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Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
EXPECTED VOLATILITY
33
Implied Volatility (Index Options)
Source: Pictet Asset Management, Bloomberg
August 2015!
Uncertainty reduced by ‘endogenous’ Fed (unemployment doesn’t decrease, QE) and BCE’s OMT/QE
Brexit
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
CORRELATION AMONG DIFFERENT ASSET CLASSES: 2003-2008
34
Source: Pictet Asset Management, Bloomberg Source: Pictet Asset Management, Bloomberg
European Bonds: negative correlation with MSCI World and Euro
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
CORRELATION AMONG DIFFERENT ASSET CLASSES: 2009-2012
35
Source: Pictet Asset Management, Bloomberg Source: Pictet Asset Management, Bloomberg
European Bonds: positive correlation with MSCI World and Euro
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
CORRELATION ANALYSIS
36
Weekly Correlations (on a rolling 12M window) between US TSY and MSCI US (lhs); EMU Bonds and MSCI EMU (rhs)
Source: Pictet Asset Management, Bloomberg
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
HOW TO FACE FINANCIAL REPRESSION REGIME AND TRANSITION TO NORMAL ITY?
38
Expected Risk & Return map of main financial assets (Yield to Maturity for bonds & Earing Yields for equities)
Source: Pictet Asset Management, Bloomberg, data as at 11.11.2016
Reference indices: MSCI World in USD (World Equities), Euro Stoxx in EUR (European Equities), S&P500 in USD (US Equities), MSCI Emerging Markets in USD (Emerging Equities), Euribor 3 months in EUR, BofA ML EUR Corporate Bonds in EUR (EUR Corporate Bonds), BofA
ML EUR High Yield in EUR (EUR High Yield), BofA ML Global Government Index in USD (World Government Bonds), JPM EMBI Global Diversified Composite in USD (USD Emerging Debt), German 10Y Government Bond in EUR
* The ‘Static Portfolio’ is a linear combination (ie assumes perfect correlation) based on 70% 3-5y Bond Index Barclays Euro Aggregate and 30% MSCI World in €
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
MONETARY POLICY EXHAUSTED
39
INEFFECTIVENESS OF THE TRANSMISSION CHANNELS OF MONETARY POLICY. Main reasons:
1. Quantitative Easing (QE). Massive sales of US Treasury by the PBoC and Oil Countries’ SWF
2. Bank Regulation. Restrictive impact on Credit and ‘Money Multipliers’ (stuck at post-crisis levels)
3. NIRP. Backfire on Bank profitability and Propensity to Save (income effect prevails on substitution
effect in savers’ decision about consumption of their disposable income: ‘Laffer curve’ type)
5 year in 5 year forward Breakeven Inflation
Source: Bloomberg
USA
EMU
JAPAN
2%
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
FINANCIAL REPRESSION POSES A DILEMMA TO INVESTORS
Yields to Maturity (BY) of 10 US
year government bonds are
around 2%, a low level compared
with the last 30 years of history
On the contrary, Equity
valuations, i.e. Earnings Yields
(EY) are close to historical
average
Yield compression has created a
dilemma for investors – forcing
them to choose between giving up
potential returns or increasing
their risk budget
40
US: Equities Earnings Yields at historical average; Bond Yields and MM rates much lower
Source: IBES, DATASTREAM, Bloomberg, Pictet Asset Management, as at 31.10.2016
-1%
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
11%
12%
JAN-99 JAN-01 JAN-03 JAN-05 JAN-07 JAN-09 JAN-11 JAN-13 JAN-15
EUR CASH EUR BONDS MSCI WORLD
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
REMOVING THE FINANCIAL REPRESSION REGIME IS UNPRECEDENTED
41
Performance of World Equities, European Bonds and FX against the Euro
Source: Bloomberg
World Equities
European Bonds
Effective EUR (Inverted scale)
Taper tantrum (Bernanke)
Scarcity Tantrum (Draghi)
Monetary Policy pause (BC G3)
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
IF BONDS SUFFER FOR ‘WRONG ’ REASONS, CONTAGION AFFECTS RISKY ASSETS TOO
42
Performance of World Equities, European Bonds and FX against the Euro
Source: Bloomberg
Brexit
ECB
Trump World Equities
European Bonds
Effective EUR (Inverted scale)
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
DURATION MAGO
43
Dentsitivity of the portfolio to a rise in interest rates
Source: Pictet Asset Management, as at 11.11.2016
* Calculated assuming the actual overall duration of the portfolio (teal-colored line) was rebased on 70% of the portfolio
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
HOW TO FACE FINANCIAL REPRESSION REGIME AND TRANSITION TO NORMAL ITY?
