Asset Management Program

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Asset Management Program
Università Bicocca
May 2007
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Programs

• Investment Process

• Asset Allocation

• Equity Investment

• Alternative investment

• Multymanager / open architecture

• Quantitative Techniques and Risk Management

Fideuram Investimenti SGR
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Investment Process / Asset Allocation
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Fideuram Investimenti SGR

• Fideuram Investimenti is Banca Fideurams Asset
  Management Firm, responsible for all the
  companys investment issues

• Fideuram Investimenti SGR employs 100 people,
  entirely involved in the asset management
  process consultancy, asset allocation, fund
  management

• Assets Under Management stand at around 50 bln
  Euro 4th largest Asset Management Company in
  Italy

• Products different kinds of SICAV, Mutual
  Funds, Pension Funds, Hedge Funds, Multimanager

• Clients private and institutional
  (Foundations, Pensions Funds, Banks).

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ORGANISATION
ASSET ALLOCATION DIVISION
MUTUAL FUNDS
Macro Analysis
Quantitative analysis
Forecasting and Strategy
Equity
Bond
Optimisation
Risk Management
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Investment Process

• Step 1 Identify investors characteristics and
  goals

Step 2 Forecast risk and return for each asset
class
Step 3 Construct Optimal Portfolio
Step 4 Choose the financial tool for each asset
class
Step 5 Execute Trades
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Step 1 investor s characteristics and goals
Define
Time Horizon
Risk Tolerance
Approach
benchmark driven (relative return)
risk driven (total return)
Set of asset classes (equity, bond, cash,
corporate, high yield, hedge fund, private equity)
Responsibility Private Banker
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Asset Allocation

• Benchmark Driven investors choose a benchmark
  according to is risk profile, asset managers
  takes tactical exposure to maximise expected
  returns
• Total Return flexible approach. Asset managers
  try to maximise expected return given a certain
  level of risk (VAR)

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Asset Allocation vs benchmark
OUTPUT
ASSET ALLOCATION
Exposure vs benchmark in terms of

• Asset Class

• Country

• Currency

• Duration

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Step 2 forecast risk and return

• Relative returns in financial markets are
  predictable

• Economic intuition and qualitative judgment must
  be supported by empirical evidence (econometric
  model, quantitative analysis)

• Use investment themes that consistently drive
  returns across global markets and asset classes
  (long-term valuation, short-term momentum, fund
  flows, risk premium, macroeconomic policy)

Responsibility Asset Allocator, Economist,
Strategist
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Step 2 forecast risk and return
Identify a set of factors, which can be grouped
into broad investment themes

• How do we forecast expected returns?

Forecasting Theme Rationale
Macroeconomic
Trade off growth inflation
Valuation
Distance between price and fundamentals
Liquidity goes into some asset classes more than
others
Fund Flows
Momentum
Rapidly appreciating assets often continue to
appreciate
Excess Return to invest in the market
Risk Premium
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Factors Commonly Used in Forecasting Absolute and
Relative Market Returns
Step 2 forecast risk and return
Variable
Asset Class
Equity
Multiple (PE, PB, PCF) Price Momentum, Earnings
Revisions Corporate cash flow (Buy Backs,
Issuance) Liquidity (M1, M2, Monetary Policy)
Yield Curve Output Gap Inflation
Bond Policy
Spread over Treasury Balance Sheet Ratio
Corporate
Interest Rate Differential Futures on Interest
Rate (Eurodollar, Euribor)
Currency
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Compare your expectations with market expectations
Step 2 forecast risk and return

• Growth

DCF Implied Earnings Growth
Inflation
Break Even Inflation (TIPS, O.A.T)
Strip of Futures on Interest Rate
(Eurodollar, Euribor)
Interest Rate
Volatility
Implied Volatility on Option (VIX)
Sentiment
Risk Premium
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Step 2 forecast risk and return
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Step 3 Optimal Portfolio

• Must have a framework to move from predictability
  to portfolio construction

• It requires a solid asset allocation tool (Mean
  Variance, Black-Litterman) and systematic
  approach to risk management

• Maximise the trade-off between expected gain and
  volatility of tracking error, given the clients
  tolerance for risk

Responsibility Quantitative Research Team
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Step 4 Investment Tools

• Portfolio Expected Return asset class return
  alfa generation costs (management fees and
  trading costs)

• Identify Optimal trade off between costs and alfa
  generation

• The more efficient a market is, the less
  worthwile it is to pay costs for alfa generation
  (Active Funds).
• Concentrate costs where Alfa generation is high.

