netwealth educational webinar - the evolution of asset allocation
TRANSCRIPT
netwealth Educational Series
Strictly confidential
March 2016
Tracey McNaughton
The evolution of multi-asset investing
Executive DirectorHead of Investment StrategyUBS Asset Management
3
Markets have evolved
Bond yields can go negative
US can be the world's largest oil producer
Donald Trump can become US President
Official interest rates can go negative
Central banks can become asset managers
Multi-asset investing has similarly evolved…and must continue to do so
Section 1
A look back: "The Great Moderation"
5
Simpler timesIndustry structure and mindset
The structure The mindset· Two major asset classes
– Equities – Bonds
· Asset classes divided into specialized categories (growth, small cap, etc.)
· Industry dominated by domestic equities and bonds
· Regulation cut – repeal of Glass-Steagall Act (1933)
· Allocate to equities as much as risk budget would tolerate
· Risk-free returns· Market is liquid· Buy and hold· Investors spent 80% of their time
on selecting managers, and only 20% on asset allocation
· Outperform the benchmark
66
· Markets validated industry structure· Rise of the equity cult· Chasing performance
16.1%
6.6%
7.7%
2.6%
0% 5% 10% 15% 20%
US Equities,1990s
US equities,1925-2015
US Bonds,1990s
US bonds, 1925-2015
Source for left hand chart: MSCI, Barclays, Triumph of the Optimists (Elroy Dimson, Paul Marsh and Mike Staunton), Credit Suisse, UBS Global AM. Based on total returns adj. for US CPI. Global Equities/Global Bonds hedged to USDSource for right hand chart: UBS Global Asset Management, DataStream
Annualized real returns across asset classes Quarterly changes in the S&P500 Index during the 1990s
1990s – Those were the days… Large sell-offs in the 90s were rare
"The Great Moderation"
-15% to -10%
-10% to -5%
-5% to 0%
0% to 5%
5% to 10%
10% to 15%
15% to 20%
>20%02468
10121416
Freq
uenc
y
Drawdowns were rare and losses recouped quickly
77
Industry dynamics: Equities risk premium in the nineties
Source: UBS Global Asset Management, Bloomberg
0
100
200
300
400
500
600
Dec-89 Dec-91 Dec-93 Dec-95 Dec-97 Dec-99
Equit
y risk
prem
ium
US Treasuries S&P 500
Who wouldn’t invest in equities!
8
Benchmark6.9%
Active2.3%
Aus Eq
Int'l Eq
REIT
Aus/Global Bond
IG & HY
TAA
Currency
EquityBond
Total Risk= 9.2%
Benchmark6.9%
Active2.4%
Aus Eq
Int'l Eq
REIT
Aus BondGlobal Sov
IG & HY
TAACurrency
Equity
BondTotal Return= 9.3% p.a.
1st Generation of Diversified Funds· Basic Building Blocks (BBs) are
– Australian Shares– International Shares– Property Securities– Diversified Fixed Interest (Aus & Int'l)– Cash
· Each BB is often "actively managed" by different PMs from the same AM firm
· Asset Allocation decisions are made jointly by managers of BBs– Deviations from benchmark allocation typically
limited
· Majority of "Alpha" comes from active security selection within each BB
· Majority of portfolio "return" and "risk" come from benchmark
For illustrative purposes only Return and Risk characteristics are calculated based on 50% EQ / 50% Bond Benchmark (2006-2015) and typical active alpha / tracking errors of active managersSource: UBS Asset Management
9
Benchmark7.0%
Active1.9%
Aus Eq
Int'l Eq
REIT
Aus/Global Bond
IG & HY
TAA
CurrencyEquity
Bond
Total Risk= 8.9%
Evolution #1: Multi Manager Diversified Funds
· Basic Building Blocks (BBs) are often kept very similar to traditional balanced fund
· Each BB is constructed by combining multiple sub-funds, actively managed by specialist PMs from different AM firms
· Manager of the total fund has two roles– Making asset allocation decisions between BBs– Manager allocations within each BB among multiple
managers selected
· Asset Allocation decisions tend to be more around manager allocations and less on allocations between asset classes
· Aim of "multi manager" funds is to reduce volatility of "Alpha" from active security selection through diversification
· Majority of portfolio "return" and "risk" still come from benchmark
Reducing Volatility of "alpha"
For illustrative purposes only Return and Risk characteristics are calculated based on 50% EQ / 50% Bond Benchmark (2006-2015) and typical active alpha / tracking errors of active managersSource: UBS Asset Management
Benchmark6.9%
Active2.4%
Aus Eq
Int'l Eq
REIT
Aus BondGlobal Sov
IG & HY
TAACurrency
Equity
BondTotal Return= 9.3% p.a.
