Risk Management, Fast and Slow

Transcription

1 Risk Management, Fast and Slow Stephan Meschenmoser, CFA (BlackRock Solutions) 08 April 2014 FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY

2 Thinking, Fast and Slow An interesting book from a number of perspectives: Judgement / decision making under uncertainty The limitations of intuitive statistics Risk Management, Fast and Slow What drives security prices? Do stock prices move too much to be justified by subsequent changes in dividends? (Robert Shiller, AER 1981) Stylised impact of sentiment and fundamentals on prices over time Impact on determining value Time Source: BlackRock. For illustrative purposes only Fundamentals Price of Risk,,,,,, Slow: in the long term prices are driven by fundamentals Fast: in the short term prices are driven by sentiment Portfolio construction and management is concerned with both the fast and the slow 2

3 Agenda Risk Management: The Slow Risk Management: The Fast Current Market Environment 3

4 Risk Management: The Slow Portfolio construction and capital market assumptions

5 Mean-variance Optimisation for Strategic Advice Model a liability proxy Create an efficient frontier using capital market assumptions Create model portfolios incorporating e.g. liquidity constraints Vary and stresstest input assumptions Result is not prescriptive but a guide, which needs to be applied with judgement Needs to be supplemented by other approaches, e.g. scenario analysis Scenario analysis also has limitations Effective scenario analysis requires a risk factor approach 5

6 Moving Towards a Long-term Strategy and a Dynamic Process Return 3 MTA Efficient Frontier 2 LTA Efficient Frontier 1 Current portfolio SAA: Strategic asset allocation MTA: Medium-term assumptions LTA: Long-term assumptions STR: Short-term risk Source: BlackRock; for illustrative purposes only Risk Current benchmark portfolio is located below a more diversified efficient frontier. Example governance decision points: Move towards the LTA efficient frontier deciding, whether to reduce risk or increase return level (or both). Regularly check, whether current market conditions offer medium-term opportunities worthwhile reaping. Selectively employ active managers / TAA focusing on short-term opportunities to seek generating excess returns. 6

7 Stress Test Results Portfolio performance under different stress tests 20,0% Absolute Return over Period (%) 15,0% 10,0% 5,0% 0,0% -5,0% -10,0% -15,0% Time Volatility Foreign Exchange Spreads Rates Equity Total Source: BlackRock. For illustrative purposes only Stress the portfolio under different historical and hypothetical scenarios 7

8 Rolling Risk Decomposition Risk Decomposition of Illustrative Portfolio over Time 1000 Risk (Standard Deviation in basis points) Mai-2007 Okt-2007 Apr-2008 Okt-2008 Apr-2009 Sep-2009 Mrz-2010 Sep-2010 Mrz-2011 Aug-2011 Feb-2012 Aug-2012 Jan-2013 Jul Swap Spreads Equity Industry Specific Others Corp & Othr Spreads Equity Country US IR Equity Style Eur Gov Spreads FX Non US IR x Eur Gov Risk Source: BlackRock. For illustrative purposes only A constant asset allocation is different to a constant risk allocation and composition 8

9 Traditional Portfolios Imply a Very Bullish View on the Economy Capital allocation of Average DB Plan Real Estate 7% Int'l Fixed Income 2% Optimal Beta Private 5% Equity 10% Dom Fixed Income 25% Cash 2% US Large Cap 25% Int'l Develop Equity 20% US Small Cap 4% Risk exposures of Average DB Plan Political 2% Liquidity 6% Economic 70% Real Rates 7% Inflation 14% Credit 1% Despite being broadly diversified in terms of capital allocation to asset classes, the traditional portfolio is a concentrated bet on economic growth Lessons learned: Portfolios are sub-optimally 1. Diversified; they rely heavily on economic growth to drive performance 2. Prepared for economic and financial market regimes that result in large drawdowns Source: Pensions & Investments, BlackRock. Average portfolio based on aggregate asset policy of Top 200 DB Plans as of September 30,

10 Risk Management: Slow HOW DO YOU GET TO CANOE FASTER? Slow: The successes (and failures) of asset managers have been largely defined by their exposure to some key secular trends among which: The last 15 years have been one way for interest rates Deleveraging: shift from corporate sector to Sovereigns, financial repression Sources of Growth: West vs. East Demographics: need for yield in a low yield environment European Crisis: exposure to periphery vs. core Qualitative overlay on quantitative analysis potentially useful to identify trends 10

11 Risk Management: The Fast Market sentiment risk metrics

12 Risk Management : Fast "The market can stay irrational longer than you can stay solvent." "The long run is a misleading guide to current affairs. In the long run we are all dead." John Maynard Keynes Fast: Markets are driven by sentiment Value at Risk (VaR) can play an important role in monitoring short term risk Advantageous to consider alongside other short term risk measures Risk factor analysis enables decomposition of risk into contributing factor 12

13 Dynamic Markets: Risk Tolerance Index Source: BlackRock; for illustrative purposes only; as of Risk and returns are estimated based on weekly data, exponentially smoothed with a half-life of 12 weeks. Cross sectional smoothed risk and returns are ranked, then the index is calculated as the correlation between the two rank vectors. Final index is exponentially smoothed, with a 2 week half-life. 13

14 Dynamic Markets: Multi-Asset Concentration Index Source: BlackRock; for illustrative purposes only; as of Correlations are estimated based on weekly data with 5 day overlap, exponentially smoothed with a half-life of 10 data points. The index is the R-squared of the first principle component. EMAC (Post Lehman) = MAC-Post Lehman Average. Ranks on Correlation is the percentage rank of the correlation pair since Jan The z-score is calculated using 1 year standard deviation. 14

