Data Analytics: Risk Mitigation in Financial Investments v01

Data AnalyticsRisk Mitigation in Financial Investments

Sumir Nagar - Chief Operating Officer Agile FT LLC, Dubai, UAE

www.agile-ft.comat

Shailesh J Mehta School of Management - IIT PowaiMarch 18, 2017

The opinions of the presenter are his individual opinions and/or advise, and are not to be construed as those of Agile FT LLC, Dubai, UAE.

Investments are subject to market risk and prudence is advised when investing in financial instruments.

Thanks to the School, Vinod, Aditya, and Shasti

House Rules & Etiquette

You can survive without your cellphones for a few minutes

I’m a big fan of interactive, let’s try and wait for logical breaks before we debate, discuss, comment

So that we don’t talk over others, please indicate that you have something to say

I’m Usually Unpopular• Just a little about me• This is a much larger topic & I will try to do justice in 60 minutes• What I have to say can be construed to be CONTROVERSIAL

• What I have to say is NOT ROCKET SCIENCE

• Simply because Data Analytics is NOT ROCKET SCIENCE, (despite our best efforts) to cast that impression

• I deal with• Basics - (usually forgotten)

• Common Sense - (The Most Uncommon Thing)

• Prudence - (Whatever That Means)

Who Is The “Investor”

• Individual

• HNI

• Mid Income

• Low Income

Who Is The “Investor”

• Corporate

Who Is The “Investor”

• Financial Institution

• Bank

• Insurance

• Pension

Understanding Risk

Risk & Reward Are Closely Intertwined

You Cannot Hide From Risk

All You Can Do Is Manage Risk Down To Manageable Levels

Risk Management Is A Simple Matter of Assessing/Analysing Data Points

Risk Framework• Needs Assessment - The Purpose

• Expected Outcome - The Result

• Horizon - Time Element

• Appetite to Loose & Absorb Shocks - Risk Appetite

• Ability to Manage Risk - Strategies

• Available Cash

Varying Objectives?• Individuals

• Life Events: Education, Marriage, Housing, Retirement• Corporate

• Manage surplus cash, even our cash flow cycles, growth, taxation

• Bank

• Manage cash flow mismatches between deposits, withdrawals, lending, defaults, growth, taxation

• Insurance

• Risk Events, Cash flow mismatches, growth

Varying Needs Analysis• Regardless of the Investor Type the measures are identical• What differs is the Analysis of the Need• For Individual Investors the cycle begins with a Risk Assessment Questionnaire (Why,

When, etc)• For Corporates it depends on their Business Plans• For Banks it depends on ALM• For General Insurance Companies it depends on

• Risk Events• Actuarial Calculations

• For Life & Pension Companies• Risk Events (death, disability, medical conditions, retirement)• Risk Assessments in case of Investment Backed or Unit Linked Plans

IndividualsIncome Group Sources Horizon Appetite Avenues Returns % Share

Low Wages Short Low BanksInsurance

FixedVariable

60%40%

Medium Wages Intermediate MediumBanksInsuranceMF’s

FixedVariable

Markets

40%30%

30%

High WagesBusiness Long High Varied

FixedVariableInsuranceMarketsHedges

PE

20%20%30%20%

10%

CorporateSize Surplus Horizon Appetite Avenues Returns % Share

Small Low Temporary Low Banks FixedVariable

60%40%

Medium Medium Intermediate Medium

BanksMF’sTreasuriesICD’sFamily Offices

FixedVariable

Markets

40%30%

30%

Large High Long High AllFixedVariableMarkets

Hedges

20%20%30%

30%

Financial Institutions

Size Surplus Horizon Appetite Avenues Returns % Share

Small Low Temporary Low Banks FixedVariable

60%40%

Medium Medium Intermediate MediumBanksMF’sTreasuries

FixedVariable

Markets

40%30%

30%

Large High Long High AllFixedVariableMarkets

Hedges

20%20%30%

30%

Risk Types

• Market Risk

• Operational Risk• Systemic Risk

Analytics• Is largely dependent on various factors

• History - Hindsight is a great thing - (BUT The Bullet has been fired)

• Future Prospects - Predictions have DEPENDENCIES (Variables)

• Guesswork - Probability (LACK of Certainty)

• Triggers - Events (we usually have little or no control)

• Availability - QUALITY Data (Sources, Cleanliness, Quantum)

• Methods, Techniques, Tools - Collection, Processing & Interpretation

Risk Frameworks

• There are frameworks• There are no global agreements• If there are agreements, they are debated

to death in the event of failures• We are only as good as our last predictions

Asset Classes & Their Nature

Equity Shares• Usually Considered to be High Risk

• Investor Types• Buy & Hold vs Dividend Stripping• Market Investors - (Price Appreciation)• Valuations - Driven by Market Perceptions• Outstanding Shares• Trading Volumes• Follow herd mentality• Informed sources close to the management• Times EPS - (How Many Times)• By what factor• There is not a single yardstick

Interest Bearing• Considered to be Low Risk• Subject to Ratings• Sanctity of Ratings• Rating Agency Advisories are Conflicting• Rating Agencies depend on Data Points

Contracts• Derivatives & Futures

• Are actually SIMPLE to Understand• They depend on an Underlying Instrument (or Basket)• They were created as a means to safeguard physical deliveries of an

underlying at predetermined rates/prices• However, they are Seldom held till expiry• The complexities arise from

