How to Hedge Cross-Asset Portfolios with Risk Transfer

Transcription

1 This document is solely for the use of professionals and is not for general public distribution. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. How to Hedge Cross-Asset Portfolios with Risk Transfer Tuesday 12 September 2017 Kokou Agbo-Bloua Managing Director, Financial Engineering, Société Générale Natasha Sibley Portfolio Manager, Janus Henderson Investors

2 Agenda Société Générale: Equity/FX correlation distortions Janus Henderson: Equity/FX correlation risk management Société Générale: Supply and demand of equity/rates correlation Janus Henderson: Equity/rates correlation as a hedge Société Générale: Alternative risk transfer opportunities in fixed income Janus Henderson: Alternative risk transfer opportunities in equities Conclusion Q&A 1

3 EQUITY/FX CORRELATION DISTORTIONS Hedging Solution around macro events

4 Cross-Asset Correlation Harvesting distortions with hybrids Investment case for hybrids : A melting pot of derivative parameters (correlation, volatility, forwards) Isolate specific outcome in joint probability distribution Leveraged, yet with limited risk Exotics book supply & demand distortion Covariance vs Correlation Exposure Correlation drives the discount Worst-of options provide the most discount. Discount in % vs vanilla assuming cross-asset correlation of 0%: Worst-of option: 70%, Contingent option: 50% Basket option: 30% Source: SG CIB Financial Engineering

5 CONFIDENTIAL AND FOR DISCUSSION PURPOSES ONLY **PLEASE SEE IMPORTANT LEGAL NOTICE AT THE END OF THE DOCUMENT** Equity/Fx Correlation Efficient Macro Hedges Hybrid Pricing: Equity puts contingent to EURUSD < 1.04 June 17 Options Current Forward Correl Offered 95% Put Disc to Vanilla SX5E 3,241 3, % 69% CAC40 4,751 4, % 71% DAX 11,535 11, % 70% SPX 2,268 2, % 64% Equity/FX Supply & Demand Context Source: SG CIB Financial Engineering, Bloomberg Demand: ECB QE & Negative Interest Rates Policy (NIRP) triggered a change in regime for SX5E/EUR correlation, which created an opportunity to buy correlation via hybrid products around Political event risks for hedge funds and asset managers looking to hedges. Supply: Natural flows by US investors buying European equities and ETFs quanto-ed in USD and structured products issuance quanto-ed in USD. THE VALUE OF YOUR INVESTMENT MAY FLUCTUATE. THE FIGURES RELATING TO SIMULATED PAST PERFORMANCES REFER TO PAST PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA.

6 Equity/FX correlation risk management

7 Equity / FX correlation Case study: Nikkei vs. USDJPY Yen and U.S. Dollar return of Nikkei 225 Hedged exposure increasingly popular Price ($) Average creation Average redemption Units (millions) Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 0 Source: Janus Henderson Investors, Bloomberg, as at August 2017 Note: Returns from exposure to Nikkei, rebalanced to 100 at January 2012 Past performance is not a guide to future performance Source: Janus Henderson Investors, Bloomberg, as at August 2017 Note: ETF is WisdomTree Japan Hedged Equity fund Past performance is not a guide to future performance 6

8 Equity / FX correlation Case study: Nikkei vs. USDJPY opportunities in covariance Historical Nikkei/USDJPY covariance Historical premium (discount) of implied covariance Source: Janus Henderson Investors, Bloomberg, as at August

9 Equity / FX correlation Case study: Nikkei vs. USDJPY correlation more attractive profile Histogram of realised covariance (normalised) Histogram of realised correlation Covariance = Correlation volatility 1 volatility 2 No bound to covariance: limitless losses Correlation mathematically bounded by +/-1 Historically correlation remained below this limit Source: Janus Henderson Investors, Bloomberg, as at August 2017 Note: Data shown is from February 2007 to August Covariance is normalised to have same mean and standard deviation as correlation. 8

