Risk Factor Investing in a Multi Asset Contextmedialibrary... · * Momentum: Equal -weighted ......

Risk Factor Investing in a Multi Asset ContextPromise or real solution?

Christian Hille, Global Head of Multi AssetOctober 21, 2016

Christian HilleRisk Factor Investing in a Multi Asset Context – Promise or a real Solution?

Deutsche Asset Management

In the past, smart diversified multi asset beta……took you a long way down the road – De-bundling of returns in the new regime

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Hedge Funds ***

World Market Portfolio (40:60) ****

Alpha or Beta? Absolute or Total-Return? Hedge fund “alpha” demystified

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2010 2011 2012 2013 2014 2015 2016World Market Portfolio (20:80) * Money Market** + 300bpMoney Market** + 400bp

Annualized return 6.1%Volatility 2.9%

Average annual max.drawdown 2.3%

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annual returnannual max. DD

*** Hedge Fund Research HFRI Fund Weighted Composite Index in USD.**** 40% MSCI World in USD, 60% Barclays Global-Aggregate USD hedged. Annual rebalancing.Time Period: Jan 03, 2000 – Jun 30, 2016. Source: Deutsche Asset Management Investment GmbH.

* 20% MSCI World in EUR, 80% Barclays Global-Aggregate EUR hedged. Annual rebalancing.** EONIA Total Return IndexTime Period: Jan 04, 2010 – Jul 29, 2016. Source: Deutsche Asset Management Investment GmbH.

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rolling 1-year return



Search for diversification in the new market regime……as the rates super-cycle is coming to an end

Diversification tailwind over past 15 years…

* Data based on Bloomberg Barclays Global Aggregate Index. As of Oct 7, 2016. Source: Deutsche Asset Management Investment GmbH, Bloomberg. For illustrative purposes only.Source: Datastream, GFD, Shiller, Goldman Sachs Global Investment Research. As of October 2016.

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Correlation S&P 500 vs. 10Y UST (lhs)

Annual return of US Multi Asset portfolio (60% bonds, 40% equities, rhs)

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Ø Return 2001-2016

Predominantly positive Correlation Predominantly negative Correlation

…and negative convexity in fixed income now

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Need for strategies with better diversification. The hurdle-rate is low right now, with $11trn negative yielding assets.

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NPV of a $1 perpetuity:Limited diversification and high negative Convexity,

while $10.7 trillion of fixed income assets are trading at zero yield or below*



Can we build better multi asset portfolios?…and achieve diversification while not compromising return

Correlation properties of risk factors Adding the right factor can create a better portfolio

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Balanced Style Basket Carry Value Volatility MomentumBalanced allocation (from left to right, all in EUR): S&P 500, MSCI Europe, MSI Japan, MSCI Asia Pacific ex Japan, MSCI EM Latin America, Barclays US Treasury 5-7, JP Morgan EMBI Global, BofA Merrill Lynch US Corp Master, BofA Merrill Lynch Euro HY, BofA Merrill Lynch US HY, Hedge Fund Research HFRI Fund Weighted Composite, Bloomberg Commodity ex-Agriculture and Livestock, UBS Thomson Reuters Global Focus Hedged Convertible Bond Index. * Momentum: Equal-weighted basket of JP Morgan Momentum Strategies, unfunded and cash reinvested at money market rate (EONIA Total Return Index).Source: Deutsche Asset Management Investment GmbH. For illustrative purposes only.

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Balanced MA Balanced MA + Momentum basket

EQ - US

EQ - EU

EQ - JP

EQ - Asia

EQ - LA FI -

US Sov.

FI - EM

FI - US IG

FI - EU HY

FI - US HY

Alt. - HF Alt. - Comm.

Alt. - Conv.

Risk Factors (Momentum)*

Annualized return 6.1%

Volatility 8.2%

Information Ratio 0.75Average annualdrawdown 9.6%

Combining a balanced MA portfolio with a basket of Momentum risk factor strategies

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Annualized return 5.5%

Volatility 3.9%

Information Ratio 1.38Average annualdrawdown 4.2%

Top Chart: Time period: Jan 02, 2006 – May 10, 2016. 1y-rolling correlations to MSCI World, Style and equal-weighted sub baskets based on 14 JP Morgan Diversified Risk Premia Strategies,.Bottom chart: Time period: May 18, 2011 – May 10, 2016. Average 1y-rolling pairwise correlations of single JP Morgan Diversified Risk Premia Strategies (Styles) and of traditional risky asset classes in the balanced portfolio (EQ sub asset classes, FI HY, FI EM) respectively.Source: Deutsche Asset Management Investment GmbH. For illustrative purposes only.

Avg. Correlation of Style Factors

Avg. Correlation traditional Risky AC

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The role of risk factorsSmart beta vs. smart alpha

Macro factors determine levels, style factors determine dispersion Smart Beta vs. Smart Alpha

Diversify across smart β factors within the EQ bucket (instead of EQ regional and

sector allocation)Risk factors as smart α, but key β diversifier

Risk free rate

Interest rate

premium

Inflation premium

Economic growth

premium

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Average Stock

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Avg Value Stock

Avg Growth Stock

Equity Market Level

Macro Factors

− Economic Growth− Credit− Inflation− Real rates− Liquidity− Emerging

Markets

Style Factors− Value− Momentum− Quality

− Size− Low Volatility− Carry− Curve Growth

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Value (Cheap) Value Tilt

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Source: Blackrock. For illustrative purposes only.Source: AQR Capital Management. „Style Investing. Can a Good Thing Last?“, May 2016.For illustrative purposes only.

