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Asset Management and Private Asset Management and Private BankingBanking
Università BicoccaUniversità Bicocca May 2008May 2008
ProgramsPrograms
Equity InvestmentEquity Investment
11
Investment Process Investment Process
Asset AllocationAsset Allocation
Alternative investmentAlternative investment
Multymanager / open architectureMultymanager / open architecture
Quantitative Techniques and Risk Quantitative Techniques and Risk ManagementManagement
Investment Process / Asset Investment Process / Asset AllocationAllocation
22
ORGANISATION
Risk Management
ASSET ALLOCATION
DIVISION
MUTUAL FUNDS
Forecasting and Strategy
Macro Analysis
Optimisation
Equity
Quantitative analysis
Bond
44
Step 1: Identify investor’s characteristics and goalsStep 1: Identify investor’s characteristics and goals
55
Investment Process
Step 2: Define the approach (benchmark vs total return) Step 2: Define the approach (benchmark vs total return)
Step 4: Portfolio Construction (Optimisation)Step 4: Portfolio Construction (Optimisation)
Step 5: Choose the financial tool for each asset class (open architecture)Step 5: Choose the financial tool for each asset class (open architecture)
Step 6: Execute TradesStep 6: Execute Trades
Step 3: Forecast risk and return for each asset class Step 3: Forecast risk and return for each asset class
Step 1: investor’ s Step 1: investor’ s characteristicscharacteristics and goals and goals
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Define:
Time Horizon
Risk Tolerance
Set of asset classes (equity, bond, cash, corporate, high yield, hedge fund, private equity)
Approach
Responsibility : Private Banker
benchmark driven (relative return)
risk driven (total return)
Benchmark DrivenBenchmark Driven: investors choose a benchmark according to is risk : investors choose a benchmark according to is risk profile, asset managers takes tactical exposure to maximise expected profile, asset managers takes tactical exposure to maximise expected returns. returns. Esempio:Esempio:
Low RiskLow Risk: 20% Equity 80% Bonds. : 20% Equity 80% Bonds. Medium RiskMedium Risk: 40% Equity 60 Bonds: 40% Equity 60 BondsHigh RiskHigh Risk: 70% Equity 30% Bonds: 70% Equity 30% Bonds
Total ReturnTotal Return: : flexible approach. Asset managers try to maximise expected flexible approach. Asset managers try to maximise expected return given a certain level of risk (Value at Risk). return given a certain level of risk (Value at Risk). EsempioEsempio::
Low RiskLow Risk: VaR 3%: VaR 3%Medium RiskMedium Risk: VaR 5%: VaR 5%High RiskHigh Risk: VaR 10%: VaR 10%
Step 2: Define the approachStep 2: Define the approach
Responsibility : Private Banker / Asset Manager
Asset Allocation vs benchmark
ASSET ALLOCATION OUTPUT
Exposure vs benchmark in terms of:
Asset Class
Country
Currency
Duration
GPF Progress 5 anni Benchmark
77
Relative returns in financial markets are predictableRelative returns in financial markets are predictable
Step 3: forecast risk and return
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Responsibility : Asset Allocator, Economist, Strategist
Economic intuition and qualitative judgment Economic intuition and qualitative judgment must be must be supported by empirical evidencesupported by empirical evidence (econometric model, (econometric model, quantitative analysis)quantitative analysis)
Use investment themes that consistently drive returnsUse investment themes that consistently drive returns across global markets and asset classes (long-term across global markets and asset classes (long-term valuation, short-term momentum, fund flows, risk valuation, short-term momentum, fund flows, risk premium, macroeconomic policy)premium, macroeconomic policy)
How do we forecast How do we forecast expected returns?expected returns?
