Advancing Strategic Asset Allocation in a Multi-Factor World Investment Strategy Group November 2014

Transcription

1 Advancing Strategic Asset Allocation in a Multi-Factor World Strategy Group November 2014 This material represents the views of the Strategy Group ( ISG ) in the of Goldman Sachs. It is not a product of Goldman Sachs Asset ( GSAM ) or Goldman Sachs Global Research. The views and opinions expressed herein may differ from those expressed by other groups of Goldman Sachs.

2 Roadmap I. What Is Strategic Asset Allocation? II. Addressing Shortcomings of Traditional Approaches III. Factor-Based Allocation across Asset Classes IV. Allocation across Factors 2

3 I. What Is Strategic Asset Allocation?

4 Asset Allocation for Different Horizons What Is Strategic Asset Allocation? Long-Term Strategic Equilibrium Tactical Tilts to Capitalize on Short-Term Market Opportunities Medium-Term Strategic Deviations Based on Economic Cycles Strategic Asset Allocation (Over Multiple Business Cycles) What would be the best long-term asset allocation without any specific market or economic views? Over multiple business cycles, portfolio returns derive from a balanced exposure to risk premia Dynamic Asset Allocation (Within a Business Cycle) What would be the best medium-term asset allocation given a specific market or economic view? Within business cycles, portfolio performance may be enhanced by better positioning for shifts in risk premia Tactical Asset Allocation (Short Term) Human emotion may drive markets away from fair values over the short term Tactical recommendations aim to capitalize on such temporary dislocations 4

5 II. Addressing Shortcomings of Traditional Approaches

6 Strategic and Dynamic Asset Allocation The World Has Changed: Our Multi-Factor Approach* Much of the science used in traditional asset allocation approaches comes from the 1950s and 1960s. These approaches are inadequate for understanding the risks and rewards in today s investment universe and for addressing the needs of individual investors. Toward Optimal Long-Term Allocations that Better Address Individual Objectives 1952 Mean-variance optimization 1992 Black-Litterman approach 2011 Robust factor-based asset allocation 1964 CAPM 1969 First multifactor model 1992 Fama-French multi-factor model 2000s Robust optimization applied to asset allocation Our New Multi-Factor Approach to Asset Allocation Leverages the best academic and practitioner insights Addresses the shortcomings of traditional approaches Constructs tailored portfolios *See Asl, F. and E. Etula (2012). Advancing Strategic Asset Allocation in a Multi-Factor World. Journal of Portfolio 39:

7 Key Advantages of Our Asset Allocation Model Shortcomings of Traditional Approaches Our Solutions and Their Advantages 1 Limited Understanding of Complex Universe Poor estimates of long-term risk and returns MULTI-FACTOR MODEL Over 2 x better estimates of expected returns and risk 2 Optimization Methodology Produces Unreliable Results Portfolio choice relies heavily on subjective judgments ROBUST OPTIMIZATION Superior portfolios even without subjective judgments 3 Risk Analytics Tend to Underestimate True Downside Less confidence on suitability and higher risk of downside surprises FACTOR-BASED ANALYTICS Reliable estimates of downside risk 4 Long-Term Wealth Projections Are Too Simplistic Erroneous projections may lead to unrealistic return expectations FACTOR-BASED PROJECTIONS Realistic projections that account for current economic environment 7

8 Risk Premium Risk Premium Why a Multi-Factor Approach? Example for Tactical Trading Hedge Funds Key Insight: Equity premium is not the only source of long-term returns. Traditional Single-Factor Approach Our Multi-Factor Approach Limited Understanding of Sources of Returns In-Depth Understanding of Sources of Returns Actual Excess Return (5.9%) Actual Excess Return (5.9%) 1 UNEXPLAINED PREMIUM Series2 Series3 Series4 Series5 Series6 Series1 UNEXPLAINED PREMIUM EM Premium FX Premium Liquidity Premium Funding Premium Explained Premium (2.9%) Term Premium Equity Premium Explained Premium (0.2%) Equity Premium Tactical Trading Hedge Funds Tactical Trading Hedge Funds 12-Fold Increase in Estimation Precision! 8

9 Multi-Factor Model Identifies Sources of Long-Term Return Our proprietary factors reflect important sources of long-term return. With more in-depth understanding of the sources of return for asset classes, we more than double the average precision of our long-term return estimates. Each Asset Class Has a Unique Risk Premium Profile Some Examples Tactical Trading Hedge Funds Emerging Market Local Debt Grade Bonds 2.9% ± 2.0% 6.1% ± 5.1% 1.6% ± 0.8% FACTOR RISK PREMIUMS Equity Premium Term Premium Funding Premium Liquidity Premium Exchange Rate Premium Emerging Market Premium REWARD Investors for Market risk; i.e., risk in earnings growth and discount rates Inflation and interest rate risk Risk in short-term credit conditions, ease of borrowing Risk in market-wide liquidity conditions, ease of transacting Systematic exchange rate risk Risks specific to emerging markets 9