Section 2
Where are we now: "The Great Volatility"
11
More complicated timesIndustry structure and mindset
The structure The mindset· Many asset classes
– Equities - DM and EM– Bonds – IG, HY, bank loans, cat
bonds– Infrastructure– Hedge funds– Private equity
· Industry dominated by many more players
· New risks – longevity, credit default risk, illiquidity
· Greater regulation – Basel III, Dodd Frank
· Return-free risk investing· Hunger for yield· Which benchmark is right?· Forget "set and forget"· Shorter investment horizons· More cost conscious· Investors spent 20% of their time
on selecting managers, and 80% on asset allocation
<-20% -20% to -15%
-15% to -10%
-10% to -5%
-5% to 0%
0% to 5%
5% to 10%
10% to
15%
15% to
20%
02468
1012141618
Freq
uenc
y
1212
"The Great Volatility"
3.8%
6.6%
5.3%
2.6%
0% 1% 2% 3% 4% 5% 6% 7%
US Equities,2000-2015
US equities,1925-2015
US Bonds, 2000-2015
US bonds, 1925-2015
Source for left hand chart: MSCI, Barclays, Triumph of the Optimists (Elroy Dimson, Paul Marsh and Mike Staunton), Credit Suisse, UBS Global AM, Merrill Lynch. Based on total returns adj. for US CPI. Global Equities/Global Bonds hedged to USDSource for right hand chart: UBS Global Asset Management, DataStream. Financial Times, 2/10/12
Annualized real returns across asset classes Quarterly changes in the S&P500 Index 2000-15
Sell offs more present in the 2000s …
1313
Industry dynamics: forget "set and forget"Equity risk premium in the noughties
Source: UBS Global Asset Management, Bloomberg
Jan-00 Jan-04 Jan-08 Jan-12 Jan-160
50
100
150
200
250
S&P 500US Treasuries
Equi
ty ri
sk p
rem
ium
14
Evolution #2 – Adding Dynamic Allocation
· Basic Building Blocks (BBs) are often kept very similar to traditional balanced fund
· Each BB is typically "actively managed" by different PMs, often from the same AM firm
· Asset Allocation decisions are made independently by a specialist PM – Deviations from benchmark allocation can change in
dynamic fashion reflecting asset allocator's outlook for each asset class
– With increased use of derivatives, asset allocation specialist can add additional layers of active positions to add alpha and control risk
· Aim of this evolution is to increase sources of "alpha" including not only active security selection but also active asset allocation
· Majority of portfolio "return" and "risk" still come from benchmark
Increasing "alpha" through Active Allocation
Benchmark6.9%
Active3.9%
Aus Eq
Int'l Eq
REIT
Aus Bond
Global SovIG & HY
TAA
Currency
Equity
BondTotal Return= 10.8% p.a.
