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TRANSCRIPT
Asset Allocation and Alternative InvestmentsPaul Moody – Head of Investment Development
Page 1
This document is for investment professionals only. The content is not to be viewed by or used with retail investors.
Please note
Page 2
Agenda
The importance of asset allocation
The problems with traditional approaches
Alternative assets
Commodities
Currency and tactical asset allocation overlays
Infrastructure assets
Private Equity
Hedge Funds
Page 3
Europe 25%
Europe 29%
Europe 22%
Europe 7%
Europe -1%
Europe 21%
Europe 37%
Europe -18%
Europe -32%
Europe 13%
N. America 29%
Asia Pac 84%
Property 11%
UK Credit 7%
Global FI 17%
Em Mkts 56%
Em Mkts 26%
Japan 45%
Em Mkts 33%
Em Mkts 66%
UK Credit 10%
Property 7%
Property 10%
Asia Pac 44%
Property 19%
Em Mkts 35%
Asia Pac 30%
World 25%
Japan 47%
O/S Govt 8%
O/S Govt 5%
UK Credit 9%
World 34%
World 15%
UK Credit 15%
Cash 5%
Cash 4%
O/S Govt 8%
N. America 30%
Asia Pac 27%
World 21%
UK Equity 14%
World 25%
Global FI 3%
Global FI 2%
Cash 3%
Japan 23%
UK Equity 13%
UK Equity 22%
Property 18%
Global FI 14%
UK Equity 24%
Em Mkts -2%
Em Mkts -6%
N. America 11%
Property 19%
UK Equity 17%
Property 12%
N. America 23%
UK Equity -6%
Asia Pac -4%
Asia Pac -14%
UK Equity 21%
Japan 11%
World 10%
N. America 7%
O/S Govt 9%
Property 14%
N. America -12%
N. America -12%
Japan -19%
Global FI 13%
Global FI 9%
UK Credit 9%
Japan 7.35%
Cash 6%
Cash 4%
World -13%
UK Equity -13%
World -20%
Property 11%
Asia Pac 7%
N. America -7%
Global FI 7%
Japan -9%
UK Credit 0.1%
Japan -20%
World -17%
N. America -22%
UK Credit 0.8%
UK Credit 7%
Cash 4%
Cash 4%
Asia Pac -9%
O/S Govt -1%
Em Mkts -31%
UK Equity -23%
Cash 3%
O/S Govt 5%
O/S Govt 4%
UK Credit 0.8%
Em Mkts -25%
Global FI -5%
Asia Pac -36%
Japan -19%
O/S Govt 2%
Cash 4%
Global FI -4%
O/S Govt 0.7%
Em Mkts 40%
Asia Pac 37%
World 10%
Global FI 9%
N. America 8%
UK Equity 5%
Cash 5%
O/S Govt 4%
UK Credit 0.4%
Property -5%
Japan -10%
N. America 29%
Asia Pac 84%
Property 11%
UK Credit 7%
Global FI 17%
Em Mkts 56%
Em Mkts 26%
Japan 45%
Em Mkts 33%
Europe 25%
Em Mkts 66%
UK Credit 10%
Property 7%
Property 10%
Asia Pac 44%
Property 19%
Em Mkts 35%
Asia Pac 30%
World 25%
Japan 47%
O/S Govt 8%
O/S Govt 5%
UK Credit 9%
World 34%
World 15%
Europe 29%
Europe 22%
UK Credit 15%
Europe 37%
Cash 5%
Cash 4%
O/S Govt 8%
N. America 30%
Europe 13%
Asia Pac 27%
World 21%
UK Equity 14%
World 25%
Global FI 3%
Global FI 2%
Cash 3%
Japan 23%
UK Equity 13%
UK Equity 22%
Property 18%
Global FI 14%
UK Equity 24%
Europe -1%
Em Mkts -2%
Em Mkts -6%
Europe 21%
N. America 11%
Property 19%
UK Equity 17%
Property 12%
N. America 23%
UK Equity -6%
Asia Pac -4%
Asia Pac -14%
UK Equity 21%
Japan 11%
World 10%
N. America 7%
O/S Govt 9%
Property 14%
N. America -12%
N. America -12%
Japan -19%
Global FI 13%
Global FI 9%
UK Credit 9%
Japan 7.35%
Cash 6%
Cash 4%
World -13%
UK Equity -13%
World -20%
Property 11%
Asia Pac 7%
N. America -7%
Global FI 7%
Japan -9%
UK Credit 0.1%
Japan -20%
World -17%
N. America -22%
UK Credit 0.8%
UK Credit 7%
Cash 4%
Cash 4%
Asia Pac -9%
O/S Govt -1%
Em Mkts -31%
Europe -18%
UK Equity -23%
Cash 3%
O/S Govt 5%
O/S Govt 4%
UK Credit 0.8%
Em Mkts -25%
Global FI -5%
Asia Pac -36%
Japan -19%
Europe -32%
O/S Govt 2%
Cash 4%
Global FI -4%
O/S Govt 0.7%
Em Mkts 40%
Asia Pac 37%
World 10%
Global FI 9%
N. America 8%
Europe 7%
UK Equity 5%
Cash 5%
O/S Govt 4%
UK Credit 0.4%
Property -5%
Japan -10%
50% Difference in 2007
Europe 29%
Europe 22%
Europe 7%
Europe -1%
Europe 21%
Europe 37%
Europe 25%
Europe -18%
Europe -32%
Europe 13%
Em Mkts 40%
Japan -10%
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Asset Allocation: Harder than it looks!
