CC-BY-SA-2.0, FlickrPhoto: Scott Hudson. Risk Budget: Spend It Wisely
For those who budget, time is an asset. Wise spending decisions often take longer to bear fruit. Committing to a budget long-term could potentially lower one’s debt and improve their cash flow. Blow the budget with short-sighted spending decisions, however, and what might have been a good financial outcome turns undeniably less certain.
Similarly, an active manager’s risk budget—how and where they decide to “spend” or allocate risk —directly impacts their potential to outperform. In fact those spending decisions are a critical component of active risk management. In budgeting risk, an active manager essentially identifies, quantifies and sets their active risk allocations as efficiently as possible. The end goal is to maximize the potential reward for the amount of risk taken.
Just as in personal budgeting, there are tradeoffs to risk budgeting — deciding to spend in one place sacrifices the ability to spend in another. So those spending decisions must be meaningful — and purposeful. For an active manager, that’s a matter of understanding the idiosyncratic risks of individual securities, seeing the potential upside and recognizing the potential downside. The idea is not to take unintended risks.
What are some of the risk budgeting decisions an active manager might make? In more difficult markets, where active managers can play to their strengths, they might choose not to own the largest stocks, which, historically haven’t grown as fast through a market cycle. Or, an active manager might try to position away from some of the most expensive parts of the market, which have often become overextended in the days leading up to market peaks. They might also position away from the most volatile parts of the market, which typically haven’t performed as well through a full market cycle. In fact part of an active manager’s potential to outperform depends on their ability to mitigate the impact of volatility by reducing the downside risk at the security level. That’s why it’s so important to integrate risk management into the investment process, all the way down to the analyst level and in the evaluation of individual companies.
Much like personal budgeting, risk budgeting needs time to come to fruition. It’s not something that can be turned off or on but rather, a process that relies on discipline and a long-term, forward looking view. Active managers budget risk based on what they think could happen, not just on what has happened. But that’s really where spending wisely could have its greatest opportunity –sacrificing a little now to potentially get closer to what you might need further out.
Photo: Tarek Saber, Head and Lead Portfolio manager of the Convertible Bonds Team at NN Investment Partners. Tarek Saber, from NN Investment Partners, brings the current state of convertible bonds to the Fund Selector Summit in Miami
Convertible bonds are a well established asset class which has outperformed through the cycle over the last 40 years. During this time, convertibles have displayed lower volatility than equities and fewer defaults than high yield debt. The main attraction of this investment class is its potential ability to generate returns from both credit markets and rising equity markets.
Tarek Saber, Head and Lead Portfolio manager of the Convertible Bonds Team at NN Investment Partners, will present the strengths of the Dutch firm’s strategy in this asset class, under the title, ‘Convertible bonds: the fixed-income alternative to equities’, at the Second edition of the Funds Selector Summit to be held in Miami on the 28th and 29th of April.
The conference, aimed at leading funds selectors and investors from the US-Offshore business, will be held at the Ritz-Carlton Key Biscayne. The event-a joint venture between Open Door Media, owner of InvestmentEurope, and Fund Society- will provide an opportunity to hear the view of several managers on the current state of the industry.
The NN Investment Partners’ convertible investment strategy team, headed by Saber since 2014, seeks to capture the essence of the opportunities offered by the market for convertible bonds globally, focusing on balanced convertibles, backed by a process of in-depth research and concentrated on a select number of convertibles.
Prior to joining NN IP, Tarek Saber was CEO / CIO for Avoca Convertible Bond Partners LLP and Head of Convertible Bond Strategies in the management company’s London office.
You can find all the information about the Fund Selector Miami Summit 2016, aimed at leading fund selectors and investors from the US-Offshore business, through this link.
CC-BY-SA-2.0, FlickrPhoto: Carlos ZGZ. Merging Markets
Despite a slowdown in trade globalisation, it looks like equity markets are more globalised than ever. When one market falls, the contagion quickly spreads to bring the others down as well. This is a change from the past. In the old way of thinking about the world, the US sneezed and the world caught a cold. The S&P 500 was always viewed as the leading indicator for global equity markets. But the perception since last summer is that it is the Chinese equity market that is doing the sneezing.
Figuring out whether a drop in one equity market causes a drop in another is a tricky task. Just because the fall of one equity market is followed by a fall in another, does not necessarily mean that the first caused the fall in the second. To assume so would make you guilty of the logical fallacy of post hoc ergo propter hoc, or “after therefore because of”. There could always be a third factor that is driving both equity markets down, but it so happens that the effect has fed through to one market earlier than the other. But given we can never test everything, there will always be the possibility of a third factor that we did not include.
