Building Efficient Return Seeking Portfolios Reassessing the Equity Allocation

Transcription

1 Building Efficient Return Seeking Portfolios Reassessing the Equity Allocation Paul M. Martin, CFA Vice President & Portfolio Manager Phillips, Hager & North Investment Management

2 Sources of Risk in a Traditional 60/40 Portfolio Canada Bonds Provincial & IG Corp Bonds Equity 0.7% 2.8% 60% of total assets in equities represents 85% of the risk budget! 19.6% Funding status can decrease by 23% in a bad year! Total 23.1% 0% 5% 10% 15% 20% 25% Risk Budget of the Excess Return according to the Annual CVaR 95 (1) Traditional portfolio assumed to be 40% FTSE TMX Canada Long Bond Overall Index, 25% S&P/TSX Capped Composite Index, 35% MSCI World Index (CAD). (2) CVaR 95: Average loss during the worst 5% of historically observed outcomes. (3) PH&N IM analysis using historical data over the period Jan 2001 March CVaR calculated using the distribution of 12-month rolling returns. (4) Liabilities are assumed to have an approximately 15-year duration as at March 31, Liability returns are approximated by using a set of assumed plan cash flows and applying the Canadian Institute of Actuaries prescribed discount rate methodology for solvency valuations. (5) This example is for illustrative purposes only and not intended to be representative of the performance of any actual or future investments. 2

3 De-Risking Multiple Ways to De-Risk 100% Fixed Income! De-Risking Continuum Reduce Interest Rate risk Revisit Equity Portfolio Diversify Return- Seeking Assets Risk Transfer Solutions Higher fixed income exposures Extended duration Different exposures across geography, capitalization, style, smart beta, etc Lower correlation strategies that offset market risk Buy-in / Buy-out Longevity Swaps 3

4 Low Volatility Equity Strategies Focus To Date Has Been On Returns Large body of research supporting the notion that low volatility stocks and portfolios would have earned higher returns historically Growing body of theory to explain this phenomenon Much of the marketing has focused on this aspect Black, Jensen, Scholes (1972) Haugen, Baker (1991) Fama, French (1992) Clarke, De Silva, Thorley (2006) Ang, Hodrick, Zing, Zhang (2006) Blitz, van Vliet (2007) Baker, Bradley, Wurgler (2010) There has been less research and emphasis on the risk part of the equation 4

5 Low Volatility Equities as a De-Risking Tool Testing the Robustness Different Definitions of Risk Volatility Drawdowns Prolonged poor returns Different Market and Economic Environments Rising interest rates or inflation Periods of general market stress Methodology Behind Our Low Volatility Equity Simulation Simple minimum variance portfolio Dataset: Canadian equity market prices, dividends, sectors, book value and earnings, January 1957 to March 2015 Simple risk model Sector, security, size limits, trading costs 5

6 Annualized 3yr Standard Deviation of Monthly Returns Volatility Consistent Reduction 30% Rolling 3 Year Volatility Dec 1962 Mar % Low Vol Simulation S&P/TSX Composite Index 20% 15% 10% 5% Dec-62 Dec-67 Dec-72 Dec-77 Dec-82 Dec-87 Dec-92 Dec-97 Dec-02 Dec-07 Dec-12 Note: for illustrative purposes only. S&P/TSX Index is represented by the S&P/TSX Capped Composite for the time periods where the capped existed, and the S&P/TSX Composite Index for the periods prior 6

7 1yr Loss of Value Drawdowns More Resilient than the Broad Equity Market Five Worst 1 year Drawdowns in the S&P/TSX Composite Index Dec 1960 Mar % 0% Early 80 s Recession 6/30/81 6/30/82 Financial Crisis 2/29/08 2/28/09 Oil Crisis 9/30/73 9/30/74 Early 70 s Recession 5/31/69 5/31/70 Tech Crash 9/30/00 9/30/01-10% -20% -30% -40% S&P/TSX Composite Index Low Vol Simulation -50% 1982/06/ /02/ /09/ /05/ /09/30 Note: for illustrative purposes only. S&P/TSX Index is represented by the S&P/TSX Capped Composite for the time periods where the capped existed, and the S&P/TSX Composite Index for the periods prior 7