99
Forecasting Forecasting ThemeTheme Rationale Rationale
Identify a set of factors, which can be Identify a set of factors, which can be grouped into broad investment themesgrouped into broad investment themes
Fund Flows
Momentum
Risk Premium
Valuation
Macroeconomic Trade – off growth inflationTrade – off growth inflation
Distance between price and fundamentalsDistance between price and fundamentals
Liquidity goes into some asset classes more than othersLiquidity goes into some asset classes more than others
Rapidly appreciating assets often continue to appreciateRapidly appreciating assets often continue to appreciate
Excess Return to invest in the marketExcess Return to invest in the market
Step 3: forecast risk and return
Factors Commonly Used in Forecasting Absolute and Relative Market Factors Commonly Used in Forecasting Absolute and Relative Market ReturnsReturns
Step 3: forecast risk and return
VariableAsset Class
Equity
Bond Policy
Corporate
Currency
Multiple (PE, PB, PCF)
Price Momentum, Earnings Revisions
Corporate cash flow (Buy Backs, Issuance)
Liquidity (M1, M2, Monetary Policy)
Yield Curve
Output Gap
Inflation
Spread over Treasury
Balance Sheet Ratio
Interest Rate Differential
Futures on Interest Rate (Eurodollar, Euribor)
1010
GrowthGrowth
Step 3: forecast risk and return
1111
Compare your expectations with market expectationsCompare your expectations with market expectations
InflationInflation
Interest RateInterest Rate
VolatilityVolatility
SentimentSentiment
DCF Implied Earnings DCF Implied Earnings GrowthGrowth
Break Even Inflation (TIPS, O.A.T)Break Even Inflation (TIPS, O.A.T)
Strip of Futures on Interest Rate (Eurodollar, Euribor)Strip of Futures on Interest Rate (Eurodollar, Euribor)
Implied Volatility on Option (VIX)Implied Volatility on Option (VIX)
Risk Premium Risk Premium
Step 4: Portfolio Construction (Optimisation)Step 4: Portfolio Construction (Optimisation)
1313
Must have a framework to move Must have a framework to move from predictability to from predictability to portfolio constructionportfolio construction
It requires a It requires a solid asset allocation toolsolid asset allocation tool (Mean Variance, (Mean Variance, Black-Litterman) and Black-Litterman) and systematic approach to risk systematic approach to risk managementmanagement
Maximise the Maximise the trade-off between expected gain and volatilitytrade-off between expected gain and volatility or or tracking error, given the client’s tolerance for risk (efficient frontier) tracking error, given the client’s tolerance for risk (efficient frontier) and historical correlation between asset classesand historical correlation between asset classes
Responsibility: Quantitative Research TeamResponsibility: Quantitative Research Team
Portfolio Expected ReturnPortfolio Expected Return = asset class return + alfa = asset class return + alfa generation – costs (management fees and trading costs)generation – costs (management fees and trading costs)
Step 5: Investment ToolsStep 5: Investment Tools
1414
Identify Optimal Identify Optimal trade off between costs and alfa trade off between costs and alfa generation generation
Investment Tools: Mutual Fund, ETF, Derivatives, Hedge Investment Tools: Mutual Fund, ETF, Derivatives, Hedge Fund.Fund.
The more efficient a market is, the less worthwile it is to pay The more efficient a market is, the less worthwile it is to pay costs for alfa generationcosts for alfa generation (Active Funds). (Active Funds).
Concentrate costs where Alfa generation is highConcentrate costs where Alfa generation is high..
Step 6: Execute TradeStep 6: Execute Trade
1515
Implement incremental portfolio that reflects current Implement incremental portfolio that reflects current views and alpha strategyviews and alpha strategy
Careful attention to transaction costs, market liquidity, Careful attention to transaction costs, market liquidity, risk constraints and client guidelines.risk constraints and client guidelines.