That is why proper science (as opposed to the dismal science of economics) is based on the idea that you can never prove anything, only disprove something. And here at least economics, or more precisely, econometrics, can help us out. We can figure out if one equity market is good at predicting changes in another equity market. This is known as predictive causality (using a test named after the late Nobel-prize winning economist Clive Granger). If changes in one market are useless at predicting the change in another market, we have at least disproven the causality. If it is useful, then we have failed to disprove the causality (even if we cannot ever prove it).
Things get a bit more confusing when we realise that the causality can actually run in both directions. So a drop in the Chinese equity market might be predictively causing a drop in the US equity market, yet at the same time there is a feedback loop whereby US equities are predicting subsequent moves in the Chinese equity market. As so often in economics, it is hard to figure out whether the chicken or the egg came first.
Sure enough, over the last decade or so the S&P 500 and the Shanghai Composite have both predictively caused moves in each other (see chart), sometimes at the same time. Some correlation is always likely, so readings above 80% probability or so start to become statistically significant (shaded darker). Between 2003 and 2005 the two moved pretty much independently, and then moves in the S&P 500 started to affect the Shanghai composite. The run-up in US equities was good at predicting a subsequent run-up in Chinese equities (albeit with a much larger proportional increase in China).
But then coming into late 2007 and 2008 it was China’s turn to take the driver’s seat, becoming a good predictor of the US. Once the financial crisis hit the causality went both ways, reflecting the global nature of the crisis.
But for the next few years, up until the end of 2011, the S&P 500 was clearly dominant. It was an effective predictor of Chinese equities (and probably most other markets as well). But this is a good example of where a third factor likely came into play. This was the period when the Fed started its quantitative easing, pushing investors out of government bonds and triggering a search for yield. So investors moved into progressively riskier assets: first US equities and then emerging market equities.
Equity markets started to reassert their independence up until the taper tantrum. Once Fed chair Ben Bernanke announced that QE would not continue forever, the effects of QE on investment appetite went into reverse. Investors started to retreat from emerging market equities first, so the causality flipped the other way. Chinese equities became a better predictor of US equities.
Since last summer the gyrations of the Chinese equity market became a clear predictor of what would happen in the US. This does not necessarily mean it was the only factor, or even the major factor, just simply that it led the moves in the US. Ask most investors and they will tell you that China is the dominant factor.
There may be some good reasons for this. Firstly, the Chinese economy has been growing rapidly (even if it has slowed down) so it is an ever larger share of the world economy. Secondly, equity markets are very often dominated by global firms who earn revenues from many other markets. So US firms with large exports to China should be reacting to downturns in China (that is, assuming Chinese equity markets are representing the real economy, which is another question entirely). Lastly, the weakness in the equity market brought about a depreciation in the CNY against the USD, even as the People’s Bank of China had to expend a lot of reserves to prevent too rapid a depreciation. Not only is currency depreciation likely to be bad for US exports to China, but the selling of reserves constitutes a substantial capital outflow, which is bad for financial markets.
But one consequence of the closer links between the Chinese equity markets and the US equity markets is that the US equity market is, almost by definition, telling us less about the US economy. The equity markets may merging, but that does not mean the economies are.
Joshua McCallum and Gianluca Moretti are part of the Fixed Income team at UBS Asset Management.
Photo: Aranjuez1404, Flickr, Creative Commons. Pamplona Capital Appoints Pedro Rapallo as Operating Partner Focused on Iberia
Pamplona Capital Management is pleased to announce the appointment of Pedro Rapallo as an Operating Partner in order to supplement its deal team and support its focus on the Iberian Peninsula. In this new position, Pedro, along with the Pamplona Capital team, will drive new investment opportunities in Spain and Portugal.
“Pedro brings a wealth of local knowledge and expertise in Spain and Portugal and a large experience in the global financial services industry. Pedro’s insight will be invaluable for Pamplona Capital as we increase our focus on investment opportunities in Iberia,” said John Halsted, Managing Partner at Pamplona Capital.
Pedro Rapallo brings 20 years of business and consulting experience to Pamplona Capital. Most recently, Pedro was a Partner and Managing Director at The Boston Consulting Group, with a focus on financial services in Iberia and wholesale transactional banking globally. Prior to joining The Boston Consulting Group, Rapallo worked for Oliver Wyman as a Partner in their financial services team focusing on corporate strategy, wholesale banking and risk and capital management, and was a visiting scholar at the Department of Economics at the University of California San Diego.