• Investment Tools Mutual Fund, ETF, Derivatives,
  Hedge Fund.

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Step 5 Execute Trade

• Implement incremental portfolio that reflects
  current views and alpha strategy

• Careful attention to transaction costs, market
  liquidity, risk constraints and client guidelines.

Responsibility Fund Manager, Trader
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Equity 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

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Equity Investment
Equity Portfolio Expected Return
BETA

ALFA

• Market Return Currency Return

Extra-return vs benchmark
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Beta Market Return
Current Dividend Yield

• Market Return

Dividend (or Earnings) growth
Change in Multiples (PE, PB, etc)
Factors changing Multiples
Liquidity
Earnings Cycle
Sentiment
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Beta factors driving market returns
Metrics Economic Growth, inflation, Yield
Curve Tool Macroeconomics analysis
Macro Markets with best trade off growth /
inflation
Metrics Multiple (PE, PB, DY), Fair Value (DDM,
DCF), Relative (B/E Yield) Tool Fundamental
analysis, quantitative metrics
Valuation Markets look cheap compared to history,
fundamentals or other asset class
Metrics EPS Growth, margins, sales Tool
Fundamental analysis, quantitative metrics
Earnings cycle Dynamic of earnings growth
Metrics Monetary policy, yield curve, M1 / M2,
currency reserves, excess liquidity, corporate
cash flow. Tool Research, Balance Sheet Analysis
Liquidity Liquidity available for financial
investments
Momentum Markets and currencies have
strong recent outperformance
Metrics Price Momentum Tool technical analysis
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2002 2005 what was behind the equity market
rally?
Macro Environment
Global Growth (3.5 real growth), without
inflation (2 CPI Core).
Central banks loosening monetary policy after
market collapse and September 11th. Zero real
interest rate, excess global liquidity.
Liquidity
Equity market cheap after 2000 2002 collapse on
multiples and relative to bonds
Valuation
Momentum
Strong
Global Profits at record level. Restructuring and
margins expansions. Best markets not best economy
(Europe vs. USA and China)
Earnings cycle
All the factors were supportive from the equity
market perspective
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2006 whats next?
Still supportive. Strong growth in 2006 2007,
reasonable inflation expectations. Risk US
budget and trade deficit, dollar collapse, Brent
spike.
Macro Environment
Changed. Major banks in mood to tighten up (US,
Europe, Japan). Excess liquidity shrinking.
Liquidity
Still reasonable. Multiples in neutral area,
equity still attractive vs. bond. Equity market
up no more than earnings (non multiple expansions)
Valuation
Momentum
Strong
Still robust, but the best is over. Margins and
EPS growth decelerating. Earnings revision still
positive.
Earnings cycle
Some factors are changing from the equity market
perspective
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Equity markets perspective

• 2002 2005 NOW
• Macro
• Valuation
• Earnings Cycle
• Liquidity / -
• Sentiment / Momentum
• Conclusion equity market still reasonable, but
  the best is over. Trends up, no major upside.
  Consolidation phase with more volatility.

