Benefits of External Portfolio Management, Selection, Investment Approach

Transcription

1 Benefits of External Portfolio Management, Selection, Investment Approach Linda Ruiz-Zaiko President & Founder Barbara E. Williams, CFA Managing Director Bridgebay Financial, Inc

2 Benchmarking Study of Balance Sheet Cash Portfolios 3.00 Trailing Returns by Duration Srategy Prepared by Bridgebay Financial, Inc Universe: 47 Companies, 111 Portfolios 0.50 Years 1.00 Years 1.25 Years 1.50 Years 1.70 Years 2.25 Years High Low Average Manager A Manager B 1.54 Manager C 1.49 Manager D 2.16 Number of Portfolios

3 Investment Manager Search Process Database Database Screen Screen Organization Organization Type Type Minimum Assets Minimum Assets Strategy Investment Style Strategy Investment Style GIPS Compliant GIPS Compliant Third Party Composite Third Party Composite Verification Verification SEC Form ADV, IAPD SEC Form ADV, IAPD Identify Manager Candidates Identify Manager Candidates Qualitative Qualitative Evaluation Evaluation Ownership Ownership Incentives Incentives Disaster Disaster Recovery Recovery Conflicts Conflicts of of Interest Interest Institutional Institutional Client Client Base Base Investment Investment Strategy Strategy & & Process Process Depth of Expertise / Research Depth of Expertise / Research Risk Management Risk Management Operational Operational Support Support Compliance Compliance Systems Systems Reporting / Accounting / Valuation Reporting / Accounting / Valuation Quantitative Quantitative Evaluation Evaluation GIPS Performance GIPS Performance Risk/Return Analysis Risk/Return Analysis Peer Peer Group Group Evaluation Evaluation Benchmark Benchmark Comparisons Comparisons Dispersion of Returns Dispersion of Returns Modern Portfolio Theory Statistics Modern Portfolio Theory Statistics Up Up and and Down Down Market Market Analysis Analysis All-in All-in Fees Fees Identify Identify Manager Manager Finalists Finalists Finals Finals Presentation Presentation Investment Committee Investment Committee Interviews managers, Interviews managers, management quality, management quality, compatibility, client compatibility, client service, fees service, fees Hire Investment Managers Hire Investment Managers 6

4 Third Party Verification of RFP Responses Independent accountants report of investment manager composite Verification letter of composites as set forth by GIPS (formerly AIMR-PPS ) Investment Manager complied with all the composite construction requirements of the Global Investment Performance Standards GIPS on a firm-wide basis for the period from January 1, 2005 to December 31, 2005, and designed its processes and procedures to calculate and present performance results in compliance with the GIPS as of December 31, SAS 70 Report Auditing firm s experience in conducting SAS 70 reports for other firms SEC Form ADV or IAPD (Investment Adviser Public Disclosure) NASD Broker-Check 7

5 Manager Peer Group Comparison Range of Annualized Returns Annualized Rate of Return Year 3 Years 5 Years 7 Years 10 Year Percentiles Maximum th Percentile Median th Percentile Minimum (1.02)

6 Universe Statistical Percentile Analysis Historical 5 Years Percentile 3.00 Maximum 75th Median 25th Minimum Return Return Std. Dev. Standard Deviation Sharpe Ratio Sharpe Ratio Tracking Error Tracking Error Information Ratio Information Ratio (0.76) 9

7 Definitions of Risk Measures (MPT Statistics) Information Ratio: A portfolio s alpha (excess return over benchmark) divided by the tracking error is the information ratio. A positive Information Ratio indicates the value added that is derived from active management by the portfolio manager. R-Square: R-Square measures the percentage of variance in the portfolio return attributed to the variance in the benchmark or market index. The closer to 1 the more correlated the portfolio is to the market index or the higher variance can be explained by the market. An index fund will have an R-Square of >.90% and is highly correlated to its market. For example, R-Square of 0.9 or 90% of the portfolio volatility explained by the market. Sharpe Ratio: A risk-adjusted measure developed by Nobel Laureate William Sharpe. The Sharpe Ratio represents a portfolio s excess return over a risk-free rate divided by the standard deviation of the portfolio s return. The Sharpe Ratio shows the amount of excess return generated per unit of risk. The higher the Sharpe Ratio, the better the portfolio s historical risk-adjusted performance. Standard Deviation: A statistical measurement of dispersion about an average, which shows the range of returns over a certain period of time. Investors use the standard deviation of historical performance to try to predict the range of returns that is most likely. An investment strategy with a high standard deviation has a wide predicted range of performance which implies greater volatility of performance. The higher the standard deviation the greater the volatility of the portfolio. Tracking Error: The portfolio return less the benchmark return is the excess return. The standard deviation of a portfolio's excess returns is the Tracking Error or Tracking Risk. The Tracking Error indicates how much the portfolio manager has deviated from the underlying benchmark. In general, the higher the tracking error, the greater the relative bets the manager has taken. Index strategies try to match the market index and maintain a low tracking error. 10

8 Investment Approach

9 Credit Rating Trends 2.00 Corporate Upgrade to Downgrade Ratio Source: Moody s Investor Services Upgrades>Downgrades Improving Credit Trend Downgrades>Upgrades YTD 2006 Moody's At 1.00 Upgrades = Downgrades 12

