capitalizing on the commodities market despite extreme volatility - presentation: michel toupin,...
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G U E S T S P E A K E R :
M I C H E L T O U P I N , M A N A G I N G D I R E C T O R
F O N D S C O M M U N D E P L A C E M E N T D E S R É G I M E S D E
R E T R A I T E D E L ’ U N I V E R S I T É L AV A L
Canadian Institutional Investment Summit
« CAPITALIZING ON THE COMMODITIES MARKET
DESPITE EXTREME VOLATILITY »
October 17-19, 2011 - Hilton Lac-Leamy,
Gatineau-Ottawa, Quebec
ORDER OF PRESENTATION
Canadian Institutional Investment Summit Oct. 2011
2
GENERAL OBJECTIVE
PENSION FUNDS OBJECTIVES AND PROCESS
COMMODITIES PORTFOLIO
A transfer of risks
Some indices
An inadequate substitute, regional consideration
A risk-reward perspective
CORRELATIONS ANALYSIS
IMPLEMENTATION
A GLOBAL PERSPECTIVE – DEMOGRAPHY AND URBANIZATION
OTHER CONSIDERATIONS AND CONCLUSIONS
PRESENTATION - GENERAL OBJECTIVE
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« To describe a commodities portfolio and to introduce its benefits for a pension fund .
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PENSION FUNDS OBJECTIVES AND PROCESS
COMMODITIES AND PROTECTION
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Two combined strategies
« to provide a protection against inflation and its
effects upon the liabilities as well the assets, no
matter the source of inflation» (considering the
commodities as a potential source)
« to reduce the global risk through a more
efficient diversification »
COMMODITIES – « THE ORIGIN »
A case : Laval University Pension Funds
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COMMODITIES FOR INSTITUTIONAL INVESTORS -
A SPHERE OF INFLUENCES IN 2011
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THE COMMODITIES MARKET
A TRANSFER OF RISKS BETWEEN PLAYERS
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Bond Holder
Shareholder
Speculator-Arbitragor-
Hedge Funds
Diversified Investors
Commodity
ProducerTransformer-Final UserFinal sales
hedging
hedging investing
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TWO COMMODITY INDICES
AND THEIR CONTENT
REGIONAL
CONSIDERATIONS AND
OPTIMISATION
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AN INADEQUATE SUBSTITUTE (1)
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• Question : Can we replace a Commodity Index (such as The
Goldman Sachs C. Index) with Canadian Stocks?
• Answer : No
1. Correlation between 4 sectors or sub-sectors of the TSE 300 and
the GSCI: Mines and Metals, Gold and Precious Metals, Oil and Gas and Pipelines versus Goldman
Sachs Index (all sectors)
• Result :
to have the best correlation TSE 300/ GSCI = 0,41 the model
keeps only Mines and Metals (TSE300), rejects others
2. Correlation between the TSE 300 (all sectors) and the GSCI :
maximum correlation = 0,42, the model keeps only Oil and Gas
and Gold Precious Metals (TSE300), rejects others
AN INADEQUATE SUBSTITUTE (2)
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• Correlation between the TSE 300 (all sectors) and the GSCI -
Energy :
maximum correlation = 0,49 between the TSE 300 and the GSCI, the model keeps 1 sector of the STX300, Oil and Gas;
Finding:
We tried to replicate, from a canadianperspective, the market behaviour as defined bya commodities index but, we failed.
What’s a possible explanation ?
CHOOSING BETWEEEN COMMODITIES AND STOCKS
A CASE : IShare Commodity Index and Chicago Mercantile
Exchange Group (the stock)
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-25%
-35%
CME Group
I Share Commodity Index
Difference = Business or “Non-
Systematic” Risk ?
