Case Study Alaska Permanent Fund Asset Allocation to Risk Allocation

Transcription

1 Case Study Alaska Permanent Fund Asset Allocation to Risk Allocation Jeffrey C. Scott, CFA Chief Investment Officer SEATTLE 999 Third Avenue Suite 4200 Seattle, Washington tel fax LOS ANGELES 2321 Rosecrans Avenue Suite 2250 El Segundo, California tel fax October

2 PROBLEM: MEAN-VARIANCE OPTIMIZATION Diversification? Growth & Prosperity Economic Environment Home Country Bias Company Exposure Risk Geography Risk and Return Contribution 2

3 PROBLEM Normal Distribution Fat Left Tail Distribution Markets exhibit larger drawdowns with greater frequency than normal distribution would suggest. 3

4 HOW DID WE GO FROM MOVE FROM ASSET ALLOCATION TO RISK ALLOCATION? Education Risk Risk allocation Recruited help Governance Principles Philosophy Policies Implementation Portfolio construction Active risk budgeting Oversight and communication 4

5 T H E W O R L D O F R I S K S Business Partner Currency Margin Active Risk Inflation Turnover Credit Deflation Real Estate Counterparty Derivatives Asset Allocation Commitment Pricing Company Principal Leverage Peer Fiduciary Liabilities Model Investment Income Political Refinancing Interest Rate Spending Rule Operational Country Staff Concentration Headline Risk Volatility Liquidity Sample List 5

6 WHAT IS RISK MANAGEMENT? Risk is NOT just the standard deviation of returns! Risk is first and foremost the risk of losing principal. At what point is the drawdown too deep? Deployment of Capital Alignment of Risk & Objectives Culture Defining Boundaries Risk is failing to meet the demands of the organization. Seizing Opportunities Communication Tool Risk is an unexpected negative event. Risk Response Not a System! 6

7 APPLICATIONS FOR RISK MANAGEMENT Defensive Controlling risk through limits Active Managing risk through capital allocation Passive Information reporting on aggregate risk 7

8 ASSETS CONTAIN MULTIPLE RISK FACTORS Bonds for Safety? NOTE: Not all are created equal 8

9 RISK FACTOR BUILDING BLOCKS Primary Risk Factors Rates Credit Equity Inflation Currency Domestic Investment Grade Domestic TIPS Secondary Risk Factors International High Yield Emerging Markets International Emerging Markets Commodities Developed Emerging Market Emerging Markets Private Private Private Curve Curve Country Country Tertiary Risk Factors Duration Liquidity Duration Liquidity Country Value Momentum Sector Curve Duration Country Carry Country Sector Size Liquidity 9

10 ACTIVE RISK BUDGETING Size Fear of regret vs fear of losing money Peer risk Reputational risk/career risk Superior Portfolio Construction True Diversification Risk factors Geography Manager Economic sensitivity Return contribution Active Risk Budgeting Managers with sound risk management philosophy Diversification of alpha risk factors Tail Risk Hedging Opportunistically purchase relative inexpensive insurance Actively harvest gains Who has the proven skill? Board Staff External Managers 10

11 SOUND GOVERNANCE IS THE KEY Monitor & Oversee Policies Spending Asset Allocation Management Manager Compensation etc. Corrective Action Mission & Philosophy Education Delegation of Authority Communication 11

12 INVESTMENT PRINCIPLES Diversification Risk Valuation Principles 12

13 INVESTMENT PHILOSOPHY In the past The Board focused on implementation, e.g. manager selection and termination Security Selection Manager Selection Active Risk Budgeting Today The focus is on governance, risk tolerances, policies, processes and oversight Risk Allocation Risk Framework 13

14 PORTFOLIO CONSTRUCTION Diversification Economic sensitivity Risk factors Geography Return contribution Active Risk Budgeting Valuation assessment Risk factor tilts Opportunistic tail risk hedging Manager allocations Risk Assessment Scenario Stress Relative risks Implementation Smart cost-effective allocation to beta exposures Judicious allocation to alpha sources 14

15 IMPLEMENTATION Liquid Beta & Alpha Hedge Funds and Real Return Managers Illiquid Beta & Alpha Bank Loans Mezzanine Debt Private Equity Distressed Debt Real Estate Infrastructure Timber Agriculture Energy High Fees Liquid Beta & Alpha Rates Credit Equity Real Assets Currency Moderate Fees 15

16 KEY TAKE-AWAYS Risk Culture Risk is more than standard deviation of returns Risk Allocation not Asset Allocation True diversification Dynamic Allocation by Proven Professionals Preservation of capital in down markets Governance & Policy Focused Board Oversight and communication; not implementation 16