INVESTMENT FORUM AN ADAPTIVE PORTFOLIO CONSTRUCTION APPROACH EDITION

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1 INVESTMENT FORUM AN ADAPTIVE PORTFOLIO CONSTRUCTION APPROACH EDITION

RISK MANAGEMENT An Adaptive Portfolio Construction Approach At Pioneer Investments, we believe that combining specialized investment skills with clearly articulated portfolio construction techniques

2 RISK MANAGEMENT An Adaptive Portfolio Construction Approach At Pioneer Investments, we believe that combining specialized investment skills with clearly articulated portfolio construction techniques is a key factor for enhancing the alpha sources of performance. Risk management is now a buzzword among many portfolio managers. At Pioneer Investments, risk controls have been central to our diligent selection process for close to a decade, explains Ali Chabaane, Head of Portfolio Construction. The perception and practice of risk management is changing for the better. Pioneer Investments is a leader in the efforts to bring about that change for clients. The increasingly volatile investment landscape has proven that risk management cannot be dismissed as a due diligence footnote. To meet the evolving challenges of today s financial markets, as we have seen in the previous pages, Pioneer Investments continues to develop a framework that help us to address the issues presented by market forces and human behavioral realities. For Pioneer Investments, this has not been a post-crisis realization, as the company has been pouring resources into portfolio construction and risk budgeting techniques since The then trailblazing risk budgeting techniques manifested themselves in European Fixed Income, and has since been developed and rolled out across other asset classes, including multi-assets investing and more recently, European equities and emerging markets. ALI CHABAANE Head of the Portfolio Construction team At Pioneer Investments, active portfolio management for clients is founded on three pillars: cutting edge top-down and bottom-up research, experienced active risk taking and advanced portfolio construction techniques. Ali Chabaane, believes that a successful risk management framework enables an active manager to build solid portfolios, assessing and monitoring the alpha sources of portfolios. Portfolio Construction Framework WELL-ARTICULATED PERFORMANCE ENGINE Well defined independent strategies Clear ownership/ accountability on strategies Clear target return/ Risk Budgets RISK/POSITION ALLOCATION PROCESS Diversification Analytical capability Performance driven analysis EFFECTIVE DRAWDOWN MANAGEMENT Tools to prevent drawdowns Tools to manage drawdowns FRAMEWORK PROMOTING RISK TAKING Behavioral risk taking Metrics Timing of risk taking Budgets FLEXIBILITY TO MARKET CHANGES Amid dynamic market conditions Tools in crafting adaptive strategies INVESTMENT FORUM 2

3 5 factors define Portfolio Construction: 1. Well-articulated and clearly defined performance engine This entails defining the alpha sources, the stakeholders accountable for executing alpha strategies, and where the targets and risk budgets associated with those strategies lie, says Chabaane. 2. Risk/Position allocation process The next important point is to review and assess the risk exposure for each chosen strategy and the position size, according to the expected returns. This is a crucial phase of the overall investment process because it is related to how we put things together and how we look at the interaction of all the investment ideas that we put in place. 3. Effective drawdown management A drawdown management system allows for each of the portfolio s strategies to be monitored against the expected performance. This means not only managing the drawdown when it happens but also looking at the conditions that could prevent the drawdown happening. Integration Process Watch the video interview Portfolio Construction 4. A framework for taking risks Identify and quantify risks, avoiding adverse risks and embracing those with the greatest potential for reward. These selections are continuously monitored to optimize their contributions to the overall portfolio performance. Results are recorded and analyzed to build a statistical assessment of the behavioral component, as we will see later. 5. Flexibility to market changes Amid dynamic market conditions, we believe flexibility to be a valuable tool in crafting adaptive strategies. Implementing Portfolio Construction: The Integration model To identify and monitor risks, Pioneer Investments has developed an integrated model. The process starts by quantifying the various sources of risk risk measurement. It analyses each risk factor to the portfolio, defining individual strategies and expected risk-adjusted return. Next, decide on the exposure: [One must] deconstruct the portfolio s risk into its constituent parts to determine ex-ante the level of risk needed to achieve the desired target, explains Chabaane. Once decided, the composition of holdings is optimized by asset class and allocation size, taking into consideration the drawdown management. The system is highly modular, which helps to delegate the oversight of relevant strategies to portfolio managers fixed income experts monitor fixed income exposures, and so on. Thanks to its high transparency and sophistication, this model is becoming a valuable communication tool for clients. Moreover, thanks to its high adaptability and scalability, it can be customized to easily fit with customer objectives and extend to a broad range of products. Risk Adjusted Performance Communication and Asset Gathering Delegated Strategies Management Efficient Drawdown Management... In recent years, Pioneer Investments has strengthened its Portfolio Construction team and is now making further investments to explore the behavioral component of risk taking. Risk Service Provider Strategies Composition Optimization Risk Budgets Planning and Review Strategies Definitions Risk Measurement Partner Today, the tool is supporting 170 portfolios and services 240 users, who are both inputting and exporting information from it. Investments into data integrity complement those made into data availability we strive to make sure our data is accurate and up-to-the-minute. INVESTMENT FORUM 3

