Download - Risk Management and Risk Premia Investing
Risk Management and Risk Premia Investing
November 18, 2015
For Financial professional Use Only. Not for redistribution under any circumstances.
Schroder Investment Management North America Inc. 875 Third Avenue, New York, NY 10022 (212) 641-3800 www.schroders.com/us
Schroder Fund Advisors LLC, Member FINRA, SIPC 875 Third Avenue, New York, NY 10022-6225
(800) 730-2932 www.schroderfunds.com
Presenting to: CFA Society of Columbus, Ohio
Representing Schroders:
Ashley Lester, Ph.D – Head of Multi Asset and Portfolio Solutions Research
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Contents
Risk Management: An Abrupt Introduction 2
What Did We Learn? 5
Post-Crisis Themes 7
Three ingredients of portfolio formulation 9
Some Conclusions and Some Questions 22
Important Information 23
1
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Risk Management An Abrupt Introduction
2
Source: Schroders, Barclays Live .Views reflect the opinion of the Multi Asset Investments and Portfolio Solutions team. Please read carefully risk warnings and performance
disclosures made throughout and in the Important Information pages of the appendix.
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01/19/2006 07/19/2006 01/19/2007 07/19/2007 01/19/2008 07/19/2008 01/19/2009
AAA Subprime (ABX) Composite Price
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Risk Management An Abrupt Introduction
3
Source: Schroders, Barclays Live .Views reflect the opinion of the Multi Asset Investments and Portfolio Solutions team. Please read carefully risk warnings and performance
disclosures made throughout and in the Important Information pages of the appendix.
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01/19/2006 07/19/2006 01/19/2007 07/19/2007 01/19/2008 07/19/2008 01/19/2009
AAA Subprime (ABX) Composite Price
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Risk Management An Abrupt Introduction
4
Source: Schroders, Barclays Live .Views reflect the opinion of the Multi Asset Investments and Portfolio Solutions team. Please read carefully risk warnings and performance
disclosures made throughout and in the Important Information pages of the appendix.
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01/19/2006 07/19/2006 01/19/2007 07/19/2007 01/19/2008 07/19/2008 01/19/2009
AAA Subprime (ABX) Composite Price
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What did 2008 change for Risk Managers? VaR is not all encompassing
5
Views reflect the opinion of the Multi Asset Investments and Portfolio Solutions team. Please read carefully risk warnings and performance disclosures made throughout and in the
Important Information pages of the appendix. VaR is Value at Risk.
Market Liquidity Risk
Credit Macroeconomic Liquidity
Extended Time Horizon
Need a model, not statistics
Can be quantitative or qualitative
Both have strengths and weaknesses
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What has changed since 2008 for investors? The Rise of Different Styles of Investing
6
Views reflect the opinion of the Multi Asset Investments and Portfolio Solutions team. Please read carefully risk warnings and performance disclosures made throughout and in the
Important Information pages of the appendix.
Newer Investment
Styles
Risk Premium
Risk Parity/Risk Allocation
Smart Beta
Factor-Based
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Post-Crisis Themes Two noticeable changes
7
Views reflect the opinion of the Multi Asset Investments and Portfolio Solutions team. Please read carefully risk warnings and performance disclosures made throughout and in the
Important Information pages of the appendix.
Seek better risk/return tradeoff
- Volatility control, risk-based allocation
Result: New thinking brought risk models
Risk managers were more worried about risk models
Short-term models did not reflect crisis conditions
Lesson:
Need models and ideas focused on the long run
1
2
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The New Models
8
Views reflect the opinion of the Multi Asset Investments and Portfolio Solutions team. Please read carefully risk warnings and performance disclosures made throughout and in the
Important Information pages of the appendix.
Observations
• Models from “normal” times may not be relevant
• Asset correlations vary over time
• The macro-economy matters for asset returns
Implications
• Different models for different circumstances
• Risk premia may be more stably related than assets
• Risk premia reward macroeconomic risk
1 crucial question
• Which investors should hold which risks?
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Three ingredients of portfolio formulation
9
Risk Premia Macroeconomic
Risk Investor
Differences
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From asset classes to risk premia Understanding real drivers of risk and return
Risk premium
Expected return for assuming a source of risk
Risk premia
Building blocks of asset classes
Asset classes
Comprised of one or more risk premia
Source: Schroders, BAML. US Investment Grade Credit is represented by BAML US Corporate Master Index, Term Premium is calculated using BAML US 7-10 year Treasury
Index. Shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell
0
1
2
3
Credit Risk Premium
Duration Risk Premium
Risk-Free Rate
Breaking an asset class down into risk premia
Example: US investment grade credit
(Yield %)
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Credit risk premium – Valuation Credit Spread Components – finding the sub premia
Source: Schroders, Markit, BAML, Barclays Capital, September 2013. Spread decomposition based on Bond and CDS spreads and Liquidity Cost Scores (LCS). LCS are a bond
level liquidity measure provided by Barclay's which represent the transaction cost to execute an instantaneous round-trip institutional trade. LCS are calculated as bid-ask spreads
multiplied spread durations for spread quoted bonds, and (Ask-Bid)/Bid for price quoted bonds. *Model history back to Dec 2007 for US IG and July 2010 for Euro IG
= + + Market
Premium
Illiquidity
Premium Default
Premium
Bond Credit
Spread
Spread (bps)
-20
80
180
280
380
480
580
680
Market Premia Default Liqudiity US IG OAS
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Credit asset class traditionally used defensively
Corporate bond returns driven by changes in the
credit premium and the underlying duration premium
The credit risk premium group focus on credit risk –
not duration risk
Credit risk premium is primarily driven by growth risk,
not duration risk
Rolling 3 year correlations
Credit risk premium Credit is a growth risk premium
Source: Schroders, Datastream, as of 21 February 2014
Growth Slowdown Inflation Alternative
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
US 7 year treasuries and ML US Corporate Masters Index
US 7 year treauries and ML US Corporate Masters Index(Duration Hedged)
S&P 500 and ML US Corporate Masters Index (Duration Hedged)
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Systematic sources of returns driven by investors’ behavioral biases
Alternative risk premia (“ARP”)
Alternative Risk Premia: Research Driven & Market Neutral
Source: Schroders, for illustrative only.