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Improve overall risk budget by combining less correlated assets
Our process considers the asset class returns, correlation and consequently the optimal mix
Correlation is the degree to which two assets have a tendency to move together ranging from (1) perfect correlation to (-1) perfect inverse correlation
Diversification benefits
+
Risk
Return
=
Risk
Return Return
Risk
Asset Class A Asset Class B Combined returns of asset class A + B
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Ontario teachers pension scheme
Source:Ontario teachers website
Page 6
The problems with traditional asset allocation approaches
Peer group benchmarks results in:
herd-like mentality with
constrained asset allocation
In practice this has resulted in over reliance on equities which:
creates problems because of volatility
Are rarely diversified across markets
inconsistent with regulatory valuation requirements
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Strategic Asset allocation has a major influence on investment performance
Asset allocation
Long-term return
forecasts
Risk-return target
Historic volatilities
Correlation of asset classes
Primary asset allocation inputs:
* Brinson et al., (1986 & 1991) referenced in J Annaert et al Journal of Banking and finance (2005) 661-680 and Blake et al., (1999) referenced in J Annaert et al Journal of Banking and finance (2005) 661-680
Evidence shows asset allocation contributes up to 95% of return variance*
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Creating optimal portfolios
Absolute Risk
Absolute Return
Bootstrap Frontier
Efficient Frontier
Emerging Markets
Cash
Emerging Markets
Cash
Other Assets
Page 9
So what are the main alternatives?
Commodities
Currency and tactical asset allocation overlays
Infrastructure assets
Private Equity
Hedge Funds
Page 10
Commodities
A consumption asset, not a financial asset
Access via commodity (index) futures/Exchange Traded Funds
Choice of index crucial
Gorton and Rouwenhorst (2006): commodities have historically provided:
equity returns at lower level of risk and with positive skew
diversification from equity returns
inflation hedge
Sources of return
spot prices driven by nominal GDP and demand/supply balance
backwardation and downward sloping futures curve: positive “roll”
Page 11
Most popular commodity indices: composition variations
Source: Thompson Financial constituents snap shot as at end-2007
69.4
10.8
2.4
12.8
4.7
33.0
18.5
9.1
30.2
9.2
0.0
20.0
40.0
60.0
80.0
Energy Industrial metals Precious metals Agriculture Livestock
% o
f ind
ex
S&P Goldman Sachs Commodity IndexDow Jones - AIG Commodity index
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Currency and tactical asset allocation overlay strategies
Currency management
TAA overlay
generate returns from long/short positions across global equity, bond and currency markets
exploits inefficiencies in asset prices resulting from:
investor sentiment such as excessive optimism or pessimism
structural anomalies such as legislation, tax or market habit
non profit-maximising market participants
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Infrastructure assets
Long term capital intensive projects that fulfil major social and/or economic needs
Increasingly PFI financed given public sector spending constraints
Economic infrastructure, eg utilities, toll roads
Social infrastructure, eg hospitals, prisons
As regulated natural monopolies/oligopolies offer bond-plus characteristics:
Relatively high and stable longer term inflation linked cash flows
High duration
Infrastructure assets are ideal for matching long dated liabilities
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Private Equity
What is it?