Responsibility: Fund Manager, TraderResponsibility: Fund Manager, Trader
Asset Allocation and Portfolio ConstructionAsset Allocation and Portfolio Construction
1313
Portfolio has 3 components:Portfolio has 3 components:
Capital ProtectionCapital Protection Currency, Short Term Bonds, Real YieldsCurrency, Short Term Bonds, Real Yields Financials instrumenst: secuirity, ETFFinancials instrumenst: secuirity, ETF
Core = Market (Beta) ExposureCore = Market (Beta) Exposure Domestic and internationals equities, bonds, corporate, Domestic and internationals equities, bonds, corporate,
high yieldshigh yields Financials instruments: ETF, Passive Funds, Long onlyFinancials instruments: ETF, Passive Funds, Long only
Satellite = Alfa ExposureSatellite = Alfa Exposure Extra return vs marketsExtra return vs markets Financials instruments: Flexible funds, hedge funds, long – Financials instruments: Flexible funds, hedge funds, long –
short equities, multimanager, tactical asset allocationshort equities, multimanager, tactical asset allocation
Asset Allocation and Portfolio ConstructionAsset Allocation and Portfolio Construction
1313
Strategic asset allocationStrategic asset allocation Medium - Long Term wiews Medium - Long Term wiews Change exposure into the Core Component: equity vs Change exposure into the Core Component: equity vs
Bonds, International equities vs Domestic Equities, Bonds, International equities vs Domestic Equities, Currency exposureCurrency exposure
Change the allocation between Core and SatelliteChange the allocation between Core and Satellite
Tactical asset allocationTactical asset allocation Short term wiewsShort term wiews Change exposure into the Satellite Component: Low Risk vs Change exposure into the Satellite Component: Low Risk vs
High Risk Funds, short term bets on some markets, etc.High Risk Funds, short term bets on some markets, etc.
Dynamic Optimisation between Core and Satellite
Asset Allocation Total ReturnAsset Allocation Total Return
VaR 5 VaR 8 VaR 12
Value at Risk -0.83% -4.03% -6.34%
Capital protection 53% 39% 26%
Euro Currency 20% 9% 5%
Short terms bonds (1 – 3) 33% 30% 21%
Core (beta) 17% 31% 44%
Medium – long Term Bond (5 – 20) 2% 2% 2%
Domestic Equity 7% 14% 20%
International Equity 8% 15% 22%
Satellite (alfa) 30% 30% 30%
Asset Allocation: Capital ProtectionAsset Allocation: Capital Protection
VaR 5 VaR 8 VaR 12
Value at Risk -0.83% -4.03% -6.34%
Capital Protection 53% 39% 26%
Euro Currency 20% 9% 5%
ETF Eonia 5% 2% 1%
FRTR 5 1/2 10/25/08 7% 3% 2%
CCTS 0 06/01/10 4% 2% 1%
CCTS 0 03/01/12 4% 2% 1%
Bond Short Term 1 - 3 33% 30% 21%
Euro Bond Short Term 1-3y 14%
BTPS 2 1/2 06/15/08 3% 1% 1%
DBR 4 07/04/09 2% 1% 1%
FRTR 4 10/25/09 2% 1% 1%
LYXOR ETF EUROMTS 1-3Y 12% 27% 18%
Asset Allocation: Market Exposure (Beta)Asset Allocation: Market Exposure (Beta)VaR 5 VaR 8 VaR 12
Value at Risk -0.83% -4.03% -6.34%
Core (beta) 17% 31% 44%
Bond 2% 2% 2%
Euro Bond medium Term 3-5y
Euro Bond Medium Term (5 – 10)
Euro Bond Long Term (10 – 30)
Inflation Linked 2% 2% 2%
Euro Corporate Bond
Bond Global EM
Bond Global High Yield
Equity 15% 29% 42%
Equity Italy 1% 3% 5%
Equity Europe 4% 7% 9%
Equity USA
Equity USA hedged 1% 2% 3%
JANUS WORLD US RISK MG CO-A= 1% 2% 3%
Equity Japan
Equity Japan hedged 3% 7% 9%