CORRELATION ANALYSIS(QUANTITAT IVE PROCESS)
HOW TO DETERMINE THE
PROPORTION, APPROPRIATE VERSUS
ACCEPTABLE
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RISK-REWARD ANALYSIS
SIMULATION WITH SIX MARKET INDICES
Indice Rendementespéré
Rendement au90
ième rang
centile
Rendement au10
ième rang
centile
GoldmanCommodities
8,4% -14,9% 26,4%
MSCI EAFE 9,4 -12,8 28,6
S&P 500 17,5 -0,2 34,9
TSE 300 3,6 2,4 4,8
SMc Univers 7,7 -0,8 14,8
Russell 2000 14,2 -8,0 35,7
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January 1992 to December 2000, Cdn $.
Expected
returnIndex Ranking 90 th Ranking 10 th
worstClose to
median
Close to
median
ADDING COMMODITIES
A RISK-REWARD OPTIMIZATION
Matièrespremières =
0%
Matièrespremières =
2%
Matièrespremières =
6%
Matièrespremières =
8%
Rendementespéré 4,6% 4,6% 4,6% 4,6%95
ième rang centile -3,6 -3,4 -3,0 -2,8
Probabilitéd’échec ( sur 3 ans
r.min=0%)
19,4 17,8 16,3 15,7
Rendementbaissier espéré(r.moy sous 0)
-2,7 -2,6 -2,4 -2,3
Titres departicipation(1/3, 1/3, 1/3)
55,0 53,0 49,0 47,0
Titres d’emprunt(1% mm et 44% obl.) 45,0
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Les rendement sont exprimés en termes réels
Commodities =
StocksBonds
Expected return
Probability of
missing the MAR
0% 2% 6% 8%
CANADIAN AND FOREIGN STOCK MARKETS
COMPARED VOLATILITIES
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R e t u r nJ a n u a r y 1 9 8 8 - A u g u s t 2 0 1 1
R a n g e o f R e t u r n s f o r 3 In v e s t m e n t C a t e g o r ie s
S & P G S C I T R C A D M S C I E M A s i a U S D S & P / T S X E n e r g y T R
- 3 0 . 0 %
3 0 . 0 %
- 2 8 . 0 %
- 2 6 . 0 %
- 2 4 . 0 %
- 2 2 . 0 %
- 2 0 . 0 %
- 1 8 . 0 %
- 1 6 . 0 %
- 1 4 . 0 %
- 1 2 . 0 %
- 1 0 . 0 %
- 8 . 0 %
- 6 . 0 %
- 4 . 0 %
- 2 . 0 %
0 . 0 %
2 . 0 %
4 . 0 %
6 . 0 %
8 . 0 %
1 0 . 0 %
1 2 . 0 %
1 4 . 0 %
1 6 . 0 %
1 8 . 0 %
2 0 . 0 %
2 2 . 0 %
2 4 . 0 %
2 6 . 0 %
2 8 . 0 %
2 3 . 0 %
- 1 7 . 9 %
2 2 . 0 %
- 2 4 . 2 %
2 3 . 3 %
- 2 1 . 1 %
H i g h e s t :
A v e r a g e :
L o w e s t :
L e g e n d
COMMODITIES
ALTERNATIVE PORTFOLIOS
COMMODITIES VARYING FROM 0% TO 50%
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R i s k ( S T D )
R e t u r n ( A M )D e c e m b e r 1 9 9 9 - D e c e m b e r 2 0 1 0
R E L A T IV E S P E R F O R M A N C E S A N D R IS K S
1 . 0 % 6 . 0 %1 . 3 % 1 . 6 % 1 . 9 % 2 . 2 % 2 . 5 % 2 . 8 % 3 . 1 % 3 . 4 % 3 . 7 % 4 . 0 % 4 . 3 % 4 . 6 % 4 . 9 % 5 . 2 % 5 . 5 %
- 0 . 1 %
0 . 9 %
0 . 0 %
0 . 1 %
0 . 2 %
0 . 3 %
0 . 4 %
0 . 5 %
0 . 6 %
0 . 7 %
0 . 8 %
P o r t f o l i o ( 1 )
P o r t f o l i o ( 2 )
P o r t f o l i o ( 3 )
P o r t f o l i o ( 4 )
P o r t f o l i o ( 5 )
• (% of total port.) 1 2 3 4 5
• Commodities 16,7 0 20 25 50
• Large Cap. US 20 20 25
• (Russell 1000)
• MSCI EAFE 20 0
• Large Cap. Can. 0 25
• (S&P/TSX 60)
• DEX Real Retrn. 20 25
• DEX All Gov. 20 0 50
Alternative portfolios
1 50% COMMODITIES
NO COMMODITIES
COMMODITIES –INFLATION AND INTEREST RATES
WHO COMES FIRST ?