Portfolio
Return
Alpha
Beta Traditional
Risk Premia
Alpha
Alternative
Risk Premia
Value
Carry
Size
Momentum
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Asset Correlations Change Macroeconomic shocks drive asset returns and correlations
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Surprise increase in … Equities Bonds Correlation
Economic growth + - -
Interest rates - - +
Inflation - - +
Correlations are key to understanding diversification
The return drivers in each asset are key to understanding correlations
Source: Schroders.
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What Do the Data Tell Us? Evidence of the drivers of returns
17
Source: Schroders. See Data slide in the appendix, and the slides on the regressions in the appendix.
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Growth, Inflation and Slowdown risk premia The “Big” risk premia driven by sensitivities to macro-economic factors
Source: Schroders
• Developed market equities
• Emerging market equities / Spreads
• IG Credit Spreads
• High Yield Spreads
Captures risk premia for
bearing risk of:
• Business cycle risk
• Unexpected economic weakness
• Purchasing power erosion
• Complements duration risk exposure
• Tends to outperform in rising interest
rate environments and linked to periods
of heightened inflation concerns
• Agricultural commodities
• Industrial metals
• Gold
• TIPS (duration-hedged)
• Energy
Growth
Inflation
Examples of assets with significant
exposure to this risk:
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• Changes in interest rates
• Complements growth risk exposure
• Outperforms in falling interest rate
environments, often linked to periods of
economic weakness
• Developed market sovereign bonds Slowdown
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A regime-based analysis Assessing the growth/inflation sensitivities
Source: Schroders. Data is simulated and not actual performance. Past performance is no guarantee of future results. Actual results would vary. For full details regarding the
simulation and definitions, please see the information at the end of this presentation.
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0%
5%
10%
15%
20%
25%
S&P 500 Trend Carry Value Size
High Growth Medium Growth Low Growth
0%
2%
4%
6%
8%
10%
12%
14%
S&P 500 Trend Carry Value Size
High Inflation Medium Inflation Low Inflation
Conditional returns in different “Growth” regimes Conditional returns in different “Inflation” regimes
Growth Intuition
Momentum 0 Indifferent to all. Only sensitive to past and
current prices
Carry + Like insurance. Best after a crisis and over a long
period of time with no crisis/small crises.
Value 0 Best at the end of a long departure from
fundamentals and a recognition of that.
Size + Larger relative impact on small cap as their
sources of financing become less constrained
Intuition
Inflation Intuition
Momentum 0 Indifferent to all. Only sensitive to past and
current prices
Carry + Different monetary policies lead to larger
interest rate differentials
Value - Poor market sentiment caused by high inflation
can result in investors ignoring fundamentals
Size +
Domestic corporates are less susceptible to
margin deterioration caused by rising import
costs
Liquid Alternatives Portfolio Simulated Returns - Empirical Evidence (Feb 1982 – Dec 2014)
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Investors: Beyond the Market Portfolio
Which risks are YOU best suited to be paid for?
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Source; Schroders.
• Are liabilities tied closely to inflation?
1
• Are liabilities greater or smaller if there is strong growth?
2
• How important is volatility vs drawdown or worst case scenarios?
3
Conclusion?
Different answers suggest different
portfolios for each investor
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Some Conclusions and Some Questions
Modern investing and risk management provide the promise of:
– Better diversified portfolios
– Richer sets of return drivers, including alternative risk premia
– Greater understanding of the RIGHT kind of risk
Questions remain:
– Are alternative risk premia also rewards for economic risk?
> Are value, momentum and quality rewards for risk? Or are they a free lunch?
– What is the implication for their continued existence?
– Have we captured the right economic risks?
– How can we help investors systematically identify the right risks to take?
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Source: Schroders.
Feb 2015 ** Remove from final presentation **
Important information
23
Schroder Fund Advisors LLC, Member FINRA, SIPC
875 Third Avenue, New York, NY 10022-6225
(800) 730-2932
www.schroderfunds.com
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(212) 641-3800
www.schroders.com/us