March Saker Nusseibeh Head of Investment Hermes Fund Managers

Transcription

1 Back to the Future Traditional Fiduciary Values with Modern Analytical Techniques March 2011 Saker Nusseibeh Head of Investment Hermes Fund Managers

2 Back to the Future The role of the Chief Investment Officer Asset Managers are conflicted Asset Manager should count on Investment Office What issues should we be raising? LDI & Solvency II impact asset allocation decision But the Investment Banks see an opportunity What Is de-risking? Entering the era of broken promises MorningStar Conference l Back to the Future 2

3 The role of the Chief Investment Officer 1980s..Asset allocator 1990s.. Sales person 2010 New breed MorningStar Conference l Back to the Future 3

4 Asset Managers are conflicted In conflict with client interests: Drive for margin Drive for assets under management Need to appease the regulator Over the past two decades Asset Managers have moved from holistic service to a narrow compartmentalised service MorningStar Conference l Back to the Future 4

5 Short-termism Contradiction posed by regulator and client ts Regulator forcing tri-annual reporting (UK) on 50 year horizon Pension Schemes Clients looking at three year horizons or five year at best Clients worry about peer pressure Regulation leads to unintended consequences Innovation leads to unintended consequences MorningStar Conference l Back to the Future 5

6 A broken model Asset Management business model does not allow for asset managers to: Be transparent Voice their opinion Criticise regulation MorningStar Conference l Back to the Future 6

7 Excess liquidity; sub-prime; modality are all symptoms of problems that led to was result of an abrogation of respons sibility: By Regulators By Bankers By Accountants By Asset Managers MorningStar Conference l Back to the Future 7

8 An Asset Manager should count on Investment Office to sit at the heart of the organisation To act as a mini consultant to clients: Needs best of breed risk analysis tools Need wide set of skills: Portfolio Management, Strategists, Performance Attribution Specialists, Risk Analysts To act for the client such an office has to be aligned with clients and not margin This demands moving risk control to the centre of Asset Management organisations and a large investmentt MorningStar Conference l Back to the Future 8

9 Client Benefits: Safety Net and Independent Vie ew Transparency Mandate monitoring Adherence to guidelines Decomposition and understanding of Risk Investment Health monitoring Qualitative assessment of philosophy and Qualitative and quantitative assessment of prospects for each strategy in different market conditions Independent investment view Market intelligence process Qualitative and quantitative assessment of market dynamics and drivers Sustainable Risk Adjusted Alpha MorningStar Conference l Back to the Future 9

10 What issues should we be raising?

11 Industry Trends Debate on Mean Variance Optimisation Possibility of extending Solvency II to Pension Funds The rise of derivatives as investments and as overlays The move of Investments Banks into Pe ension Schemes via Solutions The move towards de-risking The economic situation or Liability Driven Investments MorningStar Conference l Back to the Future 11

12 What does it look like investorss are doing? Institutional Investor (II) Searches by Asset Class 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Absolute Returns Alternatives Equities Fixed Income Other Source: II Serach Numbers shown include Completed, New and Potential mandates. Where a larger mandate includes smaller allocations to separate asset managers, each allocation is counte ed separately. MorningStar Conference l Back to the Future 12

13 What does it look like investorss are doing? Institutional Investor (II) Searches Alternat tives Searches 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Active Currency Management Currency Overlay Real Estate Alternative Hedge Funds Tactical Asset Allocation Cash Infrastructure Alternatives (Unclassified) Commodities Private Equity Source: II Serach Numbers shown include Completed, New and Potential mandates. Where a larger mandate includes smaller allocations to separate asset managers, each allocation is counted separately. MorningStar Conference l Back to the Future 13

14 LDI & Solvency II im mpact asset allocation decision

15 Where are we? Today we have a move towards LDI and perh haps towards Solvency II capital schemes. This pushes pension schemes to accrue highh capital reserves for perceived high volatility assets. Excess return* versus unadjusted SCR capital require ements 9.0% 8.0% 7.0% Cash credit Property Equity 6.0% Alternatives 5.0% 40% 4.0% 3.0% 2.0% 10% 1.0% 0.0% 0% 10% 20% 30% 40% 50% 60% SCR Capital Expected excess retu urn Source: Credit Suisse: Insurance & Pension Solutions Group *Risk adjusted spread for credit, long-term assumptions otherwise. MorningStar Conference l Back to the Future 15

16 Where does that lead us? 1. Either a simplistic higher allocation to propert ty, currency, bonds and an equity allocation with a put option. or 2. A high allocation to bonds and swaps into more esoteric alternative exposure. MorningStar Conference l Back to the Future 16

17 LDI Mean Variance Optimisation Exce ess return Efficient frontier 10% Portfolio 20 9% 8% 7% 6% 5% 4% 3% MVO frontier 2% Assets 1% Portfolio 1 0% 0% 5% 10% 15% 20% 25% 30% 35% Portfolio risk (std dev) Portfolio weights location Al Eu Govie US Govie EM Debt EUR Corp EU Eq US Eq EM Eq FX Prop HF Infra Priv Eq Commo Source: Credit Suisse: Insurance & Pension Solutions Group MorningStar Conference l Back to the Future 17

18 LDI Ex xcess return Impact of 85% puts on equity (asset only) Efficient frontier 10% Significant reduction in 9% downside risk 8% 7% 6% 5% 4% No puts 3% 2% 85% equity puts 1% 0% 0% 10% 20% 30% 40% 50% 60% 70% Portfolio risk Portfolio weights location % Al Eu Govie US Govie EM Debt EUR Corp EU Eq US Eq EM Eq FX Prop HF Infra Priv Eq Commo Source: Credit Suisse: Insurance & Pension Solutions Group MorningStar Conference l Back to the Future 18