10 Corporate Yield Spreads 1-3 Year Corporate Yield Spreads vs. Treasuries Source: Merrill Lynch AAA AA A BBB The widening and narrowing of credit spreads create opportunities to enhance total returns. 13

11 Sector Spreads Year Sector Yield Spreads vs. Treasuries Source: Merrill Lynch AAA Corporate AAA ABS AAA ABS Credit Card The widening and narrowing of sector yield spreads create relative value opportunities between sectors. 14

12 Maturity or Duration Risk and Volatility Measure 4.5% Coupon, 5 Year Par 4.5% Coupon, 2 year 101, 5 Year Par Zero Coupon, 5 Year Par, IRR 4.5% 15

13 Sensitivity Analysis Impact of interest rate changes over next 12 months 7.00% 6.00% 5.00% 6.11% 5.49% 5.00% 4.45% 4.00% 3.85% 3.00% 2.00% 1.00% 0.00% -1.00% 1.7 Year Duration -100 bps -50 bps No Change 50 bps 100 bps Income 4.22% 4.28% 4.55% 4.59% 4.65% Principal 1.89% 1.21% 0.45% -0.14% -0.80% Total Return 6.11% 5.49% 5.00% 4.45% 3.85% * Hypothetical portfolio of securities ranging from 0-3 year maturities 16

14 Mortgage Sector Analysis 20 Average Life Profiles of CMOs Cash Flow and Extension Risk Average Life (Years) Companion Type II PAC TAC Vanilla PAC (Recommended) Interest Rate Change (bps.) 17

15 Investment Performance

16 Yield vs. Return Yield Is a forward-looking, relative measure that can used for forecasting interest and tells you what you may earn in the future If you buy a security today and hold it to maturity and interest rates do not change, you may earn the yield Yield does not measure performance Return Looks back and tells you how much you have already earned on your investment over the holding period (last quarter, last year) It measures Total Dollars In and Total Dollars Out Return measures performance 19

17 Components of Total Return Income Return 0.18% 0.90% 0.19% 0.19% 0.11% 0.19% 0.21% 0.24% 0.24% 0.27% 0.32% 0.09% Price Return -0.24% -0.24% 0.07% 0.00% 0.19% -0.15% 0.03% -0.13% -0.17% -0.08% 0.04% 0.21% Total Return -0.06% 0.66% 0.26% 0.20% 0.30% 0.04% 0.24% 0.11% 0.07% 0.20% 0.36% 0.30% Reasonableness Check: Annualized Income Return 2.12% 11.35% 2.25% 2.33% 1.33% 2.30% 2.52% 2.86% 2.86% 3.30% 3.86% 1.09% WAC 2.20% 2.35% 2.35% 2.40% 2.50% 2.53% 2.55% 2.94% 2.95% 3.52% 3.95% 3.95% Current Rates 2.50% 2.50% 2.50% 2.75% 2.75% 3.00% 3.25% 3.50% 3.95% 4.00% 4.15% 4.25% Per GIPS standards, income return is never annualized but is used here only as a reality check. Bolded numbers flag an error in reported performance because they are inconsistent with current rates. 20

18 GIPS Global Investment Performance Standards Widely accepted industry standards adopted February 2005 GIPS stress performance presentation Common misconception is that firm is in compliance if their portfolio performance measurement service is in compliance. Misconception is enhanced partly by some industry software vendors who claim their systems are GIPS compliant. Software can t comply with the GIPS standards--it is just a tool that allows the firm to comply. Numerous tasks that must be performed to be in compliance. Some firms will state that they comply with the standards with the exception of one or two items. This is incorrect you either are or are not in compliance. 21

19 GIPS Required Disclosures Disclosures and conditions required to be GIPS compliant: 5 year history of returns Or since inception if the firm is less than five years old Any periods results not in compliance Must be disclosed Reason why the period is not in compliance Annual time-weighted rates of return Measure of dispersion Standard deviations High-low Asset-weighted standard deviation 22

20 GIPS Required Disclosures Disclosures and conditions required to be GIPS compliant: List and description of firm s other composites Number of portfolios in the composite Amount of assets in the composite Percentage of assets in the composite relative to the firm s total assets under management A material change in the personnel responsible for investment management Must present and describe a benchmark Must disclose the use of sub-advisors For example, it is misrepresentation to combine two entities with dissimilar investments that enhance performance or create a longer track record without disclosing the sub-advisors. A conservative, low risk fixed income composite is presented but it includes the composite of an affiliated derivatives fund (riskier) composite that is not disclosed. The composite misrepresents a low risk strategy, performance and true track record. 23

21 GIPS Required Disclosures When balanced portfolios included Must disclose method used for allocating cash Returns have been calculated gross-of-fess or net-of-fees The firm s fee schedule For net-of-fees returns Must accrue investment management fees Must disclose returns based on trade date accounting Disclose if any non-fee-paying accounts are included The effective date of compliance The use and extent of leverage For example, the SEC disapproves and it s inappropriate to combine the performance of two common control firms such as a derivatives fund (leverage) and cash management fund (no leverage) to enhance performance without full disclosure that leverage is used 24