVR Global Rates 10Yr Govt's. (loc) YTD (loc) 4.0% 3.0% 2.0% 1.0% -1.0% US Germany Italy UK Switzerland Japan -2.0% -3.0% Commodities (USD) YTD -5.0% Gold SILV OIL Corn % % % 3.0% 2.0% 1.0% -1.0% -2.0% -3.0% 5.0% -5.0% % % -3 5D 21D 63D US Germany Italy UK Switzerland Japan 5D 21D 63D Gold SILV OIL Corn Currencies 2.0% -2.0% -4.0% -6.0% -8.0% YTD YTD DXY EUR AUD GBP JPY EURCHF 1 8.0% 6.0% 4.0% 2.0% -2.0% -4.0% -6.0% -8.0% -1 5D 21D 63D DXY EUR AUD GBP JPY EURCHF -1 8

9 Risk Heat Map Equities * Credit * Rates * Currencies * Commodities Short term layer indicates potential for a risk reversal. Includes correlations, funding basis and other factors Intermediate Layer reflects the stability and health of credit intermediaries - dictates scope of any risk reversal Long Term layer subjectively reflects the state of economic factors as illustrated in our 10k' View slides on GDP, employment, EU stability etc. 9

10 Regional Risk Equities * Credit* Risk Reversal Our preference for US equity exposure is validated as a consensus opinion given the favorable (green) heat map readings. While not always desirable to be in a consensus trade, we believe valuations and structural advantages favor our overweighting U.S. Equities. 10

11 Risk Heat Map DETAIL Equities * Credit * Rates * Currencies * Commodities 11

12 Cross-Market Basis Liquidity * Funding * Risk Reversal 12

13 Equity Market Analysis S&P Industry Cross Correlation * Global Equity Credit & P/E Comps S&P 500 is only Index to experience P/E compression since onset of credit crisis in This is despite the uniform EBITDA margin compression. NKY performance especially concerning given elevated leverage, +27%. 13

14 DataBank Equities * Credit * Rates * Currencies * Commodities 14

15 Asset Allocating in the New Paradigm Asset Allocation Methodology Equities * Credit* Rates * Currencies * Commodities A Call to Reboot We assert that several structural changes occurring in the Global Markets since 2008 have combined to blunt the tools and impair the processes employed by absolute and relative return managers. A decline in trading liquidity, increase in regulation and rollout of a Zero-Rate policy globally has changed the timing, scope and source of profitability across the spectrum of Investment. At Risk Dimensions we help you identify the changes necessary to differentiate returns with tools that predict, price and inform on evolving risks across your enterprise. Our Process: Three Lenses Through Quantitative, Credit Fundamental and Economic analyses our three-tiered model informs on the scope and timing of risk and opportunity across the major five liquid global markets. Quantitative Tools have informed on market risk shocks including February 2007, September 2008, August 2011 and October 2012 to name a few with only one brief false signal. The same tools identify efficient hedge alternatives for the portfolio. Credit Fundamentals are critical to our process as credit disintermediation impacts asset prices directly through liquidity and indirectly through GDP as credit creation is critical to growth. Today we see fewer intermediaries lending less to the few, which bears on the third and final layer of Economic Factors. Economic Factors underpin our model and impact our longer term outlook. The benefit from understanding signals culled from the Qualitative and Credit lenses is augmented by understanding the interplay with models such as The Taylor Rule and the Money Multiplier effect. Given the heavy hand of Treasury and Central Bank officials, understanding the mechanics of this layer is critical to the Asset Allocation process. Value Proposition Partnerships are earned. We believe our services, like risk, are perishable products. Therefore we do not expect serial engagement; rather we seek specific mandates with estimated paybacks in the range of 3 to 10x client investment. As a former Portfolio Manager, Hedge Fund Manager and most recently Head of Risk Management, I found the production of timely and relevant reports to be one pillar of any Investment & Enterprise Risk Management Process. The second pillar is a proper governance structure which we view as the vessel through which risk information travels and is eventually implemented. Partnering with Risk Dimensions fortifies these pillars within your organization improving profitability and enterprise resiliency. risk dimensions