10 III. Factor-Based Allocation across Asset Classes

11 Risk Premium Risk Premium New Way to Think About Diversification Which Portfolio is More Diversified? Portfolio A Portfolio B Asset Allocation Allocated Among 20 Asset Classes Asset Allocation % 2.0% 1.5% 1.0% 0.5% 0.0% Factor Allocation Equity Premium Term Premium Funding Premium Liquidity Premium FX Premium EM Premium 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Factor Allocation Diversification Across Asset Classes Can Be Misleading! Factors Provide Better Understanding of Diversification 11

12 Robust Optimization is Designed to Deliver Diversification with Superior Expected Performance Sample Universe Inv. Grade Bonds High Yield Bonds EM Local Debt US Growth Equity US Value Equity Non-US Equity EM Equity Hedge Funds Private Equity Global Public REITs Private Real Estate Optimization Techniques Traditional Optimization Ignores Uncertainties in Estimated Returns Robust Optimization Acknowledges Uncertainties in Estimated Returns Global Public REITs Private Real Estate Private Equity Inv. Grade Bonds Private Equity Inv. Grade Bonds Hedge Funds High Yield Bonds US Value Equity Unreasonable Allocations in the Absence of Subjective Constraints EM Equity Non-US Equity US Value Equity EM Local Debt US Growth Equity Optimally Diversified Allocations Even Without Subjective Constraints 12

13 Expected Return Robust Optimization vs. Alternative Approaches An Example for a Universe of 21 Asset Classes 3.0% For Illustrative Purposes Only 2.5% 2.0% Robust Optimization Is Smarter Than Alternative Approaches Including Those That Focus Solely on Risk 1.5% 1.0% 0.5% 0.0% Conservative Moderate Aggressive Liquidity Leveraged Moderate Leveraged Risk Parity (Focus on Risk Only) Moderate Aggressive Risk Parity (Leveraged) 3.0% 2.5% 2.0% 1.5% 1.0% Equity Rates Risk Appetite Leveraged Moderate Currency Emerging Market Sources of Return Equity Premium Term Premium Funding Premium Liquidity Premium FX Premium EM Premium Borrowing Rate 0.5% Robust 0.0% Efficient Frontier Conservative Moderate Aggressive Conservative Moderate Aggressive Leveraged Moderate Volatility Information in this presentation is for informational purposes and as of the date of this presentation and is subject to change without notice. This information is subject to significant revision and may change materially. These examples are for illustrative purposes only

14 Other Benefits #1: Better Understanding of Downside Risk Traditional risk analytics tend to underestimate downside risks. Our Factor-Based Risk Analytics capture realistic portfolio behavior even under distressed market conditions. Traditional Risk Analytics Factor-Based Risk Analytics Unable to Capture Fat Tails Realistic Understanding of Risk Annual Return Annual Return 14

15 Projected Wealth Projected Wealth Other Benefits #2: More Realistic Portfolio Projections Wealth Projections are critical to evaluate the long-term risk/return tradeoffs of portfolios. Our Factor-Based simulation methodology adapts to the prevailing economic environment to produce more accurate projections. Traditional Wealth Projections Factor-Based Wealth Projections Agnostic to Current Economic Environment Adapt to Current Economic Environment Traditional Assumptions: Constant long-term risk-free rate Static asset class returns Normal return distribution Adaptive Assumptions: Rising risk-free rate (from current rate) Adaptive asset class returns Factor-based return distribution Traditional Projection Adaptive Projection Time Time 15

16 IV. Allocation Across Factors

17 Diversification Expected Return Investing in Factors Helps Expand the Efficient Frontier An Example For Illustrative Purposes Only Expanding the Efficient Frontier via Further Diversification Risk Premium Parity Invest in Asset Classes and Factors Invest in Asset Classes 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% Robust 0.0% Efficient Frontier Conservative Moderate Aggressive Conservative Moderate Aggressive Leveraged Moderate Volatility Information in this presentation is for informational purposes and as of the date of this presentation and is subject to change without notice. This information is subject to significant revision and may change materially. These examples are for illustrative purposes only

