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Investment Advisory in Today’s

Markets

Alexis Calla

October 31, 2012

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Important Information Disclaimer

• The presenter, Alexis Calla is the Global Head, Advisory and Investment

for Standard Chartered Bank. The views, opinions and information

reflected in this presentation are the presenter‟s own. Standard

Chartered Bank (including its branches, subsidiaries and affiliates) do not

necessarily share these opinions. This document is for informational

purposes only and no guarantees are offered as to its accuracy or

completeness. The information stated, opinions expressed and estimates

given constitute best judgment at the time of publication and are subject

to change without notice to you. Consequently, although this document

is provided in good faith, it is not intended to create any legal liability on

the part of SCB or the presenter. This document must not be forwarded

or otherwise made available to any other person without the express

written consent of the presenter.

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A different world…

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The advisory ecosystem is increasingly complex

• Post 2008, additional variables are playing a larger

role in the advisory process

Pre 2008 2009 and beyond

• In the years before 2008, the advisory lens was

focused on following markets and the investment

process.

Financial Markets

Financial Markets

Governments & Central

Banks

Regulation

Behavioral Bias

Tail Risks

?

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MARKET DYNAMICS

Part 1 -

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Market cycles have shortened

S&P500 vs. US economic surprises

• Higher volatility

• Higher correlation

• Shorter cycles

• Policy uncertainty has led to significant

market volatility, higher correlation

and has created much uncertainty.

• Unorthodox central bank policy

• Market riot – policy response cycle

• Regulation changes

• Markets have been responsive to

short-term economic surprises

Source: Bloomberg

Markets focusing on short term due to higher uncertainty

-150

-100

-50

0

50

100

600

800

1000

1200

1400

1600

Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09

S&P500 Citi US Economic Surprises Index

-150

-100

-50

0

50

100

1000

1100

1200

1300

1400

1500

Jan-10 Jun-10 Nov-10 Apr-11 Sep-11 Feb-12 Jul-12

S&P500 Citi US Economic Surprises Index

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A more volatile & correlated environment

Cross-asset returns correlation has gone up since mid-2008

• Since 2008

• Equity market volatility has gone up

• Credit market volatility has gone

down

• Correlation across asset classes

has gone up

• Rise in uncertainty a key reason for

structurally higher volatility

• Crisis-market riot-policy response

cycle has led to spikes in volatility

• Lower importance of asset class

fundamental factors

Source: Bloomberg

Higher uncertainty has raised market volatility and cross-

asset correlation

-0.2

-0.1

0

0.1

0.2

0.3

0.4

0.5

Equities-Bonds Equities-Commodities Bonds-Commodities

Pre-06/2008

Post-06/2008

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Financial markets have broadened & deepened

Local Currency securities issued by Asian countries

• Europe is fragmenting

East is broadening and deepening

• Economic growth has raised demand

for capital

• Financial markets outside the

developed world have deepened in

response

• Investors therefore have more

investment alternatives outside of

equities alone

• This has made greater diversification

of investor portfolios possible

• Asian credit market development over

the past decade a great example

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200

400

600

800

1000

1200

1400

1600

1800

2000

Mar.1987 Dec.1990 Sep.1994 Jun.1998 Mar.2002 Dec.2005 Sep.2009

Source: BIS

Total outstanding (USD bn)

Broadening & deepening of EM financial markets underway

• Asian corporate credit markets have deepened & broadened

• Asian FX markets have deepened in response to rising trade

• Asian equity markets display better sector diversification

• Greater ETF availability for regional assets

• Inflation-linked securities increasingly available

International debt securities issued by developing countries

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The disintermediation challenge

Banks

Structured Credit

Private Capital

Others?

Need for funding

(medium to high risk capital)

Investable

Money

• Banking systems across the globe are stretched

given recent credit crisis and stricter capital

requirements

• Post 2008, the structured credit market has dried

up

• Private capital is a source of funding but may not

be able to meet the entire funding need; also

limited to a certain pool of investors

• Is there a role for the retail investor in addressing

this funding gap? Level of due-diligence and

regulation are impediments to the small investor

entering this market

Can the retail investor help address the funding gap?

