Seeking Higher Returns When Saving For Tomorrow Be Careful What We Wish For.

Transcription

1 Seeking Higher Returns When Saving For Tomorrow Be Careful What We Wish For

2 DISCLAIMER This presentation is the result of my co-authors and my independent academic research and past writings on this topic. 1 It certainly shouldn t be interpreted as representing the views of the CPF Advisory Panel 1. A Tail of Two Cities: On the Downside Risk and Loss Profile of Asian and North American Hedge Funds, CAMRI Working Paper, October 2014, Joseph Cherian, Christine Kon and William Weng

3 The Low-Down Facts on Stocks Diversification helps but that does not mean a well-diversified basket of stocks (or hedge funds) are as safe in the long run. If they were safe in the long-run: they wouldn t command an equity risk premium Warren Buffet would be offering downside insurance on stocks which premiums become cheaper as your investment horizon increases! To paraphrase Nobel laureate Robert C. Merton, a goal-oriented approach to retirement planning is warranted and getting one s objective function right is paramount 3

4 Goal-based Investing Asset/Liability Management (ALM) 101 Determining the appropriate objective function (or the goal ) for any portfolio is important: Example 1: Goal is to provide for four years of tuition fees and lodging at a university, beginning when your child is 18 years old Example 2: Liability-driven investing (i.e., buy bonds!) with the goal of repaying targeted liabilities (or payouts) according to a schedule, as in a defined-benefit pension fund Example 3: A managed defined-contribution product where the goal is to receive inflation-protected retirement income for life (i.e., buy inflation-indexed bonds!), adequate to sustain a dignified standard of living from the point of retirement 4

5 It s getting harder all the time: The retirement problem The average investor is concerned about 3 fundamental issues during retirement: Receiving a reasonable, level payout every month It should last for as long as the retiree lives It should be indexed to his or her cost of living 5

6 Myths, Urban Legends and Facts about the CPF Myth: There s nothing wrong with socking away a good portion of your salary in risk-free assets for retirement purposes Fact: Start saving as much as you can for your retirement as soon as you enter the work force Reduce the temptation to dig into this retirement pot during the savings period CPF Life is a good life annuity program for all. It guarantees Singaporeans a dignified standard of living in retirement. The payouts aren t inflationindexed though 6

7 Inflation is Inflated? Myth vs Reality Check: True inflation in Singapore a.k.a. MAS Core Inflation, which excludes the cost of private accommodation and transport is around 2.0 percent per annum on average The first $60,000 of CPF combined balances in the SMRA can earn up to. The 30-year SGS bond is currently yielding ~3% So one s already beating inflation by about 1% if you invest in the 30YR SGS bond, and by about 3% (on a pre-tax basis, post-tax it s even higher) on the first $60,000 of your CPF combined balances In other words, there s a AAA-rated government that s currently effectively offering a 3% riskless real yield (tax-free) on members retirement accounts (via the issuance of SSGS to the CPF Board) 7

8 Structuring "matching and return-seeking portfolios Matching (or hedging or ALM) portfolio the safe Social Security Savings way Laddered, sovereign bond portfolios (a.k.a. SSGS) Interest rate and inflation total return swaps Returns-seeking (albeit well-diversified, low-cost) risky portfolio Equities, hedge funds, commodities, real estate CPF is here Equities Real estate Hedge funds Private equity Portable alpha Fixed Income Inflation hedges TR Swaps Forwards + Futures Options Returns Seeking (Risky Portfolio) CPF members are asking for this! Matching (Asset-Liability Management) DOWNSIDE PROTECTION (= Insurance) RISK REDUCTION + PERFORMANCE = ASSET-LIABILITY MANAGEMENT AND RISK MANAGEMENT + DIVERSIFICATION 8

9 How about this? Life Annuity (CPF Life) with Upside Potential (Private Pension Plan) Future Realized Monthly Value as of Drawdown Age Participation in upside based on Individual Risk Tolerance (Financed by CPF Savings & Home Monetisation program in excess of Minimum Sum) AGGRESSIVE MODERATE $1,200 per month Worry-free, CPF Life zone Limited downside, risk-free (Financed by Minimum Sum) CONSERVATIVE Hope For The Best, PPP zone (Temasek, GIC, ETFs, Low-fee Balanced & LifeGoal Funds) Investment depreciates Investment appreciates Source: CAMRI Future Risky Investment Value S T 9

10 Why equities & hedge funds aren t suitable for ALM or as Safety Nets (Initial Value = $1,000; Inflation =, #Periods = 5 years) Select Equity Indices Select Asian Hedge Fund Strategies FSSTI $1,276 Inflation $1,276 Indexed Floor Long-Short Equities MSCI All Country < $1,276 Macro < $1, < Equity Indices: 1. FSSTI FTSE Straits Times Index 2. MSCI All Countries Multi Strategy < $1, Note that the benchmark, CPF Life, pays out approximately $1,276 in nominal dollars for life almost surely (under current circumstances) Source: Eurekahedge, CAMRI <

11 Magnitudes of terminal values LEFT RANGE OF TERMINAL VALUES IN 5 YEARS ($0 - $1,200) $ 0 - $ 200 $ $ 400 $ $ 600 $ $ 800 $ $1000 $ $1200 RIGHT RANGE OF TERMINAL VALUES IN 5 YEARS ($1,200 - $3,200) $1200 $ 0 -- $ 200 $ $ $ $ -400 $1800 -$ 400 $ $ $2200 $ $ 800 $ $ 800 $ $ $2800 $ $ $1200- $1400 $1600 $1800 $2000 $2200 $2400 $2600 $2800 $3000 $3200 NAHF_LSEq NAHF_Macro NAHF_Multistr AHF_LSEq AHF_Macro AHF_Multistr FSSTI MXWD Source: Eurekahedge, CAMRI 11