18 Disclosures

19 Glossary of Terms Correlation is a measure of the linear relationship between the returns of two asset classes. Current Allocation is your present allocation based on information in our records and / or you have provided to us. Estimated Range of Risk Premium reflects the level of certainty we have regarding each Risk Premium estimate as measured by its Standard Error. A wider range reflects a lower level of certainty. Factor Risk Premia represent the key sources of long-term return for asset classes. In our multi-factor model, the risk premium of each asset class is a unique combination of the six factor risk premia explained below: Factor Risk Premium Rewards investors for bearing the risk associated with: Equity Term Funding Liquidity Exchange Rate Emerging Markets Fluctuations in the present value of future corporate earnings Fluctuations in inflation expectations and real interest rates Fluctuations in the ease and cost of short-term borrowing Marketwide fluctuations in the ease and cost of transacting Systematic currency fluctuations Economic, political, and institutional uncertainties in emerging markets Exchange Rate Hedging is a strategy that aims to reduce a client s exposure to fluctuations in the foreign exchange rate between the currency of investment and the client s base currency (i.e., the currency in which they measure their wealth). Probability of Loss illustrates the chance of experiencing a negative return during the specified time period. For example, a 1-year Probability of Loss of 30% means there is a 30% probability that the portfolio would lose principal over any one-year period. Risk-Free Rate is the hypothetical rate of return of an investment that is assumed to bear no risk of loss. Risk Decomposition is a breakdown of the portfolio risk contributed by each asset class included in your asset allocation. Risk Premium is the estimated long-term return of an asset class on an annual basis in excess of the Risk-Free Rate. Risk Premium Decomposition illustrates the contribution of each factor to the total risk premium of the portfolio. It shows the key sources of long-term return (our six Factor Risk Premia) in an asset allocation. Sharpe Ratio is a measure of excess return per unit of risk, where risk is represented by volatility. In general, the higher the ratio, the better the asset s or portfolio s risk-adjusted performance is expected to be over the long term. Standard Error is the standard deviation, or measure of variability, of a sample statistical estimate (e.g., Risk Premium); higher standard error means higher uncertainty. Strategic Allocation is your customized long-term allocation, excluding tactical tilts. Tactical Tilts are short-term shifts in portfolio weights in response to prevailing market conditions. Target Allocation is your customized long-term allocation, including tactical tilts. Value at Risk with 99% Confidence illustrates the percentage of portfolio value that is at risk, with a 99% confidence level during the specified time period. For example, a 1-year Value at Risk of 30% means the portfolio has a 1% chance of losing 30% or more during any one-year period. Volatility measures the possible fluctuation in the return of an asset class. For example, equities tend to have a higher volatility than fixed income. 19

20 Additional Important Information Thank you for reviewing this presentation. Please review the important information below. Our Relationship with Clients. We may act as an investment adviser or as a broker-dealer depending on our relationship with you, and may act as both for some clients. Our role and obligations will vary depending on the capacity in which we act. Where we act as an investment adviser, our primary role is to give you advice, help you manage your investments or help you hire another adviser to do so. Where we act as a broker, our primary role is to execute trades for you based on your instructions and any advice we give you is incidental to our brokerage services. How we are compensated by you (and sometimes by issuers or managers of investments who compensate us based on what you buy) and how your Professional is compensated will vary depending on whether you have an advisory or brokerage account and on the investments we or you make in your account, and may change over time. Please ask us questions to make sure you understand your rights and our obligations to you, the difference between advisory and brokerage accounts and / or how we are compensated based on the capacity in which we act. We are part of a full-service, integrated investment banking, investment management, and brokerage firm. Other firm businesses may implement investment strategies that are different from the strategies used or recommended for your portfolio. Entities Providing Services. This presentation is intended only to facilitate your discussions with the applicable Goldman Sachs entity including, but not limited to, Goldman, Sachs & Co., Goldman Sachs International, Goldman Sachs AG, Goldman Sachs Bank (Europe) plc, Goldman Sachs Paris Inc. et Cie., Goldman Sachs (Monaco) S.A.M., Goldman Sachs Saudi Arabia, Goldman Sachs Bank AG, GS International, Sucursal en Espana, Goldman Sachs (Asia) L.L.C, Goldman Sachs (Singapore) Pte (Company Number: W), Goldman Sachs Australia Pty Limited, and Brazil by Goldman Sachs do Brasil Banco Múltiplo S.A. as to the opportunities available to our private wealth management clients. This presentation has been approved for issue in the United Kingdom solely for the purposes of Section 21 of the Financial Services and Markets Act 2000 by Goldman Sachs International, Peterborough Court, 133 Fleet Street, London EC4A2BB; by Goldman Sachs Canada, in connection with its distribution in Canada; in the United States by Goldman, Sachs & Co.; in Hong Kong by Goldman Sachs (Asia)L.L.C.; in Korea by Goldman Sachs (Asia)L.L.C., Seoul Branch; in Japan by Goldman Sachs(Japan)Ltd; in Australia by Goldman Sachs Australia Pty Ltd (ACN ); and in Singapore by Goldman Sachs (Singapore) Pte. (Company Number: W). Goldman Sachs International Bank ("GSIB") is a private company incorporated under the laws of England and Wales with registered number and having its registered office at Peterborough Court, 133 Fleet Street, London EC4A 2BB. GSIB is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. GSIB is registered for VAT and its VAT registration number is GB The main business of GSIB is the provision of banking and other financial products and services in the United Kingdom and elsewhere. GSIB is a member of the group of companies consisting of The Goldman Sachs Group, Inc. and its subsidiaries. Strategy Group. The Strategy Group (ISG) is focused on asset allocation strategy formation and market analysis for Private Wealth. Any information that references ISG, including their model portfolios, represents the views of ISG, is not research and is not a product of Global Research. If shown, ISG Model Portfolios are provided for illustrative purposes only. Your actual asset allocation may look significantly different based on your particular circumstances and risk tolerance. Prices and Valuations. Prices, some of which are provided by third-party pricing services, are not guaranteed for accuracy, currency, or as realizable values. Certain positions may appear without a price if Goldman Sachs is unable to obtain a price and/or the security is not actively traded. Pricing sources and methods are available upon request and are subject to change To the extent we have included information about your non-goldman Sachs investments, we have not verified the information obtained from you or a third party source. The information is as of the date of the materials you or the applicable third party source provided. If shown, performance and other information may vary from that reflected by your custodian. 20