10 SUPPLY AND DEMAND OF EQUITY/RATES CORRELATION DIVERGING HEDGING NEEDS FOR PORTFOLIO PROTECTION

11 RATES / Equity Correlation A convex function of yield itself 1yr Equity vs. US 10yr rates Correlation on Weekly returns since 1962 High inflation 70s/80s Challenges for multiasset portfolios as Efficient Frontier shifts due to correlation shifts (Harry Markowitz). Multi-asset portfolios are now more volatile and subject to correlation shocks. QE distortions Taper Tantrum Need for new assets with more stable correlation against risky assets. Source: Bloomberg, SG CIB Flow Strategy & Solutions

12 RATES / Equity correlation Supply & Demand Dynamics Insurance companies have to manage their asset/liability duration gap by constructing an asset mix that will both generate enough income to meet the long-term guarantees commitment to their policyholders while preserving and growing their assets. One of the least desirable market scenarios is when both equities and bond yields fall simultaneously. This is because the value of their assets fall while the net present value of future liabilities rises, worsening the duration gap. They are therefore short equity/rates correlation. Hedge Solution = Buy rates/equity correlation. Conversely, multi-asset managers have the opposite issue. They dread a scenario where bond yields rise and equities fall. They have the opposite correlation risk exposure and are therefore willing sellers of that correlation to hedge a breakdown in equity/rates correlation. Hedge Solution = Sell rates/equity correlation 1Y Correlation 30Y Rate/SPX Source: Bloomberg, SG CIB Flow Strategy & Solutions PRODUCT PRICING EXAMPLE: 30Y CMS Receiver Contingent to SPX Down [ For Illustration purposes only ] Maturity Index Option Rate Strike Strike Level Equity Barrier Price Vanilla Price Discount 1Y CMS 30Y FLOORLET ATMF 2.72% SPX 95% 3.47% 6.10% 43% 1Y CMS 30Y FLOORLET ATMF 2.72% SPX 90% 2.69% 6.10% 56% 1Y CMS 30Y FLOORLET ATMF-0.20% 2.52% SPX 90% 2.05% 4.20% 51% 2Y CMS 30Y FLOORLET ATMF 2.75% SPX 95% 5.42% 8.60% 37% 2Y CMS 30Y FLOORLET ATMF 2.75% SPX 90% 4.68% 8.60% 46% 2Y CMS 30Y FLOORLET ATMF-0.20% 2.55% SPX 90% 3.83% 6.70% 43% Past performance is not a reliable indicator of future returns. Source: SG CIB Financial Engineering

13 Equity/rates correlation as a hedge

14 Equity / interest rate correlation Implications of correlation regime change are far-reaching Correlation of S&P 500 with US 10yr government yield year rolling correlation 5 year rolling correlation Regime change Source: Janus Henderson Investors, Bloomberg, as at May 2017 Efficient frontier of equity and bond portfolio 8.2% 8.1% 8.0% 7.9% 7.8% 7.7% 7.6% 7.5% 7.4% Recent environment (correlation: 40%) Historical environment (correlation: -40%) Volatility parity Target volatility = 10 Recent correlation Historical correlation 7.3% Leverage Sharpe % 4.0% 4.5% 5.0% 5.5% 6.0% 6.5% 7.0% 7.5% 8.0% Source: Janus Henderson Investors, Bloomberg, as at May 2017 Note: Equity and bond portfolio consist of S&P 500 and Bloomberg Barclays US Treasury Index 13

15 Equity / interest rate correlation Market returns poorly modelled by Normal distribution Histogram of realised correlation: 2010 present day Correlation of Monte Carlo simulated returns Source: Janus Henderson Investors, Bloomberg, as at May Simulated performance is for illustrative purposes only. 14

16 Equity / interest rate correlation Outliers matter Case study: S&P 500 vs. 10yr U.S. yield through 1987 Scatter of daily returns, with correlation influence Payout = $ notional correl realised correl strike Realised above strike: trade is profitable Black Monday Realised below strike: trade returns a loss Source: Janus Henderson Investors, Bloomberg, as at August

