Investment Advisory in Today s Markets Alexis Calla October 31, 2012 1 1
Important Information Disclaimer The presenter, Alexis Calla is the Global Head, Advisory and Investment for Standard Chartered Bank. The views, opinions and information reflected in this presentation are the presenter s own. Standard Chartered Bank (including its branches, subsidiaries and affiliates) do not necessarily share these opinions. This document is for informational purposes only and no guarantees are offered as to its accuracy or completeness. The information stated, opinions expressed and estimates given constitute best judgment at the time of publication and are subject to change without notice to you. Consequently, although this document is provided in good faith, it is not intended to create any legal liability on the part of SCB or the presenter. This document must not be forwarded or otherwise made available to any other person without the express written consent of the presenter. 2
A different world Pre 2008 In the years before 2008, the advisory lens was focused on following markets and the investment process. 2009 and beyond Post 2008, additional variables are playing a larger role in the advisory process Governments & Central Banks? Financial Markets Regulation Financial Markets Tail Risks Behavioral Bias The advisory ecosystem is increasingly complex 3 3
Part 1 - MARKET DYNAMICS 4 4
Market cycles have shortened S&P500 vs. US economic surprises 1600 1400 1200 1000 800 600 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 S&P500 Citi US Economic Surprises Index 1500 1400 1300 1200 1100 1000 Jan-10 Jun-10 Nov-10 Apr-11 Sep-11 Feb-12 Jul-12 S&P500 Citi US Economic Surprises Index 100 50 0-50 -100-150 100 50 0-50 -100-150 Higher volatility Higher correlation Shorter cycles Policy uncertainty has led to significant market volatility, higher correlation and has created much uncertainty. Unorthodox central bank policy Market riot policy response cycle Regulation changes Markets have been responsive to short-term economic surprises Source: Bloomberg Markets focusing on short term due to higher uncertainty 5 5
A more volatile & correlated environment 0.5 Cross-asset returns correlation has gone up since mid-2008 0.4 0.3 0.2 0.1 0 Pre-06/2008 Post-06/2008 Since 2008 Equity market volatility has gone up Credit market volatility has gone down Correlation across asset classes has gone up Rise in uncertainty a key reason for structurally higher volatility Crisis-market riot-policy response cycle has led to spikes in volatility -0.1 Lower importance of asset class fundamental factors -0.2 Equities-Bonds Equities-Commodities Bonds-Commodities Source: Bloomberg Higher uncertainty has raised market volatility and crossasset correlation 6 6
Financial markets have broadened & deepened International debt securities issued by developing countries 2000 1800 Total outstanding (USD bn) 1600 1400 1200 1000 800 600 400 200 0 Mar.1987 Dec.1990 Sep.1994 Jun.1998 Mar.2002 Dec.2005 Sep.2009 Local Currency securities issued by Asian countries Europe is fragmenting East is broadening and deepening Economic growth has raised demand for capital Financial markets outside the developed world have deepened in response Investors therefore have more investment alternatives outside of equities alone Asian corporate credit markets have deepened & broadened Asian FX markets have deepened in response to rising trade Asian equity markets display better sector diversification Greater ETF availability for regional assets Inflation-linked securities increasingly available This has made greater diversification of investor portfolios possible Asian credit market development over the past decade a great example Broadening & deepening of EM financial markets underway Source: BIS 7 7
The disintermediation challenge Banks Banking systems across the globe are stretched given recent credit crisis and stricter capital requirements Post 2008, the structured credit market has dried up Investable Money Structured Credit Private Capital Need for funding (medium to high risk capital) Private capital is a source of funding but may not be able to meet the entire funding need; also limited to a certain pool of investors Is there a role for the retail investor in addressing this funding gap? Level of due-diligence and regulation are impediments to the small investor entering this market Others? Can the retail investor help address the funding gap? 8 8
A strategy for current markets 1 Barbell Approach Post 2008, policy intervention and political uncertainty have pushed markets into riskon / risk-off cycles Risk Off Risk On An option to tackle this environment is implementing a barbell portfolio strategy combining market beta from risk-on and risk-off assets 2 Portfolio Immunization Risk Off Immunize Assets least affected by RORO Immunize Risk On An alternative is to partially immunize the portfolio by investing in assets that are less affected by the risk-on/risk-off cycle i.e. neutral beta. A refined version is to adopt a form of immunization approach with the option to tactically add risk-off and risk-on exposure. 3 Portfolio Immunization w/ tactical option Risk Off CTAs, Vol. Funds Tactical Assets least affected by RORO Tactical Risk On US Equity, Oil One could partially immunize the portfolio with assets to shorten portfolio duration i.e. dividend yielding equity and high yield bonds. Example of tactical positions include CTAs/Volatility funds (Risk Off option) and US Equity/Oil (Risk On option) 9 9
Innovation: Portfolio & Product Construction EDHEC Survey on Portfolio Construction Key Ideas Do you agree that the industry has to make progress on integrating state-of-the-art portfolio optimization techniques? Old paradigm portfolio construction techniques being revisited; innovation on the rise again Given elevated market volatility, a host of new techniques being proposed risk parity, alternative beta, equalweight portfolios, maximum diversification On the product side, a clear need for niche sources of return. For example, underexplored sectors in Europe vs. broad based European exposure. However, innovation challenged by investor sentiment and regulatory developments Key question is there appetite from regulators and in the retail investor space for such innovation? Source: EDHEC Risk, A Long Road Ahead for Portfolio Construction: Practitioners Views of an EDHEC Survey, (2009) Innovation is key, but how will it be received? 10
Part 2 - OTHER FACTORS 11
Impact of regulation 1 Client Suitability Post 2008, major focus on client suitability Suitability on three levels Portfolio risk Product risk Knowledge & Experience 2 Portfolio Advice Multiple models of portfolio advice based on regulation Guidance varies depending on country regulator Universal portfolio model not applicable in Asia 3 Internal Process Governance function playing an increasingly important role in advisory function Back-office costs, typically stemming from IT and compliance, constitute 45% of the total cost base (2011 Mckinsey survey) Regulation a key factor in nature of advice delivered 12
13 New Developments in Behavioral Finance The Geography of thought: How Asians and Westerners Think Differently...and Why Nisbett (2003) Source: Yang Liu, East meets West (2007) Talking Queuing Concept of Time Child Individuals in the West think that World is comprised of discrete objects belonging to categories (Greek philosophy) Rule-based approach, formal logic help explain and predict behaviors Environment is organized Life is highly subject to personal control Contradiction lead to polarization of belief Asians think that Holistic approach to a world that is full of context Relatively little use of categories and formal logic Importance of change, contradictions and multiple perspectives Search for the middle way Environment is chaotic Life is subject to changes of fortune without notice Contradiction lead to moderation of belief Behavioral finance theory generally oriented towards the Western mindset what about Asian behavioral finance?
14 Building TRUST HNW Client Trust Levels (2008-2010) Source: Capgemini/Merrill Lynch World Wealth Report, (2011) Trust in firms and advisors increasing over time
Concluding thoughts High correlation, bouts of volatility remain a reality Innovation needed but key players skepticism need to be overcome Solutions should be theoretically sound while addressing investor biases Challenges & opportunities go beyond macro-finance uncertainties Trust is being rebuilt Thank You 15