21 Additional Important Information The cost basis and acquisition date of securities purchased elsewhere and later transferred into your Goldman Sachs account(s) have not been verified. Non-Goldman Sachs investments displayed in italics in this presentation are excluded from performance and investment results. Performance / Estimated Income / Estimated Cash Flow. s in securities involve risk and the value of investments and income derived from such investments may fluctuate. Past performance is not a guide of future results. Any reference to benchmarks or indices is for informational purposes only. Benchmarks displayed may not be the benchmark for your asset allocation and therefore, your assets may not be managed against the displayed benchmark. There is no guarantee that performance will equal or exceed any benchmark displayed. Generally, total returns are pre-tax and are calculated using daily time-weighted returns in which cash and securities deposits are attributed to the beginning of the day and cash and securities withdrawals are attributed to the end of the day. Returns reflect the deduction of advisory fees, if applicable. Asset class returns may not equal the sum of investment strategy returns because they may include previously held investments and reflect prior asset classification schemas. Information on our asset classification schema is available upon request. Margin loans are generally excluded from advisory performance and are included in brokerage performance calculations. Estimated income figures and estimated private equity future cash flows are estimates of future activity, and actual results may vary substantially. Fees. Fees will vary depending on your selected investments, asset size and, in some instances, transaction levels. Actual fees may differ from estimated fees due to differences in strategies and amounts invested in particular strategies or overall. Advisory fees will generally not be charged on Goldman Sachs mutual fund holdings other than money market funds. For certain strategies, you will pay execution charges in addition to the advisory fee. A custody fee may also be assessed. Fees shown for hedge fund investments are the annual management fee and do not include the annual incentive fee that may be deducted from the NAV of the fund if certain prespecified thresholds are met. Administration and management fees of underlying funds for fund-of-funds strategies may not be included. Please refer to the applicable Offering Memorandum for each fund. Tax Information. The information included in this presentation has not been audited, should not be used for tax reporting and is not a substitute for your Form 1099, Schedule K-1, other applicable tax documents, or your monthly Goldman Sachs account statement(s). Realized and unrealized gains and loss values do not include securities for which cost basis is unavailable. Losses reflected may be disallowed or deferred by the application of capital loss limitations, wash sale rules or other special tax rules. Goldman Sachs does not provide legal, tax or accounting advice. Any statement contained in this presentation concerning U.S. tax matters is not intended or written to be used and cannot be used for the purpose of avoiding penalties imposed on the relevant taxpayer. You should obtain your own independent tax advice based on your particular circumstances. Certain s / Strategies. risks for certain strategies are outlined below. Additional details can be found in the applicable product material(s) for your investment strategies or the applicable manager s Form ADV which describes the material risks involved in each strategy and includes other important information. Money Market Funds s in money market funds are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although money market funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in money market funds. 21

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