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Consumption Wars, Catastrophes, OPEC
Demand
Oil Other
Products
GSCI Commodity Index
Canadian Interest rates
Real estate
Offer
Inflation US
US Interest rates
Inflation CDN
Real Return Bonds
MONETARY
POLICIES
COMMODITIES AND INFLATION
CORRELATION FROM 1996 to 2011
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In te rva l: 24
C o rre la tio n V a lu e s
Correlation Rolling Period 24 M onths
0.0%
80.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
50.0%
55.0%
60.0%
65.0%
70.0%
75.0% 76.3%
D e c1996
Ju n2011
De c2000
De c2005
S & P G S C I T R vs. IA S B B I U S In fla tio n
FINANCIAL CRISIS
MATURE PENSION FUNDS
PARTICULAR NEEDS
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Constraints
An urgent need to finance or match the annuities adjusted for inflation ;
Strategy (depending on each pension fund)
Matching inflows and outflows in terms of :
Dollars matching,
Sensibilty to market movments,
Timing of entry-exit, perfect synchronisation whenimplementing
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COMMODITIES AND
IMPLEMENTATION ISSUES
PORTFOLIO IMPLEMENTATION
THE BEST IS HAVING GOOD TIMING…. (easy to say !)
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COMMODITIES AND THE CURRENCY EFFECTTO AVOID A « ZERO-SUM GAME » BECAUSE OF AN APPRECIATION
OF THE CDN $
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COMMODITIES
CANADIAN DOLLAR
profits
losses
AFTER IMPLEMENTATION OF COMMODITIES
VARIOUS CORRELATIONS
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I n t e r v a l : 6 0
C o r r e l a t i o n V a l u e s
C o r r e la t io n R o llin g P e r io d 6 0 M o n t h s ( C D N $ )
- 2 0 . 0 %
6 0 . 0 %
- 1 8 . 0 %
- 1 6 . 0 %
- 1 4 . 0 %
- 1 2 . 0 %
- 1 0 . 0 %
- 8 . 0 %
- 6 . 0 %
- 4 . 0 %
- 2 . 0 %
0 . 0 %
2 . 0 %
4 . 0 %
6 . 0 %
8 . 0 %
1 0 . 0 %
1 2 . 0 %
1 4 . 0 %
1 6 . 0 %
1 8 . 0 %
2 0 . 0 %
2 2 . 0 %
2 4 . 0 %
2 6 . 0 %
2 8 . 0 %
3 0 . 0 %
3 2 . 0 %
3 4 . 0 %
3 6 . 0 %
3 8 . 0 %
4 0 . 0 %
4 2 . 0 %
4 4 . 0 %
4 6 . 0 %
4 8 . 0 %
5 0 . 0 %
5 2 . 0 %
5 4 . 0 %
5 6 . 0 %
5 8 . 0 %
4 4 . 2 %
3 8 . 2 %
2 9 . 4 %
1 7 . 4 %
1 1 . 0 %
D e c2 0 0 4
A u g2 0 1 1
M a r2 0 0 5
J u n2 0 0 5
S e p2 0 0 5
D e c2 0 0 5
M a r2 0 0 6
J u n2 0 0 6
S e p2 0 0 6
D e c2 0 0 6
M a r2 0 0 7
J u n2 0 0 7
S e p2 0 0 7
D e c2 0 0 7
M a r2 0 0 8
J u n2 0 0 8
S e p2 0 0 8
D e c2 0 0 8
M a r2 0 0 9
J u n2 0 0 9
S e p2 0 0 9
D e c2 0 0 9
M a r2 0 1 0
J u n2 0 1 0
S e p2 0 1 0
D e c2 0 1 0
M a r2 0 1 1
D J U B S C o m m o d i t y T R U S D v s . R u s s e l l 1 0 0 0 T R U S D D J U B S C o m m o d i t y T R U S D v s . M S C I E A F E U S DD J U B S C o m m o d i t y T R U S D v s . S & P / T S X 6 0 T R D J U B S C o m m o d i t y T R U S D v s . D E X R e a l R e t u r n B o n d T RD J U B S C o m m o d i t y T R U S D v s . D E X L T A l l G o v e r n m e n t s T R
FINANCIAL CRISIS
REAL RETURN BONDS
S&P/TSX60 TR
AFTER THE IMPLEMENTATION
A PERPETUAL MONITORING
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YEAR 1 : Two managers, same index : GSCI Core, index approach
