20
18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

Embed Size (px)

Citation preview

Page 1: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

18 September 2003

Joeri van AlphenLodewijk van Pol

Modelling Active Management

AFIR 2003, Maastricht

Page 2: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

2

Agenda

Introduction

The model

Example

Application to manager structure

Conclusion

Page 3: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

3

Absolute versus relative risk

Efficiënte Grenslijn

2.00

2.25

2.50

2.75

3.00

3.25

3.50

3.75

4.00

4.25

4.50

4.75

5.00

5.25

0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5

Standaarddeviatie

Gem

iddel

d reë

el ren

dem

ent

Quarterly PerformanceRelative to Benchmark

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

III1996

I1997

III I1998

III I1999

III I2000

III I2001

Added Value Rolling three year added value Added value target

Page 4: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

4

Active return matters

An additional 1% return saves an average pension fund about 6% contribution of payroll

In a low return environment, additional return from active management becomes more important

Page 5: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

5

Model

Active return normally distributed with expectation and standard deviation TE

Portfolio return Rp = Rb +

Portfolio risk: standard deviation of benchmark (b ) tracking error (TE) correlation between Rb and

2,

2 ***2 TETE bbbp

Page 6: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

6

Impact of TE and correlation on portfolio standard deviation

Impact of TE and correlation

18%

19%

20%

21%

22%

23%

24%

25%

26%

0% 1% 2% 3% 4% 5% 6%

TE

Sta

ndar

d d

evia

tion o

f act

ive

port

folio

Cor = 0.75

Cor = 0.50

Cor = 0.25

Cor = 0.00

Cor =-0.25

Page 7: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

7

Some real-life examples

Standard Deviation European Equities of Managers versus Benchmark

0%

5%

10%

15%

20%

25%

30%

Benchmark 20.3% 20.3% 20.5% 20.5% 20.1% 20.6%

Portefeuille 22.5% 21.3% 21.6% 23.1% 21.1% 25.7%

TE 5.5% 6.0% 3.7% 4.5% 3.1% 8.6%

Cor 28.1% 2.3% 20.7% 49.2% 22.8% 46.3%

1 2 3 4 5 6

Portfolio

Page 8: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

8

Two “active” asset mixes

Example 1 (IR = 0.5) Example 2 (IR = 0.25)

Bonds(50%)

Equities(50%)

Bonds(50%)

Equities(50%)

Alpha 0.5% 2% 0.25% 1%

Trackingerror

1% 4% 1% 4%

Correlationof alpha andbenchmark

0 0.5 0 0.5

Page 9: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

9

Two “active” asset mixes compared with 50/50-benchmark and 40/60-mix

Efficient frontier

50/50, IR=0,5

50/50, IR=0,25

50/50 40/60

2.00

2.25

2.50

2.75

3.00

3.25

3.50

3.75

4.00

4.25

4.50

4.75

5.00

5.25

0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5

Standard deviation (%)

Ave

rage

rea

l ret

urn

(%)

Page 10: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

10

Two “active” asset mixes compared with 50/50-benchmark and 40/60-mix

Efficient frontier

50/50, IR=0,5

50/50, IR=0,25

50/50

40/60

3.75

3.85

3.95

4.05

4.15

4.25

4.35

4.45

4.55

4.65

4.75

3.5 3.6 3.7 3.8 3.9 4.0 4.1 4.2 4.3 4.4 4.5

Standard deviation (%)

Ave

rage

real

ret

urn

(%

)

More efficient manager structure

Page 11: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

11

What is manager structuring?

How can the strategic investment allocation best be implemented taking into account the efficiency of markets, the capabilities of investment managers and the costs of investment management?

Page 12: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

12

The Investment processPension funds

Follow upSearch & selectionImplementationALM study

ISSUES TO CONSIDERSERIES OF DECISIONS PRE-DEFINED CRITERIA USEDFOR SELECTION /REVIEW

ISSUES TO CONSIDER

financial strength•Nature of Fund's liabilities and

•Legislative issues, Accounting

•The risk tolerances of sponsoring organisation

•Specific Issues of relevance tothe Fiduciaries

• Transition Management

• Investment guidelines• Statement of Investment

Policy

• Custody

•Active versus passive investment management

•Specialist or balanced mandates

•Multiple versus single manager structures

•Organizational criteria•(stability, commitment)

•Process related criteria•(research, risk management)

•Product related criteria•(performance, fees)

Determine Investment Objective / Set Asset Allocation Strategy

Determine Investment Management Structure

Review / AppointInvestment Manager(s)

Implement & Document Changes

• Monitoring & Evaluation

Page 13: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

13

Why is it important?

ALM study Implementation

Risk Benchmark +

Return Benchmark +/- (?)

Costs = zero! +

Implementation affects Assumptions of the ALM study

Manager structuring is focussed on controlling this process

Possibly to enhance return and diversify risk

Page 14: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

14

Concepts & Approach

Three basic questions

Active versus passive investment management

Balanced versus specialist investment management

Multi versus single investment management

Page 15: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

15

Active versus passive Investment ManagementThree issues

(in)Efficiency of markets

Potential of positive alpha and information ratio

Need to reduce risk

Costs

Transaction costs

Management fees

Diversification

Low correlation of Alpha with benchmark

Volatility of (active) portfolio is not sum of passive + TE

Page 16: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

16

Active versus passive: a variety of degrees of activity

TABEL: VARYING DEGREES OF ACTIVE MANAGEMENT

Outperformance target (alpha) and risk budget (tracking error)

(Global) equities (Euro) fixed incomeType ofmanagement

Alpha Tracking Error Alpha Tracking Error

Passive 0% 0% 0% 0%

Index enhanced 0,5% - 1,0% 0,5% - 1,5% < 0,25% 0,5%

Light active 1,0% -2,0% 2,0% - 4,0% 0,25% 0,5% - 1,0%

Active 2,0% - 3,0% 4,0% - 6,0% 0,5% - 1,0% 1,0% - 2,0%

Agressive active 2,0% - 4,0% >> 6,0% 1,0% - 2,0% 2,0% – 3,0%

Page 17: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

17

Active versus passive Investment ManagementTransaction costs: equities

Transaction costs Equities

Large Cap

0

20

40

60

80

100

120

US /NorthAmerica

Euro Japan EM Markets

Ba

sis

po

ints

maximum

average

minimum

Page 18: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

18

Active versus passive Investment Management Management fees: global equities

Active management feesGlobal Equities (active)

0,0

20,0

40,0

60,0

80,0

0 - < 50 50-100 100-200 200-500 500-1000

Assets under management (euro ml)

Basis

po

ints

Minimum

Average

Maximum

Page 19: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

19

Balanced versus specialist Investment ManagementPros and cons of specialization

+/+ of specialization

Select capability out of larger universe

Diversity of Investment styles

Greater flexibility in appointment

-/- of specialization

Higher fees

More complex communication

TAA will require additional solutions >> consistency problem

Extra costs for Monitoring & Evaluation, appointment

Page 20: 18 September 2003 Joeri van Alphen Lodewijk van Pol Modelling Active Management AFIR 2003, Maastricht

20

Summary & Conclusions

Manager structuring has impact on ALM assumptions

All pension funds have to decide on:

Active versus passive

Balanced versus specialist

Multiple versus single

Modeling and quantification is possible, but…

Make careful assumptions!

In active equity investment management, style diversification appears attractive