Equity Pacific ex Japan
Equity Pacific ex Japan hedged 1% 1% 2%
Equity Global EM 2% 3% 5%
Settoriali EU 2% 4% 6%
Asset Allocation: Satellite (Alfa)Asset Allocation: Satellite (Alfa)
VaR 5 VaR 8 VaR 12
Value at Risk -0.83% -4.03% -6.34%
Satellite (alfa) 30% 30% 30%
System 100 10% 10% 10%
Basket Flessibili di Terzi 20% 20% 20%
FORTIS L FUND-CRED SP EMR-CC 2%
ABN AMRO FDS-ABS RET BD =-A 4% 3%
CAF-DYNARBITRAGE VR 4 EUR-SC 2% 2%
JPM INV-HIGH STAT MAR N-A=-A 5% 5% 4%
SCHRODER INT EU ABSOL RT-AAC 2% 4% 4%
MELLON GLOBAL-EV GL ALPHA-A= 3% 3% 4%
AMERICAN EXP WLD-CRY AL+-AE= 2%
FORTIS L FUND-BD CONV WRLD-C 2% 3% 4%
MELLON GLOBAL EV CU OPT-A 2%
Hedge Fund
Equity InvestmentEquity Investment
Factors driving equity markets returns
Equity markets performance of the last 3 years. What’ s next?
Alfa Generation: TOP Down vs Bottom Up Approach
Quantitative techniques for equity investments
Fundamental analysis and equity valuation
1616
Market Return + Market Return + Currency ReturnCurrency Return
1717
Equity Investment
Equity Portfolio Expected ReturnEquity Portfolio Expected Return
Extra-return vs Extra-return vs benchmarkbenchmark
BETABETA ++ ALFAALFA
Market ReturnMarket Return
1818
Beta: Market Return
+ Dividend (or Earnings) growth+ Dividend (or Earnings) growth
Current Dividend YieldCurrent Dividend Yield
LiquidityLiquidity
+ Change in Multiples (PE, PB, etc)+ Change in Multiples (PE, PB, etc)
Factors changing MultiplesFactors changing Multiples
Earnings CycleEarnings CycleSentimentSentiment
ValuationMarkets look cheap compared to history, fundamentals or other asset class
Metrics: Price MomentumTool: technical analysis
LiquidityLiquidity available for financial investments
Earnings cycleDynamic of earnings growth
1919
Beta: factors driving market returns
Metrics: Economic Growth, inflation, Yield CurveTool: Macroeconomics analysis
MacroMarkets with best trade off growth / inflation
Metrics: Multiple (PE, PB, DY), Fair Value (DDM, DCF), Relative (B/E Yield)Tool: Fundamental analysis, quantitative metrics
Metrics: EPS Growth, margins, salesTool: Fundamental analysis, quantitative metrics
Metrics: Monetary policy, yield curve, M1 / M2, currency reserves, excess liquidity, corporate cash flow.Tool: Research, Balance Sheet Analysis
MomentumMarkets and currencies have strongrecent outperformance
2020
2002 – 2006: what was behind the equity market rally?
LiquidityLiquidity
ValuationValuation
All the factors were supportive from the equity market perspectiveAll the factors were supportive from the equity market perspective
Earnings cycleEarnings cycle
MomentumMomentum
Global Profits at record level. Restructuring and margins expansions. Best markets not best economy (Europe vs. USA and China)
StrongStrong
Equity market cheap after 2000 – 2002 collapse Equity market cheap after 2000 – 2002 collapse on multiples and relative to bondson multiples and relative to bonds
Central banks loosening monetary policy after Central banks loosening monetary policy after market collapse and September 11th. Zero market collapse and September 11th. Zero real interest rate, excess global liquidity. real interest rate, excess global liquidity.
Global Growth (3.5% real growth), without Global Growth (3.5% real growth), without inflation (2% CPI Core). inflation (2% CPI Core).