15 Dynamic Markets: Multi-Asset Concentration Index Excess MAC Index Source: BlackRock; for illustrative purposes only; as of Correlations are estimated based on weekly data with 5 day overlap, exponentially smoothed with a half-life of 10 data points. The index is the R-squared of the first principle component. EMAC (Post Lehman) = MAC-Post Lehman Average. Ranks on Correlation is the percentage rank of the correlation pair since Jan The z-score is calculated using 1 year standard deviation. 15

16 Dynamic Markets: Risk Tolerance and Concentration Concentration and Sentiment Indices Diversified Risk Taking Concentrated Risk Taking Sentiment Diversified Risk Aversion Concentrated Risk Aversion Source: BlackRock Market Concentration 16

17 Dynamic Markets: Risk Tolerance and Concentration Concentration and Sentiment Indices Pre-2008 markets are diversified and risk is rewarded. The velocity of change in market structure is low Source: BlackRock 17

18 Dynamic Markets: Risk Tolerance and Concentration Concentration and Sentiment Indices Post-2008 markets are less diversified and risk is not always rewarded. The velocity of change in market structure is high. Source: BlackRock 18

19 Dynamic Markets: Risk Tolerance and Concentration Concentration and Sentiment Indices Source: BlackRock 19

20 Current Market Environment

21 Views in a Nutshell Synchronised, but below trend, global growth Europe joins the developed recovery but global growth remains below trend with no signs of inflation Income and wages are key in the US; so is the convergence between peripherals and the core in Europe central bank policy still a key market driver ECB surprisingly inactive, BoE drops forward guidance and the Fed potentially on BoE s track Inflection point in central bank policy keeps rate volatility elevated Equities over bonds, with focus on Japan and Europe DM equities still favoured over bonds, but watch earnings in Europe, wage reforms and nuclear talks in Japan Fixed income Continue to favour credit over rates but watch the rebalancing of bondholders and shareholders EM: One size doesn t fit all EM outlook still mired in lagging cyclical growth factors and idiosyncratic risks Focus on safer selective opportunities: differentiated EM equity access, $ EMD 21

22 1. Europe: gotta earn it! 2013 saw a multiple expansion rally, in 2014 earnings need to be upgraded to sustain the Europe story Simultaneously, supportive central bank policy and improving sentiment continue to support reallocation into the region EURO STOXX 50 has high exposure to peripherals such as Italy, a key outperformer in 2014 German equities and UK equities have lagged DM equities, but both continue to lead the Europe recovery 2014 earning outlook adjusted post average Q4 reporting, but still strong ,5-3,8-1 -1,2 At the beginning of the year Latest Top line 2,4 13,5 At the beginning of the year EPS 1,4 10,9 Latest German equities underperformed high beta Europe YTD 101% 99% 97% 95% 93% 91% 89% 87% 102% 101% 100% 99% 98% 97% 96% 85% 95% 02Jan 16Jan 30Jan 13Feb 27Feb 13Mrz DAX/FTSEMIB DAX/SX5E Source: Chart 1, BofAML, data as at February Chart 2, Bloomberg, data as at February

23 2. Japan: the beat goes on Potential 2014 catalysts Corporate wage growth (on-going discussions in Q1) More reforms (pension allocation trend, and potential corporate tax cut expected in June) Further BoJ easing, and increased retail activity ahead of the April consumption tax hike Investors have been buying Japan on dip especially as YTD underperformance has been on external triggers Japan Europe US Poor US ISM Argentina s peso devalue Dec Jan Feb 14 February ETF flows January ETF flows NKY Source: Barclays, data as at January

24 3. EM equity: how to survive your favourite band s breakup Going forward, differentiation remains key in EM: countries with strong current account fundamentals such as Korea and Taiwan and regional exposures such as EM Asia might be attractive Eastern Europe benefits from strong trade and sentiments linkages with a recovering Europe, and Poland further experiences a domestic boost from loose central bank policy Latest 3m change in Industrial Production 25% 20% Hungary Czech republic 15% 10% Poland 5% 0% -5% Brazil Mexico Russia India China -10% Turkey -15% -20% -15% -10% -5% 0% 5% 10% 15% 20% 25% Latest 3m change in C/A Source: Bloomberg, data as at November

25 4. High yield: carry with caution Despite long-term tightening, HY spreads supported by low default rates Structural questions are rising 16% 14% 12% 10% 8% 6% 4% 2% % US 12m Default HY SPW Source: Chart 1, Moody s, Citigroup, data as at February Chart 2, IMF, data as at December Last credit cycle, when default activity was similar, median spreads were 374 bp. Today they are 420bp 25

26 5. EMD: Relative value in external debt Opportunity rising in $ EMD on attractive value and a more constructive outlook OAS, bps Feb10 Okt10 Jun11 Feb12 Okt12 Jun13 EUR BBB EM BBB US BBB and it has started to break away from other EM assets in % 102% 100% 98% 96% 94% 92% 90% 02Jan 16Jan 30Jan 13Feb 27Feb EM equities $ EMD EM local $ EMD supported by likely negative net issuance in 2014 Bn USD forecast Gross Issuance Redemptions Net Issuance (Right) Bn USD Source: Top and bottom right charts, Bloomberg, data as at January Bottom left chart, Bloomberg, Barclays Research. Data to 21 January for each year. 26

27 Conclusion

28 Risk Management Risk management does not mean risk avoidance, risk management is about taking the right risks: Deliberate Diversified Scaled Risk cannot be a single number (markets are very complex). There are at least two broad dimensions: Fast (short-term) Slow (long-term) Risk factors play an important role in both dimensions: Which risk factors are rewarded in the long-term? Which risk factors are currently rewarded? Are risk factors currently rewarded at all? 28

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