A native of Madrid, Spain, Rapallo holds bachelor degrees in Law and Business Administration from the Universidad Pontificia de Comillas, and a Masters and C.Phil. in Economics from the University of California, San Diego.
Pamplona Capital Management is a London and New York based specialist investment manager established in 2005 that provides an alternative investment platform across private equity, fund of hedge funds and single manager hedge fund investments.
Pamplona Capital Management, LLP manages over USD 10 billion in assets across a number of funds for a variety of clients including public pension funds, international wealth managers, multinational corporations, family offices and funds of hedge funds. Pamplona is currently managing its fourth private equity fund, Pamplona Capital Partners IV LP, which raised $4 billion in 2014. Pamplona invests long-term capital across the capital structure of its portfolio companies in both public and private market situations.
CC-BY-SA-2.0, FlickrPhoto: Janus Capital. Bill Gross: “Don’t Go Near High Risk Markets, Stay Safe and Plain Vanilla”
The BoJ’s surprise move to take interest rates into negative territory this month helps Bill Gross continue its case against ultra-low interest rates policies. “How’s it workin’ for ya?” He writes in reference to central bankers.
The US Federal Reserve, the European Central Bank and the Bank of Japan, “they all seem to believe that there is an interest rate SO LOW that resultant financial market wealth will ultimately spill over into the real economy. I have long argued against that logic and won’t reiterate the negative aspects of low yields and financial repression in this Outlook. What I will commonsensically ask is ‘How successful have they been so far?’… The fact is that global markets and individual economies are increasingly ‘addled’ and distorted,” says the former Bond King at PIMCO and now part of Janus Capital Group.
In its February’s outlook, Gross lists the main distortions of recent monetary policy:
Venezuela – bankruptcy just around the corner due to low oil prices and policy mismanagement. Current oil prices are (in significant part) a function of low interest rate central bank policies over the past 7 years.
Puerto Rico – default underway due to overspending, the overpromising of retirement benefits, and the inability to earn adequate investment returns due to ultra-low global interest rates.
Brazil – in deep recession due to commodity prices, government scandal and in this case, exorbitantly high real interest rates to combat the effect of low global interest rates, and currency depreciation of the REAL. No country over time can issue debt at 6-7% real interest rates with negative growth. It is a death sentence. In the interim, the monetary authorities deceptively issue, then roll over more than a $100 billion of “currency swaps” instead of selling dollar reserves in an effort to hoodwink the world that there are $300 billion of reserves to back up their sinking credit. This maneuver effectively costs the government 2% of GDP per year, leading to the current 9% fiscal deficit.
Japan – 260% government debt/GDP and climbing sort of says it all, but there’s a twist. Since the fiscal (Abe) and the monetary (Kuroda) authorities are basically one and the same, in some future year the debt will likely be “forgiven” via conversion to 0% 50-year bonds that effectively never come due. Japan will not technically default but neither will private investors be incented to make a bet on the world’s largest aging demographic petri dish. I’m tempted to say that “Where Japan goes – so go we all”, but I won’t – it’s too depressing.
Euroland – “Whatever it takes”, “no limit”, what new catchphrases can Draghi come up with next time? It’s not that there’s a sufficient recession ahead, it’s just that the German yield curve is in negative territory all the way out to 7 years, and the shaky peripherals are not far behind. Who will invest in these markets once the ECB hits an effective negative limit that might be marked by the withdrawal of 0% yielding cash from the banking system?
China – Ah, the dragon’s mysteries are slowly surfacing. Total debt/GDP as high as 300%; under the table capital controls; the loss of $1 trillion in reserves to support an overvalued currency; a distorted economic model relying on empty airports, Potemkin village housing, and investment to GDP of 50%, which somehow never seems to transition to a consumer led future. Increasingly, increasingly addled.
U.S. – Well now, the U.S. is impervious to all this, is it not? An 85% internally generated growth model that relies on consumption which in turn, relies on job growth and higher wages, all of which seems to keep on keepin’ on. Somehow, though, even the Fed seems to have doubts, as in last week’s summary statement, where for the first time in 15 years they were unable to assess the “balance of risks”. “We need some time here to understand what is going on”, says Kaplan from the Dallas Fed. Shades of 2007. The household sector has delevered, but the corporate sector never did, and with Investment Grade and High Yield yields 200-1000 basis points higher now, what does that say about future rollover, corporate profits and solvency in many commodity-sensitive areas?