17 ALTERNATIVE RISK TRANSFER OPPORTUNITIES IN FIXED INCOME A long history of product innovation & evolution across asset classes

18 CONFIDENTIAL AND FOR DISCUSSION PURPOSES ONLY **PLEASE SEE IMPORTANT LEGAL NOTICE AT THE END OF THE DOCUMENT** Alternative Risk Transfer A long history of product innovation Innovations where SG was the first bank to trade Traded between SG and Janus Henderson Source: SG CIB Flow Strategy & Solutions, Bloomberg THE VALUE OF YOUR INVESTMENT MAY FLUCTUATE. THE FIGURES RELATING TO SIMULATED PAST PERFORMANCES REFER TO PAST PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA.

19 CONFIDENTIAL AND FOR DISCUSSION PURPOSES ONLY **PLEASE SEE IMPORTANT LEGAL NOTICE AT THE END OF THE DOCUMENT** Rates Risk Transfer 1 digital vs linear 0% put on us 30y-2y curve Supply & Demand Context Dual-Range Accruals are typically structured into notes that pay retail investors a high USD coupon rate if 30y-2y or 10y-2Y stay above zero and 10y USD swap rates remain below 4-5%. Banks issuing these instruments cannot warehouse the 0% curve digital risks on their books because of risk limits constraints. Combining a digital puts with a linear puts allows banks to create a profile that is attractive for an investor looking to earn carry and/or protect against a mild inversion of the yield curve. $3,000,000 $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $0 -$500, $1,000,000 -$1,500,000 2Y-30Y Swap Curve -$2,000,000 -$2,500, Digital vs Linear Put Payoff US 30y-2y Swap Curve since % line - FOMC Tightening Cycles /1/99 1/1/01 1/1/03 1/1/05 1/1/07 1/1/09 1/1/11 1/1/13 1/1/15 1/1/17 Solution Long a 0% Digital Floor and short a 0% Linear Floor creates an attractive opportunity whether the curve remains steep or inverts Target Investors: Volatility HFs and asset managers. Trade Implementation: Buy 1% Payout Digital 5x10 Expiry, Quarterly-Look 30Y-2Y Curve Floor, K= 0% vs. Sell Linear 5x10 Expiry, Quarterly-Look, 30Y-2Y Curve Floor, K= Indicative 25 bps initial premium credit. If the 30Y-2Y curve is above zero at quarterly expirations, beginning in 5 years for the following 5 years, there is no payment on either the Digital or Linear and one profits by the initial premium credit. If the 30Y-2Y curve is at or below zero, then the Digital will pay the long a full 1% * Notional at each expiration while the Linear short will pay out 1 bp * Notional per basis point of inversion at each expiration, both adjusted for number of days on a 30/360 basis (figure 1). The cumulative P&L of the trade will be sum of the 20 quarterly sets on both the Digital and Linear over the 5 year period plus the 25 bps of initial premium. Risks If the 2Y-30Y swap curve were to invert below -100 bps at any single quarterly expiration, such as to the extremes in UST curve in the period toward the end of the 1970 s, losses could theoretically be unlimited. Source : SG Flow Strategy & Solutions, Bloomberg as of 3 rd March THE VALUE OF YOUR INVESTMENT MAY FLUCTUATE. THE FIGURES RELATING TO PAST PERFORMANCES AND/OR SIMULATED PAST PERFORMANCES REFER OR RELATE TO PAST PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA.

