on alphas and betas: global equity and hedge funds

L U M E N I N V E S T M E N T S

L U M E N

S a n F r a n c i s c o S i n g a p o r e S a o P a u l o N e w Y o r k

On Alphas and Betas: Global Equity and Hedge Funds

Aaron Low

Principal

Lumen Investments

CFA Institute Board of Governors

13 March 2013

L U M E N I N V E S T M E N T S

TAKE 15

GLOBAL EQUITY MARKETS

o GLOBAL VS EMERGING & ASIA

GLOBAL HEDGE FUNDS

o SEARCHING FOR ALPHAS

o ALPHA BETA SEPARATION

L U M E N I N V E S T M E N T S

EQUITY VALUATION CHEAP OR REASONABLY PRICED?

US equity PE is close to historical norm ….. …. But ‘cyclically adjusted’ valuations look a little more challenging

L U M E N I N V E S T M E N T S

BONDS AS INSURANCE FOR RISK ON TRADES

Although methodologically unrelated, …., from a finance theoretical perspective, the mark-to-market volatility associated with bond duration is not a source of risk if it is negatively correlated with broader measures of market risk.

Rather, it is a source of insurance, or market risk mitigation. Investors could, for example, use their holdings of ‘safe haven’ bonds to diversify away some exposure to market risk created by their equity portfolio. They should not expect to be paid for owning this insurance; they should expect to pay for it, in the form of a negative risk premium. From this perspective, it makes perfect sense to expect (in contrast to much historical experience) ‘safe haven’ bonds to earn less than cash.

o Barclays

L U M E N I N V E S T M E N T S

BOND BETAS

L U M E N I N V E S T M E N T S

RISK FREE RATES AND REAL RETURNS WHAT ALTERNATIVES ARE THERE?

Real Returns from last Ten years unlikely to repeat for the next Ten.

Source: Centre for Research into Security Prices (CRSP), Barclays

US Asset Returns (1925-2012)

L U M E N I N V E S T M E N T S

EMERGING EQUITIES VALUATIONS POINT TO BULLISH IMPLIED GROWTH

Source: Bloomberg, J.P. Morgan, DataStream, MSCI, IBES

GBI-EM Bond Maturity and Yield to Maturity are used for each country.

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THE GREAT MODERATION & THE FAT TAIL

NEW NORMAL OR LOW RISKS/LOW RETURNS?

L U M E N I N V E S T M E N T S

MARKET PREFERENCE STYLES EQUITY L/S, MACRO, CREDIT TOP ALLOCATIONS

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Equity Long Short

Macro Credit Event Driven Emerging CTAs

Global

US

EU

Asia

Source: UBS, Lumen

L U M E N I N V E S T M E N T S

THE SHORT BOOK TOP 3 SHORTED SECTORS BY SHORT MARKET VALUE (SMV)

0%

4%

8%

12%

16%

20%

US

0%

5%

10%

15%

20%

25%

EU

0%

5%

10%

15%

20%

25%

30%

ASIA

Source: UBS, Credit Suisse, Lumen

L U M E N I N V E S T M E N T S

CROWDED TRADES EMERGING ALLOCATIONS POINT TO ECONOMIC CYCLE

Most Crowded Least Crowded

Colombia Poland

Philippines Czech Rep

Thailand Morocco

South Africa Hungary

Turkey India

Source: UBS, Lumen

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CHINA FUND ALPHAS: LOW DISPERSION OF ACTIVE ALPHAS

Average Monthly Alpha 12 month MA (2001-2013)

Source: Lumen, Bloomberg

L U M E N I N V E S T M E N T S

ASSET ALLOCATION (ALPHA BETA SEPARATION): CHINA ALPHAS LOW CORRELATION TO WORLD BETAS

Correlation of Alphas with China Betas & Global Betas (12 Month Rolling 2001-2013)

Source: Lumen, Bloomberg

L U M E N I N V E S T M E N T S

ALPHA-BETA SEPARATION A WAY OF VIEWING CHINA

Global Beta

China Beta

China Alpha

Global Alpha

China betas and alphas still have diversification benefits but from returns generation and risk budgeting China alphas is a better alternative

L U M E N I N V E S T M E N T S

ASSET ALLOCATION

What we like:

TIPS

o Insurance for risk-on-off trades and hedge against inflation

Latin High Yields

o High Yield: Avoiding negative real yield prospects

o Special Opportunities: Precatorios

Emerging Equity Alphas, US Equity Betas

o Smart Betas and Sustainable Alphas