“Our finance-based global economy is transitioning due to the impotence of monetary policy which has always, and is now increasingly focused on the elixir of low/negative interest rates. Don’t go near any modern day Delos Romans; don’t go near high risk markets, stay safe and plain vanilla. It’s not predetermined or guaranteed, but a more prosperous outcome should be somewhere around the corner if you do.” He concludes.
CC-BY-SA-2.0, FlickrPhoto: Tambako The Jaguar. Lyxor Named “The Leading UCITS Hedge Fund Platform”
Lyxor was named “The Leading UCITS Hedge Fund Platform” at the Hedge Fund Journal Awards 2016 held in London last week. This accolade highlights Lyxor’s outstanding accomplishments in the field of Alternative UCITS.
By the end of 2015, Lyxor grew its assets under management to $2bn across 8 alternative UCITS fund and is the 6th largest provider of Alternative UCITS funds. Lyxor’s Alternative UCITS Platform achieved a progression in assets of more than 30% vs. 2014 (and 450% vs. 2013). HFM Week also recently distinguished Lyxor as the 3rd platform with the highest growth in the industry last year (with net new assets of $504m in 2015).
Since the end of 2014, Lyxor has expanded its Alternative UCITS range with the launch of several new managers, including Capricorn Capital Managers with a long/short equity program focusing on global emerging markets, Chenavari’s European-focused long/ short credit strategy, and Och-Ziff with a Long/Short US equity fund. The firm is eyeing the addition of a further managers in 2016 and will look to add strategies that are currently not present or under-represented on the platform
. Julius Baer Announces Final Settlement with the U.S. Department of Justice Regarding its Legacy U.S. Cross-Border Business
Julius Baer announced that it has reached a final settlement with the DOJ in connection with its legacy U.S. cross-border private banking business. This settlement is the result of Julius Baer’s proactive and long-standing cooperation with the DOJ’s investigation. The two Julius Baer employees indicted in this context in 2011 have also taken an important step towards a resolution of their cases.
Julius Baer has entered into a Deferred Prosecution Agreement pursuant to which it will pay USD 547.25 million. In anticipation of the final resolution, the Group had already taken provisions in June and December 2015, totalling this amount, and booked them to its 2015 results.
In announcing the settlement, Daniel J. Sauter, Chairman of Julius Baer, commented: “Julius Baer’s ability to reach this final settlement with the U.S. Department of Justice is the result of its constructive dialogue and cooperation with U.S. authorities. I would like to thank all our employees, clients and shareholders for their ongoing trust and support.”
Boris F.J. Collardi, CEO of Julius Baer, added: “Being able to close this regrettable legacy issue is an important milestone for Julius Baer. The settlement ends a long period of uncertainty for us and all our stakeholders. This resolution allows us now to again fully focus on the future and our business activities.”
Wikimedia CommonsPhoto: Wes Sparks, Head of Credit Strategies and Fixed Income at Schroders. Wes Sparks, of Schroders, Will Discuss High Yield Bond at the Funds Selector Summit 2016
Continuing volatility and elevated risk premiums mean that high yield bond returns in 2016 could be in the mid single-digit range; however, Wes Sparks, Head of US Credit Strategies and Fixed Income at Schroders, believes that the asset’s expected performance will continue to make it attractive in relation to many other fixed income alternatives.
Wes Sparks will be discussing this market’s expected performance at the second edition of the Fund Selector Summit on the 28th and 29th of April. The meeting, aimed at leading fund selectors and investors within the US-Offshore business, will be held at the Ritz-Carlton Key Biscayne.
The event, a joint venture between Open Door Media, owner of InvestmentEurope, and Funds Society, provides an opportunity to hear several management companies’ view on the industry’s current issues. During his presentation, Sparks will also give his views on global corporate debt market, on which he is an expert following 22 years in the industry.
Wes Sparks is based in New York, leading the US team responsible for all of Schroders’ investment-grade and high yield credit portfolios. He is the lead fund manager for Schroder ISF Global High Yield, a position he has held since the inception of the fund in 2004, and is additionally a co-manager for Schroder ISF Global Corporate Bond and various US Multi-Sector funds.
Sparks joined Schroders in 2000 from Aeltus Investment Management (1999 to 2000) and Trust Company of the West (1996 to 1999), where he worked as Vice President and Portfolio Manager with the corporate sector.