• End Use• Lack of Standardised Pricing Models• Traders usually have a pet Quant who works off complicated Excels• And no Quant agrees with the other

Contracts

• Foreign Exchange

• Markets are driven by International Trade Flows

• Subject to Government Intervention• Easily swayed by unscrupulous Traders

Commodities

• Depend on Acts of God

• Discoveries

• Extraction Methods

Real Estate

• Considered one of the safe investment avenues

• Subject to Infra

• Usually considered to be illiquid

Metals & Crude• Gold

• Indian housewives hold 11% of the world's gold. That is more than the reserves of the USA, the IMF, Switzerland, and Germany put together

• Earlier a country’s currency was valued in terms of its gold reserves• The Gold Standard was abandoned• This led to the advent of deficit financing

• Silver

• Platinum

• Copper

• Oil

• That can quickly change, as alternative energy technologies do exist, its just a matter of time until Black Gold looses its lustre

Alternate Asset Classes

• MBS• ABS• Strips• Exotics• Digitals• Structures

Invisible Cash Flows

• Arms

• Drugs

• Though illegal the income from these make it into mainstream investing

Investment Scenarios• Scenario Analysis - What If?

• Show Me The Money

• Money is like WATER

• It finds its own LEVEL

• It usually flows to where Money ALREADY exists

• Few take a Contrarian View

• The TREND is your FRIEND

• FOLLOW the TREND

Ever Heard of the 80:20 Rule?

Well here it is

80% of Investors have to LOOSE for the 20% to GAIN

This is called The SMART MONEY

They are SMART ‘cause they have what 80% DON’T

DATA

So Let’s Talk About DATA ANALYTICS

• It deals with Histories• It seeks to PREDICT basis the PAST• History does’t always repeat itself• It means throwing several variables into the MIX• One of the biggest variables is The CYCLIC NATURE of market

movements• It must predict when Cycles begin and End• There are Macro Cycles and Micro Cycles (wheels within

wheels)• There are ALWAYS LEAD and LAG Indicators

Data Quality• Data comes from various sources• Its usually delayed• To clean Data various interpolation

techniques have to be applied• Log Linear• Cubic Spline

Data Sources• Data comes from various sources

• Markets - Prices• Governments - Economic• Agencies - Feeds

• Its usually delayed• To clean Data various interpolation techniques have to be

applied• Log Linear• Cubic Spline

Analytical Challenges• Cross Referencing

• Feed Delays pose challenges• Conflicting Data Sets need careful analysis

• Interpretation needs to be led by Humans• Humans are usually subjective

• Algorithms are written by Humans• Self Learning & AI are the new buzz words, BUT their accuracy

will take time to establish• We will get it all wrong before we get it right

So Do We need Analytics

• Unequivocally - YES

• What we need is - Standardisation

• We need Global and Regional Models

• What works for the Advanced Economies Doesn't necessarily work for the LDC’s

Decision Support• Decision Support Systems are nothing but Algorithms

• Collect Data• Clean Data• Query Data• Fetch Data• Run Algorithm factoring in Variables we referenced earlier• Publish on Screen or via Report• Run various scenarios by changing around a few variables• And Finally, in the face of a plethora of information taking a

decision

Risk Mitigation

Technical Analysis• Prices• Volumes• Trends• Cycles

• Macro• Micro

• Indicators• Strategies

Strategies• The Long & Short of It All

• Taking Long Positions• Taking Short Positions

• Naked vs Covered• Alternating Long & Short within Cycles

• Butterflies• Long Butterfly• Short Butterfly

• Straddles• Strangles• Combining Holdings & Derivatives

Tools• MACD

• Day Moving Average• Signal• Crossover

• Japanese Candlesticks• Fibonacci Numbers• Finally its all about PATTERNS & CYCLES (My favourite is a Double Top Followed by a

Double Bottom)• Thought to be PURE in terms of indication of market movements• Markets are moved by Money Flows• Money Flows are controlled by People• So, someone makes the first move and the Markets follow• That SOMEONE is the SMART MONEY (the 20%)

Fundamental Analysis• Balance Sheet Analysis

• Key Financial Ratios• Past Performance• Future Prospects• Sector Analysis• Industry Analysis• Competitor Analysis• Technology Obsolescence & Ever-greening • Distribution Framework• Capital Adequacy• Management Track Record

Hybrid Analysis

• Combine Fundamentals & Technicals• Base macro decisions on Fundamentals• Base Entry & Exit on Technicals• Use the Snake in the Tunnel Technique

Tips & Tricks• DON’T take a NAKED Short unless you have money to throw• Market Tops & Bottoms are predicted by FOOLS or GENIUSES• One Prediction does not a Guru Make• Analyse, Analyse, Analyse• Pick an Investment Strategy based on your Risk Appetite• Stick with your Strategy, give it time• If you’ve picked a good stock, don’t panic at the first downturn• Cut Your Losses, Let your Profits Run• Book Profits periodically, you’re bound to run afoul of the Trend at some

time• TRY (hard) not to average a loosing position

Manage Your Portfolio

Models• Build a Risk Based Model• Models can be as Generic or Specific as You like• Balance your Risk/Model• Hedge your Bets• Do Dry Runs BEFORE entering the Market• Play out your Hypothesis• Course Correct as You go• Don’t let EGO get in the way of your Investment Decisions• Finally, its about MAKING Money• Prudence and Balance are your FRIENDS, NOT Greed

Questions?

Comments?

Suggestions?

Contact

sumirnagar.com

sumirnagar@yahoo.com