4 The Behavioral Component: Making The Winners Count The risk management lexicon is unfamiliar to most, but soon becomes second nature. In addition to data integrity, drawdown management and risk budgeting, portfolio construction is also concerned with the hit ratio and the win/loss ratio. These measures bring a new frontier to the behavioral risk management that Pioneer Investments is exploring. The Behavioral Component Chabaane. If the portfolio manager has a hit ratio of 50% it means that half of his/ her ideas finished in positive territory. However, it is important to see also if the winning positions earn more than the losing positions lose (win/loss ratio). A manager with a win/loss ratio of 1.4 accumulates 40% more when he/she wins than when he/she loses. Hence an investor can potentially have a low hit ratio and a high win/loss ratio. Drawdown management, point three of the five-point portfolio construction At Pioneer Investments, we believe that understanding this behavioral component is a crucial step to continuously improve our portfolio management process. Moreover, we strive to make risk budgeting solutions robust and scalable. In conclusion, Portfolio construction is much more than a risk management tool. It helps to more clearly articulate the position s upside. It is organized to allow experts to monitor the relevant asset classes and portfolios. It adds a framework to an already exemplary active portfolio management experience, and it is a pursuit in which Pioneer Investments will continue to innovate. HIT RATIO Ratio between winning and losing decisions WIN/LOSS RATIO Ratio between average profit and loss To have successful investments, two things are needed Ali says. First, that the good ideas are more than the losing ideas (that is the hit ratio); second, that winning ideas run more than the losers (the so called win/loss ratio). Observed alone, in fact, the hit ratio does not tell the whole story. It s not uncommon for investors to sell out of winning positions early while holding losing positions for too long, in the hope that things will improve. We first review how many implemented ideas finish in positive territory, explains framework, is a key element to prevent losses from running too far. Moreover, thanks to a well-articulated performance engine, i.e. one in which a price target is established, gains have the opportunity to run. Monitoring the evolution of portfolio positions, the decisions taken during the life of a trade, through an appropriate set of quantitative tools, may help the portfolio manager to optimize the behavioral component of his/her decision process and, eventually, put in place corrective measures to the strategies. INVESTMENT FORUM 4

5 Important Information Unless otherwise stated, all information contained in this document is from Pioneer Investments and is as of October 10, Unless otherwise stated, all views expressed are those of Pioneer Investments. These views are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested. Neither Pioneer, nor its representatives, are legal or tax advisors. In addition, Pioneer does not provide advice or recommendations. The investments you choose should correspond to your needs, goals, and risk tolerance. For assistance in determining your financial situation, please consult an investment professional. This material does not constitute an offer to buy or a solicitation to sell any units of any investment fund or any service. Pioneer Investments is a trading name of the Pioneer Global Asset Management S.p.A. group of companies. Date of First Use: November 10, 2013.

Agenda. 1. Framework of Portfolio Construction 2. Applying What We Know to Equities

Agenda. 1. Framework of Portfolio Construction 2. Applying What We Know to Equities Agenda 1. Framework of Portfolio Construction 2. Applying What We Know to Equities Page 2 I For Dublin 2013 Investment Conference Attendees Only and Framework Successful portfolio construction should rely