12 Probabilities of terminal values PROBABILITY (Terminal Value < X) IN 5 YEARS NA LSEq NA Macro NA Multistr Asia LSEq Asia Macro Asia Multistr FSSTI MXWD X $200 $400 $600 $800 $1,000 $1, PROBABILITY (Terminal Value > X) IN 5 YEARS Inflation Indexed floor X $1,200 $1,400 $1,600 $1,800 $2,000 $2,200 $2,400 $2, NA LSEq NA Macro NA Multistr Asia LSEq Asia Macro Asia Multistr FSSTI MXWD Source: Eurekahedge, CAMRI 12

13 Learn from the pros Healthcare of Ontario Pension Plan s strong funding status driven by liabilityhedging The $51.6 billion Canadian fund, The Healthcare of Ontario Pension Plan, returned 8.55 percent for the 2013 financial year, exactly half the return of But it finished the year in a better position than the year before, demonstrating that returns are only half the story. Jim Keohane described the fund s liabilitydriven investment style: 2 years ago, the Plan moved to a liability-driven investing approach, and now divides its portfolio into two distinct parts: a liability-hedging portfolio, where all the physical assets are invested, and a return-seeking portfolio, implemented entirely through financial derivatives. The Healthcare of Ontario Pension Plan finished 2013 with a funding status 10 percent higher than in 2012, putting the defined benefit plan in a positive position of 114 percent funded! Source: 3 Mar

14 Summary Retirement Plans should: First get their objective function right. If ALM is the call for the day, start with ALM first (which is what the CPF Board does with its CPF Savings and Life programs) Second, members can perhaps seek (privately-sourced) additional risk-adjusted returns or alpha to re-shape their retirement payoff: Via equity & hedge fund managers with deep experience in portfolio management Low-cost, well-diversified, good liquidity Disciplined portfolio construction and downside (tail) risk management Culture of continuous innovative research, transparent investment process 14

15 APPENDIX

16 Eurekahedge North American Hedge Fund Indices HF Index Arbitrage Fixed Income Long-Short Equities Macro Multi Strategy No. of months of negative returns % of negative returns Sharpe ratio No. of 3 month consecutive negative return periods No. of 6 month consecutive negative return periods Number of funds Eurekahedge Asian Hedge Fund Indices HF Index Arbitrage Fixed Income Long-Short Equities Macro Multi Strategy No. of months of negative returns % of negative returns Sharpe ratio No. of 3 month consecutive negative return periods No. of 6 month consecutive negative return periods Number of funds Data as of July 31, 2013 Source: Eurekahedge, CAMRI

17 North America Asia Pre-GFC HF Index Arbitrage Fixed Income Long-Short Equities Macro Multi Strategy -40 HF Index Arbitrage Fixed Income Long-Short Equities Macro Multi Strategy North America Asia Post-GFC HF Index Arbitrage Fixed Income Long-Short Equities Macro Multi Strategy HF Index Arbitrage Fixed Income Long-Short Equities Macro Multi Strategy USD BOND CREDIT SP500 CMDTY ΔVIX Based on Historical Returns From Jan 00 to Sep 08 (Pre-GFC) and Oct 08 to Jul 13 (Post-GFC) 17 Source: Eurekahedge, CAMRI

18 Rolling β Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan NA Macro Asia Macro Rolling β Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan NA LS Equities Asia LS Equities Source: Eurekahedge, CAMRI

19 Value Relative Value Others Multi-Strategy Macro Long Short Equities Fixed income Event driven Survival rate of Asian hedge funds by strategy Survival of funds (Jan Survival by 2000 strategy to of Sep funds (%) 2012) by strategy (%) Value Relative Value Others Multi-Strategy Macro Long Short Equities Fixed income Event driven Survival rate 95.6% 56.1% 42.9% 57.3% 52.3% 50.1% 64.9% 47.8% Value Dual approach Others Distressed debt Macro Fixed income CTA/Managed Futures Dual approach Bottom-up CTA/Managed Futures Dual approach Distressed debt CTA/Managed Futures Bottom-up Arbitrage Arbitrage Arbitrage Live Dead Average survival rate across strategies: % 44.1% 59.3% 78.3% 59.4% 19 Source: Eurekahedge, CAMRI

20 Loss distribution of individual hedge funds by lock-up periods (Jan 95 Feb 13) North America Asia 5 1 st 5 th 10 th 25 th 50 th 5 1 st 5 th 10 th 25 th 50 th 0 0 Maximum 12 month drawdown Less than 1 year 1 year More than 1 year None 9 Source: Eurekahedge, CAMRI

21 Loss distribution of individual hedge funds by leverage (Jan 95 Feb 13) North America Asia 0 1 st 5 th 10 th 25 th 50 th 0 1 st 5 th 10 th 25 th 50 th Maximum 12 month drawdown Yes No 10 Source: Eurekahedge, CAMRI

22 North America Asia Long-Short Equities $1,276 $1,276 Macro < $1,276 $1,276 < Multi Strategy < $1,276 $1,276 < < <