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US INDICATORS
Updated 03/31/06
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Earnigs Revisions
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Earnings Growth
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Equity portfolio alfa generation
Equity markets
Usa, Europe, Asia, Japan, Italy. Emerging Markets
Benchmark
SP500, Eurostoxx, Topix, Han Seng, MSCI.
Fund Managers Issue
Beat the benchmark.
HOW CAN A FUND MANAGER BEAT THE MARKET?
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Equity portfolio alfa generation
Top Down Approach
beta exposure futures
Market Exposure
Currency exposure
hedging - Forward
Sector Allocation
Energy vs Financials
Value vs growth
Style Allocation
Size Allocation
Blue Chips vs Small Cap
Factor Allocation
sensitivity to macro data (inflation, interest
rates, industrial production, etc)
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Equity portfolio alfa generation
Bottom up approach Stock Selection
Valuation
Earnings Quality
Profitability
Were earnings derived from sustainable
sources? Metrics Accruals-to-total-assets,
Change in net operating assets
Are market prices coherent with firms
fundamentals? Metrics Price / Earnings, DDM,
DCF, Price to Book, ROE break down.
What are the companys profit margins?
How efficient are its operations? Metrics Earning
s-to-sales ratio, Sales-to-total-assets ratio,
EBIT-to-enterprise value, Forecast
earnings-to-price
Momentum
Sentiment
Management
How has the market responded to the
companys changing fortunes? Metrics Short-term
reversals, Medium-term continuations, Long-term
reversals
What is company management strategy
and behaviour? Metrics Net external financing,
Change in shares Outstanding, Company visits
Are analysts upgrading or downgrading their view
of this company? Metrics Earnings forecast
revisions, Recommendation changes
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Equity portfolio alfa generation
Portfolio optimisation maximises risk- adjusted
expected return

• Country and currency exposure

Sector exposure
Transaction cost estimates
Style exposure
Portfolio Optimisation
Active bets
Size exposure
Optimal portfolio
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Our approach philosophy and aims
Extra-return vs Bcmk
200 / 300 bp per year
Rule for portfolio construction and rigorous risk
management, Absolute (VaR) and Relative to bcmk
(RVaR, Tracking Error)
Disciplined Approach
Lower trading costs mean higher portfolio returns
Minimising Costs
Two Phase
Defensive Phase (optimisation)
Active Phase
Immunisation vs a diversified set of risk factors
(market, currency, sector, style, size exposure)
Bottom up approach. Two Sources of alfa
generation quantitative model and fundamental
analysis
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Defensive Phase
Equity portfolio alfa generation
Evidence shows that performance vs. benchmark is
driven more by bets you are not conscious of
(factor risk exposure, stock you dont own) than
active bets you are aware of.

To maximise expected gains with respect to
benchmark and subject to a constraint of tracking
error, it is important to isolate sources of alfa
generation.

Optimisation Process
High number of stocks (80 market coverage)
Market and currency neutral (beta 1)
Sector Neutral
Monitoring of Style and Size Bias
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Equity portfolio alfa generation
Active PhaseTwo Sources of Alfa Generation
Source 2
Source 1
Quantitative Model
Fundamental Analysis

• 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

• Analyst / Fund Managers for most sectors
• Proprietary valuation model (DCF Break up ROE)
• Qualitative study of the company (sector
  analysis, company visits, management
  presentations)

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Investment Process
Three Blocks

• Portfolio Low Tracking Error

• Quantitative Basket (80 100 stocks)

• Fundamental Basket (proprietary valuation model)

NO exposure to
Market, Currency, Sector, Style
Alfa concentrated in
Stock Picking
Product responsibility Risk Allocator Quantitat
ive Analysts Fund Managers /Sector Analyst
Team
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Construction of Quantitative Model

• Sectors
• Selected Variables
• Ranking of Stocks in Each Sector
• Sector Construction
• Portfolio Construction

Market
Utilities
Banks
Energy
Cash Flow
P/E
Price to Book
STM
Dividend Yield
EV/EBITDA

• GDF
• E.On
• Enel

• UBS
• BPM
• Santander

• BP
• ENI
• Repsol

GDF, E.On, Enel
UBS, BPM, Santander
BP, ENI
SSM
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Results Europe

• Back test January 97
• Universe MSCI Europe
• Performance with dividends Total Return

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Results. USA

• Back test January 98
• Universe MSCI USA
• Performance with dividends Total Return

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REFERENCES

• Strategic Asset allocation Portfolio choice for
  Long Term Investors, Oxford University Press,
  2002.
• The Term Structure of the Risk Return Trade
  Off. Financial Analysts Journal, January /
  February 2005
• Investment Valuation Damodaran Wiley Finance
  - 2004
• Winning the Losers Game Charles D. Ellis -
  2004