Venture capital funds: provide start up and development equity capital
Buyout funds:
buy into companies cheaply, restructure/change their business model, or
buy stake in quoted companies, act as friendly activist…
…and sell stake to the market or trade buyer at a sizeable profit
What is the objective?
generate a return in excess of that from quoted equity
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Private Equity has divergent performance
Performance derives from combination of asset class and skill set:
Buyout funds outperform venture capital funds*
Returns heavily skewed towards top performing funds*:
22.9% top quartile IRR
10.6% mean IRR
0.5% median IRR
Evidence of performance persistency*
Apparent diversification results from Private Equity values being booked at cost
Manager and strategy selection is crucial – increasingly accessed via fund-of-funds
* Net Pooled Returns for 279 Private Equity Funds formed 1980 - 2005. Source: Thomson Financial, European Private Equity and Venture Capital Association. 27 July 2006.
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Hedge Funds
What is a Hedge Fund?
Private limited partnership/unregulated pooled investment fund administered by professional investment managers
What do Hedge Funds seek to do?
Generate absolute returns, ie positive returns independent of market conditions
How?
By employing wide range of investment strategies, techniques andinstruments
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Hedge Funds
Are all hedge funds the same?
No agreed definition of what constitutes a hedge fund: very heterogeneous universe
Not an asset class: more of a skill set as low correlation between and within strategies
Most combine specific strategy with leverage to magnify returns - few are truly hedging market risk as name implies
Around 8,000 known hedge funds managing total assets c.$1.5tn –many others escape scrutiny
Originally for HNWIs: now institutional investors driving growth
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Optimised portfolio including fund manager skill
EM Equities
UK Property
Commodities
UK Equities
UK Gilts
UK CashReturn
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
2%
Risk
7% 12% 17% 22% 27% 32%
CAPS balanced managed
Optimised portfolio including fund manager skill
Alternative assets and
manager skill
Risk and return
Resulting in a highly diversified portfolio targeting equity-like returns for bond-like risk
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Lessons learned
Asset allocation is the main driver of investment returns
Unconstrained asset allocation makes sense
The are an ever increasing number of exotic and alternative asset classes
It makes sense to consider the widest array of asset classes
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Important notes
Except where stated as otherwise, the source of all information is Morley as at 31 May 2008.
Any future returns and opinions expressed are based on our internal forecasts and should not be relied upon as indicating any guarantee of return from an investment with Morley. No part of this document is intended to constitute advice of any nature nor should any part be construed as a recommendation to purchase or sell stocks.
Where past performance has been illustrated it is not intended to be a guide to the future.
When investing with Morley investors should be aware that the value of an investment and any income from it may go down as well as up. Investors may not get back the original amount invested.
Morley is a business name of Morley Fund Management Limited, registered in England No. 1151805. Registered Office: No. 1 Poultry, London EC2R 8EJ. Authorised and regulated in the UK by the Financial Services Authority and a member of the Investment Management Association.
Morley is also a business name of Morley Fund Services Limited and Morley Pooled Pensions Limited. All are Aviva companies.
Contact us at Morley Fund Management Limited, No. 1 Poultry, London EC2R 8EJ. MFM/MFM/08/xxx