44
Expected Risk & Return map of main financial assets (Yield to Maturity for bonds & Earing Yields for equities)
Source: Pictet Asset Management, Bloomberg, data as at 11.11.2016
Reference indices: MSCI World in USD (World Equities), Euro Stoxx in EUR (European Equities), S&P500 in USD (US Equities), MSCI Emerging Markets in USD (Emerging Equities), Euribor 3 months in EUR, BofA ML EUR Corporate Bonds in EUR (EUR Corporate Bonds), BofA
ML EUR High Yield in EUR (EUR High Yield), BofA ML Global Government Index in USD (World Government Bonds), JPM EMBI Global Diversified Composite in USD (USD Emerging Debt), German 10Y Government Bond in EUR
* The ‘Static Portfolio’ is a linear combination (ie assumes perfect correlation) based on 70% 3-5y Bond Index Barclays Euro Aggregate and 30% MSCI World in €
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
EX-ANTE VOLATILITY OF PICTET MULTI ASSET GLOBAL OPPORTUNITIES (MAGO )
45
Risk Management in Portfolio Construction
Source: Pictet Asset Management
2,00%
2,50%
3,00%
3,50%
4,00%
4,50%
5,00%
5,50%
6,00%
6,50%
SEP-13 DEC-13 MAR-14 JUN-14 SEP-14 DEC-14 MAR-15 JUN-15 SEP-15 DEC-15 MAR-16 JUN-16 SEP-16
4,18%
A sset C lass C o ntributio n to Vo lat ility (bps)
Bonds 27
Cash 26
Equities 351
Alternative 5
Commodities 9
TOTAL 418
VOLATILITY BUDGET
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
MAGO VS PEERS (3 YEARS)
46
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
Macro and Market Scenario Analysis 5.
47
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
MONETARY POLICY EXHAUSTED
48
INEFFECTIVENESS OF THE TRANSMISSION CHANNELS OF MONETARY POLICY. Main reasons:
1. Quantitative Easing (QE). Massive sales of US Treasury by the PBoC and Oil Countries’ SWF
2. Bank Regulation. Restrictive impact on Credit and ‘Money Multipliers’ (stuck at post-crisis levels)
3. NIRP. Backfire on Bank profitability and Propensity to Save (income effect prevails on substitution
effect in savers’ decision about consumption of their disposable income: ‘Laffer curve’ type)
5 year in 5 year forward Breakeven Inflation
Source: Bloomberg
USA
EMU
JAPAN
2%
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
-0,5
0,0
0,5
1,0
1,5
2,0
2,5
3,0
3,5
4,0
4,5
5,0
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16
Fed Fund rate Tgt
FF avg [OIS 10Y]
Zero Curve 10Y
TP = (Zero - CDS) 10Y - FF avg [OIS 10Y]
SINCE THE CHINESE CRISIS OF 2015 TERM PREMIUMS HAVE NORMALISED
49
Term premium on T-Notes: yield to maturity - CDS - average interest rate on Fed funds for the next 10 years
Source: Pictet Asset Management, Bloomberg
Term Premium: 30bp (by difference)
T-Note: 2,35%
Expected FF: 1,65% (Estimated w FF Futures
etc.)
CDS10 on T-Note: 40bp
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
ONLY NOW, AFTER QE IS OVER ½ OF THE MOVE DUE TO THE TERM PREMIUM !
50
The Fed has contributed to the confusion with ambiguous interventions, the market has misunderstood
MONETARY
INTEREST RATES
(forward)
TERM PREMIUM
YIELD TO MATURITY Net of Credit Risk
19 April 2013 11 November 2016 change
1,62% 1,65% +3bp
-0,36% 0,30% 66bp
1,26% 1,95% 69bp
QE
Guidance*
* In December 2012 became quantitative: rate hikes were conditional
upon macro-economic objectives (Unemployment < 6,5%; inflation >
2,5%); since March 2014 Fed’s guidance is again qualitative.
TOTAL
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
MONETARY IMPULSE TRANSMISSION
Large Scale Asset Purchases (QE) extremely expansive, restrictive regulation and decreasing yields alter the relation between these values
• The traditional stable relation between monetary aggregates sharply modifies after 2008, and money (or
credit) multiplier becomes unstable. How does transmission mechanism changes? From deleverage to
restrictive regulation?
• The traditional stable relation between money and economic activity loosens: since 15 years ago velocity
of money is falling. May the preference for liquidity (even corporate) and negative rates explain the effect?
Multipliers and Speed of money circulation
Monetary Base Monetary Aggregates Nominal GDP Monetary multiplier
Velocity of money
51
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
STRUCK MULTIPLIER? QE COMPENSATED DELEVERAGE OF THE SYSTEM
Multiplier of money USA (M2/H quotient between money created by banking system via credit granted and monetary basis)
Multiplier is 1/3 of pre subprime crisis level. How much of this decrease is structural?