Benchmark6.8%
Active2.8%
Aus Eq
Int'l EqREIT
Aus/Global Bond
IG & HY
TAA
Currency
Equity BondTotal Risk= 9.6%
For illustrative purposes only Return and Risk characteristics are calculated based on 50% EQ / 50% Bond Benchmark (2006-2015) and typical active alpha / tracking errors of active managersSource: UBS Asset Management
15
Evolution #3 – Efficient product design to keep cost down
· Basic Building Blocks (BBs) are often kept very similar to traditional balanced fund
· Each BB is made up of "passively managed" sub-funds / sleeves
· Asset Allocation decisions can be "active" or "passive"– UBS Tactical Beta Funds employ dynamic
active allocation with derivative overlay to generate alpha
– Other competitor funds are managed with fixed allocation against benchmark which is reviewed periodically (eg. Annual)
· Aim of this evolution is to minimise the cost for investors
· Majority of portfolio "return" and "risk" still come from benchmark
Minimising cost at expense of some "alpha"
Benchmark6.9%
Active1.9%
Aus Eq
Int'l Eq
REIT
Aus BondGlobal Sov
IG & HY
TAA
CurrencyTotal Return=8.8% p.a.
Benchmark7.0%
Active1.7%
Aus Eq
Int'l Eq
REIT
Aus/Global Bond
IG & HY
TAA
CurrencyTotal Risk= 8.7%
For illustrative purposes only Return and Risk characteristics are calculated based on 50% EQ / 50% Bond Benchmark (2006-2015) and typical active alpha / tracking errors of active managersSource: UBS Asset Management
16
Comparison of Return / Risk ProfileBenchmark is Important
Return Risk SR EQ Bond Asset Alloc CurrencyGlobal Balanced 9.3% 9.2% 0.52 √ √ √ √Multi Manager 9.3% 8.9% 0.54 √√√ √√√ √ √Dynamic Allocation 10.8% 9.6% 0.65 √√ √√ √√√ √√√Lower Cost 8.8% 8.7% 0.49 X X √√√ √√√Benchmark 6.9% 7.4% 0.32* based on 50% EQ + 50% Bond Mix, using index data for Jan 2006 - Dec 2015 and typical active alpha / tracking errors of active managers
10 yr Simulation* Active Management
For illustrative purposes only Source: UBS Asset Management
80100120140160180200220240260280300
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Benchmark Global Balanced Multi ManagerDynamic Alloc Lower Cost
17
Diversified Funds: Effective choice for long term InvestorsPortfolio Outcome links closely with "Return / Risk" characteristics of benchmark
Source: Bloomberg, UBS Asset Management*Inception date: 3 November 1992. **Inception date: 15 June 1992. Performance data has been prepared in accordance with 2011 GIPS standards. Performance is quoted gross of fees and expenses. The performance data quoted are historical. Performance can be volatile and future returns can vary from past returns.
100
200
300
400
500
600
700
800
Sep 9
2Se
p 93
Sep 9
4Se
p 95
Sep 9
6Se
p 97
Sep 9
8Se
p 99
Sep 0
0Se
p 01
Sep 0
2Se
p 03
Sep 0
4Se
p 05
Sep 0
6Se
p 07
Sep 0
8Se
p 09
Sep 1
0Se
p 11
Sep 1
2Se
p 13
Sep 1
4Se
p 15
Sep 1
6
Wea
lth In
dex A
$
Balanced Investment Fund
Neutral Allocation
Since Inception:Gross Returns 8.78% paNeutral Allocation 8.27% paActual Volatility 7.63% pa
100
200
300
400
500
600
700
Jun 9
2Ju
n 93
Jun 9
4Ju
n 95
Jun 9
6Ju
n 97
Jun 9
8Ju
n 99
Jun 0
0Ju
n 01
Jun 0
2Ju
n 03
Jun 0
4Ju
n 05
Jun 0
6Ju
n 07
Jun 0
8Ju
n 09
Jun 1
0Ju
n 11
Jun 1
2Ju
n 13
Jun 1
4Ju
n 15
Jun 1
6
Wea
lth In
dex A
$Defensive Investment Fund
Neutral Allocation
Since Inception:Gross Returns 8.05% paNeutral Allocation 7.51% paActual Volatility 4.27% pa
FundAvg Risk Budget
(standard dev %pa)LT Performance
Characteristics %paInvestment
HorizonUBS Balanced Investment Fund 9-10% pa CPI plus 6-8% 3-5 yearsUBS Defensive Investment Fund 5-6% pa CPI plus 4.5-6.5% 3-5 years
Section 3
Unchartered territory – from ZIRP to NIRP
19
1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 2015-6
-4
-2
0
2
4
6
8
10
123-month US T-Bill yield minus US CPI inflation (% yr/yr)
Lower real rate regime here for "protracted" periodCentral bank regimes are visible
Source: Federal Reserve and Bureau of Labor Statistics via Haver; UBS Global Asset Management. Sample: 1970-2014.