Macro Macro EnvironmentEnvironment
3030
Active aprroach: philosophy and aims
Extra-return vs Bcmk 200 / 300 bp per year
Disciplined Approach
Rule for portfolio construction and rigorous risk management, Absolute (VaR) and Relative to bcmk (RVaR, Tracking Error)
Minimising Costs Lower trading costs mean higher portfolio returns
Two Phase
Defensive Phase (optimisation)
Immunisation vs a diversified set of risk factors (market, currency, sector, style, size exposure)
Active Phase
Bottom up approach. Two Sources of alfa generation: quantitative model and fundamental analysis
Defensive PhaseDefensive Phase
3131
Equity portfolio: alfa generation
Evidence shows that Evidence shows that performance vs. benchmark is driven performance vs. benchmark is driven more by bets you are not consciousmore by bets you are not conscious ofof (factor risk exposure, (factor risk exposure, stock you don’t own) than active bets you are aware of. stock you don’t own) than active bets you are aware of.
To maximise expected gains with respect to benchmark and To maximise expected gains with respect to benchmark and subject to a constraint of tracking error, subject to a constraint of tracking error, it is important to it is important to isolate sources of alfa generation.isolate sources of alfa generation.
Optimisation ProcessOptimisation Process
High number of stocksHigh number of stocks (80% market coverage) (80% market coverage)
Market and currency neutralMarket and currency neutral (beta 1) (beta 1)
Sector NeutralSector Neutral
Monitoring ofMonitoring of Style and Size Bias Style and Size Bias
• Multifactor model, covering over 600 stocks
• Transparency (no black box)
• Testing of different sets of variables (fundamental, technical, valuation) for each sector
• Basket of stocks sector neutral
• Backtest over 12 years
Source 2Source 1
3232
Active PhaseActive PhaseTwo Sources of Alfa GenerationTwo Sources of Alfa Generation
Equity portfolio: alfa generation
Quantitative Model Fundamental Analysis
• Analyst / Fund Managers for most sectors
• Proprietary valuation model (DCF + Break up ROE)
• Qualitative study of the company (sector analysis, company visits, management presentations)
3333
Investment Process
Three BlocksThree Blocks
1.1. Portfolio Low Tracking ErrorPortfolio Low Tracking Error
2.2. Quantitative Basket (80 – 100 stocks)Quantitative Basket (80 – 100 stocks)
3.3. Fundamental Basket (proprietary valuation model)Fundamental Basket (proprietary valuation model)
NO exposure to Market, Currency, Sector, Style
Alfa concentrated in Stock Picking
Product responsibility = Risk AllocatorProduct responsibility = Risk Allocator
Quantitative AnalystsQuantitative Analysts
Fund Managers /Sector AnalystFund Managers /Sector Analyst
Team
SectorsSectors
Selected Variables Selected Variables
Ranking of Stocks in Each Ranking of Stocks in Each SectorSector
Sector ConstructionSector Construction
Portfolio ConstructionPortfolio Construction
Utilities Banks Energy
Cash Flow P/E Price to Book STM Dividend Yield
EV/EBITDA
1. GDF
2. E.On
3. Enel
4. …
1. UBS
2. BPM
3. Santander
4. …
1. BP
2. ENI
3. Repsol
4. …
GDF, E.On, EnelUBS, BPM, Santander
BP, ENI
SSM
Market
3434
Construction of Quantitative Model
REFERENCESREFERENCES
Strategic Asset allocation: Portfolio choice for Long Strategic Asset allocation: Portfolio choice for Long Term InvestorsTerm Investors, Oxford University Press, 2002., Oxford University Press, 2002.
The Term Structure of the Risk – Return Trade OffThe Term Structure of the Risk – Return Trade Off . . Financial Analysts Journal, January / February 2005Financial Analysts Journal, January / February 2005
Investment ValuationInvestment Valuation – Damodaran – Wiley Finance - – Damodaran – Wiley Finance - 20042004
Winning the Loser’s GameWinning the Loser’s Game – Charles D. Ellis - 2004 – Charles D. Ellis - 2004
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