M2: Money created by the intermediaries’ system
H: Monetary base
m: Money multiplier
Source: Bloomberg 52
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
REGULATORY RESTRICTIONS AND MACRO-PRUDENTIAL POLICIES
Source: JP Morgan – Q2 2014
53
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
INEQUALITY, ‘LAFFER ’ EFFECT BEHIND THE RISING SAVINGS RATE IN G3
54
G3 Savings Rate (% disposable income)
Source: Pictet Asset Management, Penn World Table, CEIC, Datastream
G3 Savings Rate (% disposable income) – 3y average
Source: Pictet Asset Management, CEIC, Datastream
23
24
24
25
25
26
26
27
27
28
28
29
0
2
4
6
8
10
12
14
16
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16
% d
ispo
sabl
e in
com
e
% d
ispo
sabl
e in
com
e
U.S.EURO AREAJAPAN
G5Households saving ratio (%
disposable income, 5-year average)
U.S. 6.0
Euro area 12.5
Japan 26.0Working age polulation
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
SAVING RATIOS FOR WEALTH CLASSES -> HIGHER AVERAGE SAVING RATIO ?
Source: Saez, Zucman, NBER 2014
55
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
MONETARY POLICY EXHAUSTED
56
Interest rate
GDP
LM
LM’
LM’’
IS
i
i’
i’’
Traditionally expansionary impact
Monetary Policy effectiveness is reduced…
Could fade completely with Z/NIRP
y y’ y’’
LM’’’
i’’’ y’’’
…as a Liquidity Trap unfolds
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
FISCAL POLICY
57
Interest rate
GDP
LM
IS
i
IS’
y y’
i’
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
TRUMP’S AGENDA AND MACRO
58
Fiscal Policy Growth Inflation
Infrastructure Spending $1,000 bln + +
Corporate Tax Repatriation Plan + +
Cut Personal Income Tax + +
Repeal of Obamacare - +
Federal Reserve – Regulation
Yellen 2018, FOMC - ?
Fed on automatic pilot - -
Deregulation + ?
World trades and foreign policy
Stop TPP/NAFTA, duties - +
Immigration = +
NATO/Russia = =
Indipendence of OPEC + +
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
EVENT SCENARIO ANALYSIS
59
Scenario Analysis: Brexit
Source: Pictet Asset Management
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
CONCLUSIONS
60
• The benefits coming from diversification are directly proportional to the degree
of decorrelation among the investment portfolio’s assets.
• Since the subprime crisis of 2008, correlations remained relatively high
(typical during financial turmoil). On the contrary, the volatilities have
experienced a normalization.
• One of the causes of the correlations behavior is the standardization of the
investors’ behavior, affecting in particular intra-assets correlations. The
correlation between equities and bonds has been affected by the European Debt
Crisis and by the behavior of the Fed in the USA, and later many other Central
Banks adopting Quantitative Easing, that favor (at least a temporary) inversion of
the correlation sign from negative to positive.
• When there is uncertainty on the economic growth, the correlation between
equities and bonds should be ‘normal’ (negative): this could encourage holding a
longer duration.
• Because of the paucity of decorrelations, there are now less opportunities than
before. How to face this new world? Two solutions: i) Reduce your Total Return
objectives; ii) become more «aggressive» in order to reach ‘sub-optimal’ but
higher gains. Either way, we are induced to diversify through additional presence
of risky assets (equities).
In this last case, using a max Diversification portfolio (or based on Risk Parity), instead of a max Sharpe one, may hold better in the face of uncertain/unstable
correlations.
Asset Allocation in a distorted environment
Only for academic purposes
Pictet Asset Management
For more information please contact your client relationship manager.
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issued by Pictet Funds (Europe)
S.A. It is neither directed to,
nor intended for distribution or
use by, any person or entity
who is a citizen or resident of,
or domiciled or located in, any
locality, state, country or
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Only the latest version of the
fund’s prospectus, regulations,
annual and semi-annual reports
may be relied upon as the basis
for investment decisions. These
documents are available on
www.pictetfunds.com or at
Pictet Funds (Europe) S.A., 15,
avenue J. F. Kennedy L-1855
Luxembourg.
The information and data
presented in this document are
not to be considered as an offer
or solicitation to buy, sell or
subscribe to any securities or
financial instruments.
Information, opinions and
estimates contained in this
document reflect a judgment at
the original date of publication
and are subject to change
without notice. Pictet Funds
(Europe) S.A. has not taken any
steps to ensure that the
securities referred to in this
document are suitable for any
particular investor and this
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depends on the individual
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The value and income of any of
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Performance data does not
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is not intended to be a
substitute for the fund’s full
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61