8 Performance Indexed to 100 Performance Indexed to 100 Prolonged Poor Returns Path Of Returns is Steadier May 1969 April yrs 60 May-69 May-70 May-71 May-72 May-73 May % % -1.7% Jul 1987 Feb yrs 60 Jul-87 Jul-88 Jul-89 Jul-90 Jul-91 Jul % Apr 1998 Oct yrs +5.0% +0.1% Aug 2000 Feb yrs +6.6% % 60 Apr-98 Apr-99 Apr-00 Apr-01 Apr Aug-00 Aug-02 Aug-04 Aug-06 Aug-08 Low Vol Simulation S&P/TSX Composite Index Note: for illustrative purposes only. All returns are annualized. S&P/TSX Index is represented by the S&P/TSX Capped Composite for the time periods where the capped existed, and the S&P/TSX Composite Index for the periods prior 8

9 10yr Canada Bond Yield Rising Interest Rates or Inflation Not As Large A Driver As You Might Expect 20% 10yr Canada Bond Yield, Dec 1959 to March % 16% 14% Jun 1979 Sep 1981 S&P/TSX Index 11.4% Low Vol Simulation 10.1% Sep 1981 Mar 1987 S&P/TSX Index 17.7% Low Vol Simulation 22.7% 12% 10% 8% Dec 1959 Jun 1979 S&P/TSX Index 9.6% Low Vol Simulation 11.1% Mar 1987 Mar 2015 S&P/TSX Index 8.3% Low Vol Simulation 11.0% 6% 4% 2% Dec 1980, TSX was: 24% Oil and Gas Producers 16% Base Metals 5% Gold 4% Paper and Forest Products 0% Dec-59 Dec-63 Dec-67 Dec-71 Dec-75 Dec-79 Dec-83 Dec-87 Dec-91 Dec-95 Dec-99 Dec-03 Dec-07 Dec-11 Note: for illustrative purposes only. All returns are annualized. S&P/TSX Index is represented by the S&P/TSX Capped Composite for the time periods where the capped existed, and the S&P/TSX Composite Index for the periods prior 9

10 Annual Returns Annual Returns General Market Stress Low Volatility Earns Its Keep in Risk Off Environments 20% 10% 0% -10% Relative Performance: Low Vol Simulation vs the S&P/TSX Index -20% -30% % 20% 10% 0% -10% Relative Performance: High Yield Bonds vs. the Universe Bond Index -20% Source: Bloomberg, RBC GAM High Yield Bonds represented by the Merrill Lynch US High Yield Master II index (CAD), Universe bonds represented by the FTSE TMX Canada Universe Bond Index 10

11 All That New Found Room In The Risk Budget! How To Spend It Less Overall Risk Small Cap Stocks More Equities Other Alternatives Emerging Market Bonds More Hedge Funds Core Plus Bonds Emerging Market Equities High Yield Bonds 11

12 Cutting or Re-Allocating The Risk Budget Baseline Equity Portfolio Low Volatility Equity Portfolio Diversified Return-Seeking Portfolio 40% 60% Foreign Equity 40% 60% Foreign Low Volatility Equity Low Volatility Equity 50% 20% 15% Small Cap Equity 15% Emerging Market Equity Domestic Equity Domestic Low Volatility Equity Global Credit Baseline Portfolio Low Volatility Equity Portfolio Diversified Return-Seeking Portfolio Expected Return 7.3% 6.5% 7.2% Expected Volatility 14.6% 9.1% 10.1% Expected Sharpe Ratio Expected downside** -23.1% -13.6% -16.9% Note: only the 60% return seeking portion of the portfolio is shown. Portfolio also contains a 40% allocation to long bonds. See appendix for details including risk-return modeling assumptions and asset class disclosures. **CVaR 95: Average loss during the worst 5% of historically observed 12-month outcomes. This analysis is for illustrative purposes only and not a guarantee of future returns or risk. 12

13 Portfolio with Diversified Return-Seeking Assets A More Balanced Total Risk Budget* Canada Bonds 0.6% Provincial & IG Corp Bonds Foreign Credit 2.7% 2.5% Equities now represent 66% of the risk budget (instead of 85%) 27% reduction in funded status risk but similar expected return Equity 11.1% Total 16.9% 0% 5% 10% 15% 20% 25% * Risk Budget of the Excess Return according to the Annual CVaR 95 (1) See slide 2 or appendix for the assumed composition of the revised return-seeking portfolio. (2) CVaR 95: Average loss during the worst 5% of historically observed outcomes. (3) PH&N IM analysis using historical data over the period January 2001 March CVaR calculated using the distribution of 12-month rolling returns. (4) Liabilities are assumed to have an approximately 15-year duration as at March 31, Liability returns are approximated by using a set of assumed plan cash flows and applying the Canadian Institute of Actuaries prescribed discount rate methodology for solvency valuations. (5) This example is for illustrative purposes only and not intended to be representative of the performance of any actual or future investments. 13