20 CONFIDENTIAL AND FOR DISCUSSION PURPOSES ONLY **PLEASE SEE IMPORTANT LEGAL NOTICE AT THE END OF THE DOCUMENT** Rates Risk Transfer 2 US 5yCMS floor Spread SG is positioned to sell floor spreads on 5CMS (5Y swap) on the back of Reverse Convertible Note issuance (RCNs). RCNs are 1Y maturity structured notes that pay a high coupon as long as 5Y or 10Y swaps remain above a strike level until maturity. If the referenced swap rate drops below the strike before maturity the holder will begin to lose principal in proportion to the then current swap rate over the initial swap rate until the rate hits zero. Most of these strikes on 5CMS reside around the 0.60% and 0.65% level. The hedging of these notes leaves SG long the aforementioned 0.60% strike and short the 0% strike, therefore we can offer this 5CMS floor spread at attractive levels Supply & Demand Context USD and EUR 5Y Swap Rates /10/ /04/ /10/ /04/ /10/ /04/ /10/2016 $80,000,000 $60,000,000 $40,000,000 $20,000,000 Higher Strike 5Y Swap Rate USD 5Y Swap EUR 5Y Swap Payout Profile (per $10bn notional) $0-1.00% -0.80% -0.60% -0.40% -0.20% % 0.40% 0.60% 0.80% 1.00% Target Investors: Solution 1Y expiry, single-look floor spread on 5CMS with strikes of 0.60% and 0% Volatility HFs and asset managers. Trade Implementation: The investor buys 1Y expiry, single-look floor spread on 5CMS with strikes of 0.60% and 0%. The client pays 2.6bps with max payout of 60bps or 23:1. There is historical precedence for a USD 5Y swap move of a magnitude to make the structure in-the-money within 1Y. The recent case of EUR 5Y rates exemplifies how the low level of rates is not necessarily an insurmountable hurdle to such a move. This structure compares favourably to eurodollar options for several reasons: (1) 5CMS minimizes the LIBOR distortions that could affect eurodollar prices if rates were to collapse due to a financial crisis. (2) Ease of execution for a relatively large size. Risks: Loss is limited to premium spent Source : SG Flow Strategy & Solutions, Bloomberg as of 3 rd March THE VALUE OF YOUR INVESTMENT MAY FLUCTUATE. THE FIGURES RELATING TO PAST PERFORMANCES AND/OR SIMULATED PAST PERFORMANCES REFER OR RELATE TO PAST PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA.

21 Alternative risk transfer opportunities in equities

22 Supply demand imbalance driving mispricings Regulation is leading to inefficiencies Investment bank risk $m Dodd-Frank FSO Vickers EMIR Liikanen Basel III CRD IV EBA Volker -78% from Peak Demand up Supply down Structured product issuance $bn Others SPX HSI KOSPI2 NKY SX5E HSCEI 0 FY 2006 FY 2008 FY 2010 FY 2012 FY 2014 Q2 2016* Source: Henderson Global Investors, Bloomberg, as at 30 June 2016 Note: Summed Investment Bank Equity VaR on 99% daily basis * Based on Q2 or H data 0 Q1-11 Q1-12 Q1-13 Q1-14 Q1-15 Q1-16 Q1-17 Source: Henderson Global Investors, J.P. Morgan Equity Derivatives Strategy, KSD and KIS Pricing, as at March 2017 Note: Publicly available equity linked structured product issuance out of Asia 21

23 Opportunity in equity delta one Long dated forwards dislocated to underlying parameters Finance 101: Forward = Spot x e (interest rate - dividend) x time The Spot 2800 Interest rates effect Estimated dividend effect 2600 Mar-17 Mar-19 Mar-21 Mar-23 Mar-25 Mar-27 real world: F = Se (interest rate div repo +basis) x time Dividend seasonality 2600 Mar-17 Mar-19 Mar-21 Mar-23 Mar-25 Mar-27 Basis Repo Dividend risk premium Source: Henderson Global Investors, Bloomberg, as at May Based on the Euro Stoxx 50 index, for illustrative purposes only. 22