19 The Problem with Alternatives Long-term reward One should question th he value add Recent record One should question the diversification MorningStar Conference l Back to the Future 19

20 Do Alternatives give higher returns? Property: A 350 year case study Herengracht Index The house took 350 years to double its real value Then more than tripled in value in the 22 years between 1983 and 2005 So in the longest of long runs, real estate as an investment didn t deliver Real property values on the Herengracht, adjusted for inflation, went up a mere 0.2 per cent per year. This index is based on the transactions of the buildings on the Herengracht, one of the canals in Amsterdam. Since its development, the quality of the buildings on this canal has been on a constant, high level, which makes the Herengracht a unique sample to base a long run house price index upon. The index is a hedonic repeated-measures index and is estimated in real terms. An index is also constructed in nominal terms. The average real price increase after World War II is about 3.2% per annum. Nevertheless, the real value of the index in 1973 is only twice as high as it was in Source: Herengracht Index MorningStar Conference l Back to the Future 20

21 Do Alternatives provide diversification? Markets have become more correlated post the credit crisis Pre-Crisis to Post-Crisis to Bond Correlation to Equities (J.P. Morgan Global Aggregate Bond Index versus MSCI World Index Hedge Fund Correlation to Equities (HFR Global Hedge Fund Index versus MSCI World Index) Source: Bloomberg in US$ MorningStar Conference l Back to the Future 21

22 Risk on : Risk off The Correlation of Everything Source: Hermes MorningStar Conference l Back to the Future 22

23 But the Investment t Banks see an opportunity

24 Asset Management offering in the Pensions Business Fiduciary management Segrega ated Accounts Pooled Solutions Can be done both by Asset Managers or Consultants Tends to be more liability fixed income although also execute Interest rate and inflation overlays Funds which are scalable which have interest rate and inflation protection, generally via swaps. Employ diversity it of asset classes (equity/property/commodities protection and either cash or corporate bond based LIBOR generator) MorningStar Conference l Back to the Future 24

25 Pension Funds An overview Hedging/Overlay/Mandate Specific VAR based LDI based cross asset overlays Fiduciary Mandates Equity Asset Allo ocation Fixed Income Commodity Property Alternatives Traditional Instruments Collectives Collectives Single stocks Bonds/government ETFs securities ETFs Collectives ETFs Physical Fund of hedge funds Collectives Single strategy HF Single stocks Private equity CDOs Quantitative strategies Investment Banking Solution Derivative overlay - Call overwriting etc - Futures Yield enhancement - Swaps/synthetics - Stock loan - Dividend enhancements - Outperformance certificates Access products - Customised baskets - Single stocks e.g. Brazil p notes - structured notes/funds -Tactical derivative trades e.g. variance options Derivative overlay - Interest/rates/yield curves - Inflation Credit linked notes Customised baskets Structured Structured notes e.g. IPD notes/funds linked Customised baskets Yield enhancment on single name via derivatives, financing trades Managed account platforms - Synthetic access UCITS III funds Quantitative research and tactical derivative trades Synthetic HF replicators MorningStar Conference l Back to the Future 25

26 What is de-risking?

27 Euro-zone as a bloc, less competitive since the euro Euro-zone s relative unit labour costs (RULC), vs its current account as % GDP C/acc % GDP (LHS) RULC ('05 = 100) '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10e'11p'12p Source: Hermes Fund Managers Ltd, based on national sources & OECD MorningStar Conference l Back to the Future 27

28 Individually, mixed competitiveness since the euro Shows change since Jan 2000 in a country s relative unit labour costs (RULC), vs its c/account shift as % GDP Improving competitiveness Germany 6 Sweden 4 Austria Neths Denmark 2 UK Ireland RULC change -2 Portugal -zone weighted av Belgium Spain -4 France Greece* Italy Finland -6-8 C/acc shift Falling competitiveness Source: Hermes Fund Managers Ltd, based on national sources & OECD. (*NB: Greece s from 2001 when it joined the euro) MorningStar Conference l Back to the Future 28

29 Entering the era of broken promises

30 The legacy is debt build-up Gross & net, as a % GDP. * 98 data; ** 00 data p Moody's local ccy Gross Net Gross Net US Aaa 67 Japan Aa2 101 Euro-zone n/a 81 UK Aaa 52 Greece Ba1 (-ve) 100 Italy Aa2 130 Iceland Baa3 77* Ireland Baa1 62* Latvia Baa3 53** OECD av * * n/a 75 n/a Source: OECD, OBR, Thomson Reuters Datastream, & Moody s Investor Services MorningStar Conference l Back to the Future 30

31 Our governments are insolvent Source: Societe Generale / OECD / Gokhale (2009) *2010 OECD projections ** 2005 estimates of total Fiscal Imbalance MorningStar Conference l Back to the Future 31

32 Silver content of Roman coin during 3 rd century fiscal crisis Source: Societe Generale / MorningStar Conference l Back to the Future 32

33 Euro-zone - peripherals trading at pre-euro spreads Generic 10-year spread vs German Bund, % points Source: Thomson Reuters Datastream MorningStar Conference l Back to the Future 33

34 What questions should we be asking? If we know yields are going up If we know the value of bond portfolios at best will fall, at worst some will restructure If we know governments will struggle to meet sovereign and social obligations Question: What is the de-risking trade? Bonds or Equities? MorningStar Conference l Back to the Future 34

35 200+ Years of Bond Rates (Average yield = 5.8%) Source: SG Cross Asset Research MorningStar Conference l Back to the Future 35

36 Thank-you

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