You will find all the information regarding the Fund Selector Summit Miami 2016, which is aimed at leading fund selectors and investors within the US-Offshore business, in this link.
CC-BY-SA-2.0, FlickrPhoto: Stefan Krause, new Portfolio Manager at Schroders. Schroders Strengthens Convertible Bond Team with New Hire
Schroders is pleased to announce the hire of Stefan Krause in the role of Portfolio Manager in its convertible bond team based in Zurich. Stefan will work alongside Peter Reinmuth as co-manager of the Schroder ISF Global Conservative Convertible Bond.
Stefan joins Schroders from Man Investments (CH) AG where he was responsible for managing the Man Convertibles Europe Fund. Prior to joining Man in 2012, Stefan spent two years with Warburg Invest in Hamburg as a portfolio manager for European convertibles and almost five years with UBS in Zurich. Stefan holds a Master’s in Business Administration from the University of Zurich.
The hire coincides with the first anniversary of Schroder ISF Global Conservative Bond, in which the fund has achieved strong performance against the benchmark and peers, and continues to see positive inflows. The fund aims to provide capital protection and growth within volatile markets by investing in high quality convertibles with an average credit quality of investment grade at all times. The conservative approach emphasises protective elements of convertibles, focusing on above-average downside protection.
With a team of eight specialists, Schroders convertible bond team manages three dedicated investment strategies: global opportunistic, global conservative and Asian convertible bonds.
CC-BY-SA-2.0, FlickrPhoto: Helfrain. Japan Lowers Its Rates into Negative Territory: the Currency War Intensifies and Gives Wings to Short-Term Equities
In a surprise move, the Bank of Japan decided on Friday to join the ECB’s strategy and cut interest rates by 20 basis points, taking rates into negative territory at -0.1% (from the previous + 0.1%) for deposits of financial institutions at the central Japanese bank. The experts are divided: the news will help the markets and an economy with great export weight, but accentuates the currency war spiral to capture very modest overall growth and finally, the consequences may not be as promising.
The adoption of a negative rate helps the Bank of Japan to fight deflation by reducing financial costs, in an attempt to breathe some life into Abenomics, the government’s major plan to revive the economy. The Bank of Japan, which blames oil prices for persistently low inflation in the country, adds this new measure to its program of quantitative easing which involves the annual purchase of 80 trillion yen in assets.
In response, the yen fell sharply against the dollar and other reference currencies like the euro, fueling a currency war which though undeclared, continues to cause panic in the trading rooms of half the financial sector.
In the press conference following the decision, the Bank of Japan’s Governor, Haruhiko Kuroda, stated that he does not rule out expanding the quantitative easing program, which could even include further cuts to increase the dip into negative territory.
“As such this challenges our previous outlook and as a result we are stepping back from some of our long yen currency positions as we reassess the absolute and relative policy stances of developed market central banks,” explained Kevin Adams, Director of Fixed Income atHenderson Global Investors.
Meanwhile, despite the rise in stock markets and debt, Keith Wade, Chief Economist and Strategist at Schroders, believes that the decision is caused by weakness and increases the risk that China may retaliate by further depreciating its currency.“If so, we will have entered a new phase in the currency wars where countries fight over a limited amount of global growth, an outcome which does not bode well for risk assets,” Wade points out.
Equities and fixed income
For Simon Ward, Henderson’s Chief Economist, it is more likely that the move is interpreted by the market as a negative signal for economic prospects, and as evidence of “Bank of Japan’s desperation”. This, claims Ward, will cause the market to be more, rather than less, risk-averse.
In the short term, however, the Bank of Japan has become the investors’ best friend. Japanese stocks rose on Friday and analysts agree that they are likely to continue rising in the short term. Robeco’s portfolio of international equities, Robeco Investment Solutions, is overweight in Japan. “We will obviously continue with this strategy. Our position has been strengthened by the decision of the Bank of Japan,” says Leon Cornelissen, Chief Economist at the firm.
“We believe that the surprise announcement is likely to have an incrementally positive effect on the outlook for Japanese equities, as it tempers the recent concern around the drag of a stronger yen on earnings. We maintain the view that Japanese stocks could withstand a moderate appreciation of the yen,” explains the team at Investec’s multi-asset strategies.
Regarding fixed income, Anjulie Rusius, from the Retail Fixed Interest team at M & G, pointed out that the move by the Japanese central bankhas been supportive of Japanese government bonds, alongside those of other countrieswhich have also adopted negative rate regimes, in a movement which could be repeated in the medium term.