14 Considerations for Investors What is your goal? Are equities the only piece of the puzzle needing addressing? What are your beliefs on expected return and risk? What is your approach to benchmarking? How will you define success? Communication with constituents, present and future Selecting a low volatility equity strategy 14

15 Return Low Volatility Equity Strategies Are Not All The Same Think About Process and your Definition of Success 16% Low Volatility Global Equity Strategies ($USD) Risk and Return for 3 Years 15% 14% 13% 12% 11% 10% 9% 6.0% 6.5% 7.0% 7.5% 8.0% 8.5% 9.0% 9.5% 10.0% Standard Deviation MSCI World Min Volatility MSCI World Manager A Manager B Manager C Manager D Manager E Manager F Manager G For the three years ended March 31 st, Source: evestment 15

16 Conclusions Pension plans currently have a fantastic opportunity to de-risk There are many different ways for a plan to de-risk Return-seeking assets should not be neglected Low volatility equities a simple, robust, low cost way to meaningfully reduce and rebalance portfolio risk Can enable the pursuit of higher returns in other equity strategies or other asset classes 16

17 Appendix

18 Low Volatility Equity Portfolio Simulation Summary Statistics Jan 1960 to Mar 2015 Low Volatility Portfolio Simulation TSX/TSE Index Sharpe Ratio Information Ratio Realized Standard Deviation 11.49% 14.94% Realized Tracking Error 6.95% Annual Rate of Return 12.14% 8.95% One-Way Turnover 41.15% Total Return 56,128% 11,271% Max Drawdown 34.55% 49.75% Drawdown Detection Threshold 5.00% 5.00% Number of Drawdowns Over Threshold

19 Assumptions and Disclosures for Slides 2, 12 and 13 Capital Market Assumptions Asset Category Asset Class Representative Data Series Expected 10-yr Annualized Return Assumed Annual Volatility Large Cap Equity Canadian Equities S&P/TSX Capped Composite Index 7.0% 16.9% Large Cap Equity U.S. Equities S&P 500 Index (CAD) 7.0% 14.3% Large Cap Equity International Equities MSCI EAFE Index (CAD) 7.0% 18.0% Low Volatility Equity Canadian Low Vol Equities RBC QUBE Low Volatility Canadian Equity Fund* 6.3% 12.6% Low Volatility Equity Global Low Vol Equities RBC QUBE Low Volatility Global Equity Fund* 6.3% 10.7% Small Cap Equity Canadian Small Cap Equities BMO Small Cap Index 8.0% 25.4% Small Cap Equity U.S. Small Cap Equities Russell 2000 Index (CAD) 8.0% 18.4% Emerging Market Equity Emerging Market Equities MSCI Emerging Markets Index (CAD) 9.0% 21.3% Global Credit High Yield Bonds Custom Index** 5.0% 11.5% Global Credit Emerging Market Debt JP Morgan Government Bond Index-Emerging Markets Broad Diversified (USD) 5.5% 9.4% *Simulated data used prior to fund inception. This information is meant for investors with sophisticated investment knowledge sufficient to fully understand the risks and limitations of simulated performance data. Simulated performance data is for illustrative purposes only and not indicative of actual results. Please refer to the simulation disclosure at the end of this presentation for complete disclosure notes and simulated performance information. **50% BoA/Merrill Lynch U.S. High Yield Master II Index (USD), and 50% BoA/Merrill Lynch Global High Yield Index (USD) Assumptions represent the views of PH&N for the purposes of illustrating and understanding the potential risk-reward trade-off of different portfolio decisions. Investors should be aware of the limitations using forwardlooking assumptions in that there is absolutely no guarantee that future performance will occur according to any ex-ante expectation. 19

20 Canadian Equities U.S. Equities (CAD) Int'l Equities (CAD) Canadian Low Vol Equities Global Low Vol Equities (CAD) Canadian Small Cap Equities US Small Cap Equities (CAD) Emerging Market Equities (CAD) Emerging Market Debt (USD) High Yield Bonds (USD) Assumptions and Disclosures for slides 2, 12 and 13 Capital Market Assumptions Correlations Canadian Equities 1.0 U.S. Equities (CAD) Int'l Equities (CAD) Canadian Low Vol Equities Global Low Vol Equities (CAD) Canadian Small Cap Equities US Small Cap Equities (CAD) Emerging Market Equities (CAD) Emerging Market Debt (USD) High Yield Bonds (USD)