20
Risks are higher- bonds "safe-haven" status at risk
Australia 10yr U.S. 10yr U.K. 10yr Italy 10yr France 10yr Germany 10yr Japan 10yr
30
21
1816
6
21
Source: Bloomberg, UBS, Data as at 31 March 2016
How much would yields need to rise in a year before you get a negative total return on bonds (bpts)?
Choice of benchmark matters
Source: Merrill Lynch Global Broad Market Index, Bloomberg; Global Balanced is 50/50 Global Broad Market, Global MSCI Past performance does not ensure against loss.
-500
50100150200250300350
Dec-89 Dec-93 Dec-97 Dec-01 Dec-05 Dec-09 Dec-13
Global equities - Rolling 10-year periods
26 down periods out of 293: 8.9%
Match your investment time horizon to your benchmark horizon
05
1015202530354045
Dec-99 Dec-02 Dec-05 Dec-08 Dec-11
0 down periods out of 173: 0%
Global Composite Bond – Rolling 3-year returns
012345678
Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-11 Jan-14
0 down periods out of 220: 0%
Cash- Annual returns
-20-10
0102030405060
Dec-03 Dec-06 Dec-09 Dec-12
6 down periods out of 125: 4.8%
Global Balanced– Rolling 7-year returns
22
Increases the importance of risk managementWinning by not losing
Successful long-term investing is more to do with avoiding catastrophic losses than it is to do with capturing unrealised
gains
S&P/ASX 200 relative to pre-crisis peak
05 06 07 08 09 10 11 12 13 14 1540
50
60
70
80
90
100
Inde
x Oc
t-07=
100
Source: Bloomberg, UBS,
Loss percentageGain percentage
required
-10% 11%
-20% 25%
-30% 43%
-40% 67%
-50% 100%
-60% 150%
-70% 233%
-80% 400%
-90% 900%
Section 4
New Generation MAI: Outcome Oriented Solutions
24
New Generation MAI: think smarter & look further for ideas
1. Unconstrained - broaden opportunity set– Long and short positions– Wide asset class bands– Choice of benchamrk
2. Need to flexible– Flexible in choice of instrument– Nimble tactical asset allocation– Liquid
3. Risk risk management – manage the journey– Tail/event risk hedges– Scenario analysis– Stress testing
Lower for longer environment– implications for investors
25Lin
ear D
irectio
nal Eq
uity
Non-Lin
ear Dire
ctiona
l Equ
ity
IG Credit
Duratio
n Man
agemen
t
L Germ
an vs
. Swed
ish Eq
ui...
