Asset Management and Private Banking

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Asset Management and Private Banking
Università Bicocca
May 2008
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Programs

• Investment Process

• Asset Allocation

• Equity Investment

• Alternative investment

• Multymanager / open architecture

• Quantitative Techniques and Risk Management

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Investment Process / Asset Allocation
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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 Define the approach (benchmark vs total
return)
Step 3 Forecast risk and return for each asset
class
Step 4 Portfolio Construction (Optimisation)
Step 5 Choose the financial tool for each asset
class (open architecture)
Step 6 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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Step 2 Define the approach

• Benchmark Driven investors choose a benchmark
  according to is risk profile, asset managers
  takes tactical exposure to maximise expected
  returns. Esempio
• Low Risk 20 Equity 80 Bonds.
• Medium Risk 40 Equity 60 Bonds
• High Risk 70 Equity 30 Bonds
• Total Return flexible approach. Asset managers
  try to maximise expected return given a certain
  level of risk (Value at Risk). Esempio
• Low Risk VaR 3
• Medium Risk VaR 5
• High Risk VaR 10

Responsibility Private Banker / Asset Manager
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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 3 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 3 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 3 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 3 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 4 Portfolio Construction (Optimisation)

• 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 or tracking error, given the clients
  tolerance for risk (efficient frontier) and
  historical correlation between asset classes

Responsibility Quantitative Research Team
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Step 5 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 6 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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Asset Allocation and Portfolio Construction

• Portfolio has 3 components
• Capital Protection
• Currency, Short Term Bonds, Real Yields
• Financials instrumenst secuirity, ETF
• Core Market (Beta) Exposure
• Domestic and internationals equities, bonds,
  corporate, high yields
• Financials instruments ETF, Passive Funds, Long
  only
• Satellite Alfa Exposure
• Extra return vs markets
• Financials instruments Flexible funds, hedge
  funds, long short equities, multimanager,
  tactical asset allocation

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Asset Allocation and Portfolio Construction

• Strategic asset allocation
• Medium - Long Term wiews
• Change exposure into the Core Component equity
  vs Bonds, International equities vs Domestic
  Equities, Currency exposure
• Change the allocation between Core and Satellite
• Tactical asset allocation
• Short term wiews
• Change exposure into the Satellite Component Low
  Risk vs High Risk Funds, short term bets on some
  markets, etc.

Dynamic Optimisation between Core and Satellite
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Asset Allocation Total Return
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Asset Allocation Capital Protection
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Asset Allocation Market Exposure (Beta)
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Asset Allocation Satellite (Alfa)
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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 2006 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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Active aprroach 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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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