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A strategy for current markets

Risk On

Risk

Off

• Post 2008, policy intervention and political

uncertainty have pushed markets into “risk-

on”/”risk-off” cycles

• An option to tackle this environment is

implementing a barbell portfolio strategy

combining market beta from risk-on and risk-off

assets

• An alternative is to partially immunize the

portfolio by investing in assets that are less

affected by the risk-on/risk-off cycle i.e. neutral

beta.

• A refined version is to adopt a form of

immunization approach with the option to

tactically add risk-off and risk-on exposure.

• One could partially immunize the portfolio with

assets to shorten portfolio duration i.e.

dividend yielding equity and high yield bonds.

• Example of tactical positions include

CTAs/Volatility funds (Risk Off option) and US

Equity/Oil (Risk On option)

Barbell Approach 1

2 Portfolio Immunization

Assets

least

affected

by RORO

Risk Off Risk On

Immunize Immunize

3 Portfolio Immunization w/ tactical option

Assets

least

affected

by RORO

Risk Off Risk On

Tactical Tactical CTAs, Vol.

Funds

US Equity,

Oil

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Innovation: Portfolio & Product Construction

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EDHEC Survey on Portfolio Construction

• „Old paradigm‟ portfolio construction techniques being

revisited; innovation on the rise again

• Given elevated market volatility, a host of new techniques

being proposed – risk parity, alternative beta, equal-

weight portfolios, maximum diversification

• On the product side, a clear need for niche sources of

return. For example, underexplored sectors in Europe vs.

broad based European exposure.

• However, innovation challenged by investor sentiment

and regulatory developments

• Key question – is there appetite from regulators and in

the retail investor space for such innovation?

Key Ideas

Innovation is key, but how will it be received?

Source: EDHEC Risk, “A Long Road Ahead for Portfolio Construction:

Practitioners‟ Views of an EDHEC Survey”, (2009)

“Do you agree that the industry has to make progress on

integrating state-of-the-art portfolio optimization techniques?”

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OTHER FACTORS

Part 2 -

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Impact of regulation

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Client Suitability

• Post 2008, major focus on client suitability

• Suitability on three levels

• Portfolio risk

• Product risk

• Knowledge & Experience

Portfolio Advice

• Multiple models of portfolio advice based on

regulation

• Guidance varies depending on country regulator

• Universal portfolio model not applicable in Asia

Internal Process

• Governance function playing an increasingly

important role in advisory function

• Back-office costs, typically stemming from IT and

compliance, constitute 45% of the total cost base

(2011 Mckinsey survey)

Regulation – a key factor in nature of advice delivered

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New Developments in Behavioral Finance

The Geography of thought: How Asians and Westerners Think Differently...and Why – Nisbett (2003)

Individuals in the West think that

• World is comprised of discrete objects belonging to

categories (Greek philosophy)

• Rule-based approach, formal logic help explain and

predict behaviors

• Environment is organized

• Life is highly subject to personal control

• Contradiction lead to polarization of belief

Asians think that

• Holistic approach to a world that is full of context

• Relatively little use of categories and formal logic

• Importance of change, contradictions and multiple

perspectives

• Search for the middle way

• Environment is chaotic

• Life is subject to changes of fortune without notice

• Contradiction lead to moderation of belief

Queuing

Concept of Time

Talking

Child

Source: Yang Liu, “East meets West” (2007)

Behavioral finance theory generally oriented towards the Western

mindset – what about Asian behavioral finance?

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Building TRUST

HNW Client Trust Levels (2008-2010)

Trust in firms and advisors increasing over time

Source: Capgemini/Merrill Lynch World Wealth Report“, (2011)

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Concluding thoughts

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• High correlation, bouts of volatility remain a reality

• Innovation needed but key players skepticism need to be overcome

• Solutions should be theoretically sound while addressing investor

biases

• Challenges & opportunities go beyond macro-finance uncertainties

• Trust is being rebuilt

Thank You