L Nort
h Asia
vs. E
M Equit
ies
L Aust
ralia
3yr vs
. US 2
yr
Italian
Flatt
ener T
rade
Active
Currenc
y
Portfo
lio Risk
0%
2%
4%
6%
8%
10%
12%
14%
16%
6.78% Diversification
benefit
Portfolio Risk 6.17%
Equity optionsEquity linear
Directional fixed incomeRelative value market
Relative currency
Unconstrained + flexible = efficient risk allocation
Direc-tional equity25%
Direc-tional credit25%
Relative value
markets25%
Relative value
currency25%
Trade diversification Time diversification
0 – 6 months
22%
7 – 18 months52%
> 18 months
26%
For illustrative purposes only
Instrument diversification
Equity fu-tures65%
Equity op-tions 35%
26
The cost of constraints – benchmark risks can change
Jun-00 Jun-02 Jun-04 Jun-06 Jun-08 Jun-10 Jun-12 Jun-143.0
3.2
3.4
3.6
3.8
4.0
4.2
4.4
4.6
4.8
Modified duration of the AusBond Composite 0+ Year Index (years)
Source: Bloomberg
Capital impact of a 1% rise in yield for benchmark investor
-3.2%
-4.6%
27
Integrate risk management into return management
Charts are for illustrative purposes only
Trade design• Anticipate risk-return impacts of new trades
to the overall portfolio
• Help to avoid doubling risks with the inclusion of new trades
% in GAAC 3.6% 0.7% 12.3% 2.7%
ST \ LT AAT74 AAT66 AAT34 AAT53AAT74 1.0 -0.2 0.2 0.4AAT66 -0.2 1.0 -0.2 -0.7 AAT34 0.1 -0.3 1.0 0.4AAT53 0.2 -0.8 0.4 1.0
% in Fund
Trade 1Trade 1
Trade 2 Trade 3 Trade 4
Trade 2Trade 3Trade 4
ST \ LT
Portfolio Construction
• Optimize the risk-return profile of the total portfolio (efficient frontier)
• Identify sources of alpha in the portfolio (negative and positive)
Expected Return
100% Cash
Benefit of Risk Diversification and Efficient Portfolio Construction
Risk
Leverage
Tail-risk management
• Identify the tail-risks to protect the portfolio
• Sophisticated risk measures beyond simple volatility
% R
etur
nsTime
MaximumDrawdown
28
The end game - achieving an asymmetric portfolio
For illustrative purposes only
Stress test summaryScenario Total Return HorizonEQ down IR down spreads widen -5.64% 1 month
All markets down -5.34% 1 month
Flight to quality currency pegs hold
-5.18% 1 month
IR up spreads widen -3.03% 1 month
USD weakening (currency only) 0.29% 1 month
IR down spreads narrow 10.17% 1 month
EQ up IR up spreads narrow 10.17% 1 month
All markets up 11.04% 1 month
29
Risk parity – different way of thinking about risk
29
Source: UBS Global Asset ManagementFor illustration purposes only
Traditional Approach (example) Risk Parity Approach (example)
Asset Weights Risk Contributions Asset WeightsRisk Contributions
Allocating units of risk versus amounts of money
Traditional 60/40 versus risk parity allocation
Equity 60%
Fixed Income
40%
0%
20%
40%
60%
80%
100%
120%
Asset weight
Equity90%
Fixed Income10%
Asset weights drive risks
Equity 18%
Fixed Income
95%
Commodities 20%
0%
20%
40%
60%
80%
100%
120%
140%
Asset weight
Commodities33%
Fixed Income33%
Equity33%
Risk allocation drives asset weights
30
21794
30
Multi-asset investing must evolve or…
Copyright © 2002 The Parking Lot is Full
31
UBS Multi-Asset Fund evolutionBalanced Investment
FundDefensive Investment
Fund
Tactical Beta Funds Dynamic Alpha Strategy Fund A
Global Balanced w/ dynamic allocation
Global Balanced w/ Lower Cost Approachand Dynamic Allocation
Real Return Strategy
Total FUM (A$m) 1,082m 466m 1,511m
Managers Keiko Kondo/Tom Rivers
Keiko Kondo/Tom Rivers
Andreas Koester/Tom Rivers
Benchmark Custom SAA benchmark Custom SAA benchmark UBS Bank Bill
SAA TAA Currency exposure Active overlay Active overlay Active overlay
Building blocks Active Passive Mainly derivatives
Target alpha CPI + 6-8% / CPI + 4.5-6.5% CPI + 4.5-6% 3.5-5.5%
Average risk budget 9-10% / 5-6% 8-9% for Balanced 7-10%
Inception Nov/June 1992 May/Oct 2012 June 2007Source: UBS Global Asset Management. As at 29 February 2016
32
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