21 Assumptions and Disclosures for Slides 2, 12 and 13 Composition of the revised return-seeking portfolio Low Volatility Equity Portfolio 40% FTSE TMX Canada Long Term Overall Bond Index 25% RBC QUBE Low Volatility Canadian Equity Fund 35% RBC QUBE Low Volatility Global Equity Fund Diversified Return-Seeking Portfolio 40% FTSE TMX Canada Long Term Overall Bond Index 15% RBC QUBE Low Volatility Canadian Equity Fund 15% RBC QUBE Low Volatility Global Equity Fund 9% Russell 2000 Index (CAD) 9% MSCI Emerging Markets Index (CAD) 6% Custom Global High Yield Bond Index* 6% JP Morgan GBI-EM Broad Diversified (USD) *50% BoA/Merrill Lynch U.S. High Yield Master II Index (USD), and 50% BoA/Merrill Lynch Global High Yield Index (USD) 21

22 Disclaimer This presentation is intended for institutional investors only. This document has been provided by Phillips, Hager & North Investment Management (PH&N IM) for information purposes only and may not be reproduced, distributed or published without the written consent of PH&N IM. It is not intended to provide professional advice and should not be relied upon in that regard. PH&N IM takes reasonable steps to provide up-to-date, accurate and reliable information, and believes the information to be so when printed. Information obtained from third parties is believed to be reliable, but no representation or warranty, express or implied, is made by PH&N IM, its affiliates or any other person as to its accuracy, completeness or correctness. We assume no responsibility for any errors or omissions. The views and opinions expressed herein are those of PH&N IM as of the publication date and are subject to change without notice. This information is not intended to be an offer or solicitation to buy or sell securities or to participate in or subscribe for any service. No securities are being offered, except pursuant and subject to the respective offering documents and subscription materials, which shall be provided to qualified investors. This document is for general information only and is not, nor does it purport to be, a complete description of an investment in any RBC, PH&N or BlueBay funds. If there is an inconsistency between this document and the respective offering documents, the provisions of the respective offering documents shall prevail. Commissions, trailing commissions, management fees and expenses all may be associated with the funds mentioned in this presentation. Please read the offering materials for a particular fund before investing. The performance data provided are historical returns, they are not intended to reflect future values of any of the funds or returns on investment in these funds mentioned in this presentation. Further, the performance data provided assumes reinvestment of distributions only and does not take into account sales, redemption, distribution or optional charges or income taxes payable by any unitholder that would have reduced returns. The unit values of non-money market funds change frequently. For money market funds, there can be no assurances that the fund will be able to maintain its net asset value per unit at a constant amount or that the full amount of your investment in the fund will be returned to you. Mutual fund securities are not guaranteed by the Canada Deposit Insurance Corporation or by any other government deposit insurer. Past performance may not be repeated. The amount of risk associated with any particular investment depends largely on the investor s own circumstances. Investors should consult their professional advisors/consultants regarding the suitability of the investment solutions mentioned in this presentation. This document may contain forward-looking statements about general economic factors which are not guarantees of future performance. Forward-looking statements involve inherent risk and uncertainties, so it is possible that predictions, forecasts, projections and other forward-looking statements will not be achieved. We caution you not to place undue reliance on these statements as a number of important factors could cause actual events or results to differ materially from those expressed or implied in any forward-looking statement. All opinions in forward-looking statements are subject to change without notice and are provided in good faith but without legal responsibility. PH&N IM is a division of RBC Global Asset Management Inc. (RBC GAM Inc.). RBC GAM Inc. is the manager and principal portfolio adviser of the Phillips, Hager & North (PH&N) investment funds. RBC GAM Inc. is registered with the various securities commissions of Canada as a portfolio manager, which permits it to provide discretionary investment management services to its clients, and as an exempt market dealer which permits it to act as a dealer for prospectus exempt trades in certain circumstances. RBC GAM Inc. is also registered as an Investment Fund Manager in Ontario, British Columbia, Quebec and Newfoundland and Labrador and as a Commodity Trading Manager in Ontario. Each of RBC GAM Inc. and BlueBay Asset Management LLP (BlueBay) is a wholly-owned subsidiary of Royal Bank of Canada, and an affiliated company and may be considered as related issuers and/or connected issuers under applicable securities legislation. / Trademark(s) of Royal Bank of Canada. Used under licence. RBC Global Asset Management Inc., IC

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24 Building Efficient Return Seeking Portfolios Reassessing the Equity Allocation Paul M. Martin, CFA Vice President & Portfolio Manager Phillips, Hager & North Investment Management