24 Opportunity in equity delta one Dividend risk premium pronounced in Europe Sell-side expectations (red line) are upward sloping, pricing in growth Dividend future prices (black line) are upward sloping in other major markets In the Euro Stoxx 50, investment bank hedging pressure is causing price distortion Eurostoxx 50 Nikkei 225 S&P Forecast Market price CAGR: 4.4% Forecast Market price 4.9% Forecast Market price 4.4% Risk premium % % CAGR: -1.8% Source: Henderson Global Investors, Bloomberg, Goldman Sachs, as at April Charts show analyst forecasts, actual levels may differ significantly. Note: Dividends rebased to 100 at December

25 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Opportunity in equity delta one Complex risk management: focus on dividend beta Pre-crisis beta Months 12 to expiry Post-crisis beta Liquidity adjustment Up beta Down beta Seasonality of constant maturity Asymmetry Regime variation Source: Henderson Global Investors, Bloomberg, Goldman Sachs, as at May Charts show beta of Euro Stoxx 50 traded dividends. 24

26 Opportunity in equity delta one A diversifying source of return Correlation to major markets Back-test of systematic forward sales 220 S&P 500 total return index US 10yr yield US high yield index Global hedge fund index VIX Source: Henderson Global Investors, Bloomberg, as at 31 March 2017 Note: Correlation is over last 5 years 130 Back-test statistics 100 Return (ann.) 8.2% Volatility (ann.) 10.7% Sharpe Jul-08 Jan-10 Jul-11 Jan-13 Jul-14 Jan-16 Source: Henderson Global Investors, Bloomberg, as at 31 March 2017 Note: Please see the disclaimer slide for back-test assumptions. Past performance is not a guide to future performance. 25

27 CONCLUSION

28 Conclusions SELLSIDE PERSPECTIVE 1. Risk transfer allows banks to free up balance sheet capacity to serve clients 2. Allows investors to match and hedge opposite risks (equity/rates correlation) 3. Innovative solutions in packaging and wrapping risks a key factor of success BUYSIDE PERSPECTIVE 1. Risk transfer typically has positive expected return 2. With careful selection and risk management they can be diversifying 3. Actively managed risk transfer mitigates principal/agent dilemma 27

29 Q&A

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32 Disclaimer Slide 25: The back-test shown uses Bloomberg data to simulate the performance of a delta one risk premium strategy. This strategy is simulated by systematically selling 5-year Euro Stoxx 50 forwards on an annual basis. It uses quarterly rolled Euro Stoxx 50 futures to delta hedge, using the team s proprietary dividend beta model. It uses Bloomberg interest rate swap data to rho hedge. The performance shown includes estimated transaction costs but does not include fees. These results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have underor-over compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown. 31

33 Janus Henderson Investors 201 Bishopsgate, London EC2M 3AE Tel: Fax: Important information This document is intended solely for the use of professionals, defined as Eligible Counterparties or Professional Clients, and is not for general public distribution. Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Tax assumptions and reliefs depend upon an investor s particular circumstances and may change if those circumstances or the law change. If you invest through a third party provider you are advised to consult them directly as charges, performance and terms and conditions may differ materially. Nothing in this document is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment. Any investment application will be made solely on the basis of the information contained in the Prospectus (including all relevant covering documents), which will contain investment restrictions. This document is intended as a summary only and potential investors must read the prospectus, and where relevant, the key investor information document before investing. Issued in the UK by Janus Henderson Investors. Janus Henderson Investors is the name under which Henderson Global Investors Limited (reg. no ), Henderson Fund Management Limited (reg. no ), Henderson Investment Funds Limited (reg. no ), Henderson Investment Management Limited (reg. no ), AlphaGen Capital Limited (reg. no ), Henderson Equity Partners Limited (reg. no ), Gartmore Investment Limited (reg. no ), (each incorporated and registered in England and Wales with registered office 201 Bishopsgate, London EC2M 3AE) are authorised and regulated by the Financial Conduct Authority to provide investment products and services. Telephone calls may be recorded and monitored. Ref: 34S G:\CS\UK\2017\!P\G17\SGJH on Risk Transfer - CBOE Sep-17.pptx 32