YEAR 4: One manager, one index : GSCI Light Energy (agriculture under represented)
YEAR 7: New manager (3rd) : Dow Jones, more “balanced”
Fees less than 30 pb, no incentive,
Continual challenge : strict discipline
DEMOGRAPHY AND URBANIZATION
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A GROWING DEMAND FOR
COMMODITIES
WORLD GROWTH AND DEMOGRAPHY
POPULATION OF “LDC’S” INCREASES BY 50%
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Source : United Nations
100%
URBANIZATION AND POTENTIAL DEMAND
FOR COMMODITIES
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Source : United Nations
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OTHER CONSIDERATIONS AND CONCLUSIONS
A FIDUCIARY PERSPECTIVE
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Pros’
A proven diversificationtool
Technical factors
No default risk, clearinghouse
Extreme liquidity
Efficient if you manageadequately the collateral
Cons’ Source of nervosity or source of
exuberance
Test your capacity to maintain
discipline while assuming your
choice (decided allocation and
indexing, if any)
The investment is original and
rapidly appear a conflict
between prudence and the
optimal allocation to maintain
COMMODITIES AND CURRENT YIELD
A CHALLENGE FOR MATURE PENSION FUNDS
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• Bet on the performance instead of the current yield ;– Commodities : generate a pretty weak yield from the money
market, the price appreciation makes the difference :
– Real estate : generate positive cash-flows on a monthlybasis, the cash-flows may be indexed depending on the sector ;
– Real return bonds : generate a series of coupons fully indexedwith a possible capital appreciation.
COMMODITIES
DIVERSIFICATION TOOL
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The « tolerance point » is intuitive and seems to be around 10% of the total portfolio although…
The « optimal point » may reach » up to 25% of the total portfolio (rarely seen…);
A target around 8% is a risk-reducer which keeps constant the performance of the total portfolio;
The real value behind commodities is its weak correlation withtraditional invesments. Caution : the « ups’ and downs’ are frequent and may be important.
COMMODITIES – LITTLE-KNOWN ASPECTS
A COMBINATION OF CHALLENGES
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RATIONAL AND MEMORY TO JUSTIFY THE
PRODUCT
(DIVERSIFICATION VERSUS
SPECULATION)
DISCIPLINE TO MAINTAIN THE
PRODUCT
(IN ADVERSE CONDITIONS)
LUCK TO INTRODUCE
THE PRODUCT
(YOU NEVER KNOW WHEN)
CONCLUSIONS
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Since we measure our performance attribution, commodities added up to 40-50 pb. To the total performance
You should consider to hedge the US position on commodities, our hedge ratio is 50% of the US exposure (based on a frequent evaluation of the market value)
Ask your consultant to :
Identify the “good” index, test more than one ;
To do not try to time the market when implementing and after and,
• Remain indexed until you feel comfortable with the asset class
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