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Fixed IncomeAlternatives

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Risk factor

Building risk factor baskets (1/2)What is the right choice of factors, asset classes and portfolio construction techniques?

Risk Factor Map Portfolio construction techniques

Selection of JP Morgan Diversified Risk Premia Strategies. List of asset classes, styles and strategiesis not conclusive.Source: Deutsche Asset Management Investment GmbH, JP Morgan. For illustrative purposes only.

Source: Bank of America Merrill Lynch. Risk ‘n mix – The what, why & how of Cross asset Risk factorinvesting, Mar 07, 2016.

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Carry ValueMomentum

Equal Vol (EV)

Equal Tail Vol

Equal RiskContribution

Min Variance

Most Diversified

Min correlation

Equal Return

Equal Max Drawdown

Max Sharpe Black-

Litterman

VolatilityCorrelation

Return

Fixed Weight

CapitalisationWeight

𝑤𝑤𝑖𝑖 � 𝜎𝜎𝑖𝑖 = 𝑤𝑤𝑗𝑗 � 𝜎𝜎𝑗𝑗,∀𝑖𝑖, 𝑗𝑗

Equal weight(EW)

𝑤𝑤𝑖𝑖 = 𝑤𝑤𝑗𝑗,∀𝑖𝑖, 𝑗𝑗

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EQ

• Fundamental• Cross-sectional• Time-series EQ Carry Basket

FIFX Global FX Carry

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m.

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Equity Value

Equity QualityEQ Rel. Momentum

FI Carry Basket

Rates Rel. Momentum

Credit Abs. Momentum

FX Abs. Momentum

Commodity Carry Commodity ValueComm. Momentum



Building risk factor baskets (2/2)Many different choices, but does it actually matter?

Baskets of J.P. Morgan Diversified Risk Premia Strategies (18 single risk factor strategies in 4 factor styles and 5 asset classes). Weighting schemes: EWx: Equal Weight, EVx: Equal Volatility. Weighting level: xxS: weighting of single strategies, xxA: weighting of asset classes, xxF: weighting of factor styles.Time period: Jan 03, 2006 – Jul 29, 2016. Source: JP Morgan, Deutsche Asset Management Investment GmbH.

EWS EVS EWA EWS

EWF EWS

EVA EWS

EVF EWS

EWA EVS

EWF EVS

Total Performance 54,0% 50,1% 49,1% 54,5% 49,7% 55,7% 46,8% 50,8%

Performance p.a. 4,2% 3,9% 3,8% 4,2% 3,9% 4,3% 3,7% 4,0%

St.Dev. of Perf. 2,2% 1,7% 2,3% 2,3% 2,1% 2,2% 2,0% 2,0%

Information Ratio 1,92 2,24 1,70 1,80 1,83 1,94 1,87 2,01

Downside Deviation 1,6% 1,2% 1,6% 1,7% 1,5% 1,6% 1,4% 1,4%

Sortino Ratio 2,68 3,16 2,40 2,48 2,58 2,70 2,63 2,75

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EWS EVS EWA EWS EWF EWSEVA EWS EVF EWS EWA ERS EWF ERS

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Risk factor baskets, built using alternative portfolio construction techniques

Different permutations to build a risk factor portfolio … and small differences in the long-term outcome

Despite fundamentally different approaches to build multi risk factor baskets, the resulting portfolios do not exhibit significantly different risk-return properties

1 choosing the right, complementary principal factors to achieve a defined purpose

Once you combine a defined number of orthogonal factors, there is little value add from doing more. Rather focus on factor PCA1 as well as individual factor definition and construction



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Equity Value factors in US(relative to MSCI US)

MSCI US Value Price / Book Dividend Yield FCF Yield

Risk factors are not genericFactor definition and construction matter

How is the Value factor defined and constructed? Does Value behave differently across regions?

Factor baskets for each of the three sub-factors are based on top-50 ranked stocks. Stocks are sector normalized, so that portfolio sector representation is comparable to the benchmark sector representation. Monitored as Excess Returns (i.e. portfolio returns - Benchmark Returns). Benchmark is the Total Returns Index for Europe / US. Time Period: Mar 31, 1994 – Sep 30, 2016 (Europe), Dec 31, 1993 – Sep 30, 2016 (US). Source: JP Morgan, Deutsche Asset Management Investment GmbH.

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Equity Value factors in Europe (relative to MSCI Europe)

MSCI Europe Value Price / Book Dividend Yield FCF Yield

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What you see is what you get? (1/2)Select the right strategy for the right purpose

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Momentum vs. Carry Strategies Distribution in the tails matters

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2007 2008 2009 2010 2011 2012 2013 2014 2015Momentum Carry World Market Portfolio

Distribution within worst quintileMomentum Carry

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Momentum: Basket of equal-weighted JP Morgan Diversified Risk Premia Strategies capturing the momentum premia of single and cross assets, Carry: Short put strategy, i.e. writing (10% of notional daily) of97.5% OTM 2W puts on S&P 500, World Market Portfolio: Equal weighted basket of global equities (MSCI World in EUR) and global bonds (Barclays Global Aggregate Index hedged to EUR). Time period: Sep 21, 2007 – Aug 31, 2016. Source: JP Morgan, Bank of America Merrill Lynch, Deutsche Asset Management Investment GmbH.

Momentum Carry

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Distribution within best quintile



No cointegration in terms of drawdown … … and complementary risk-return distributions

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Momentum Carry World Market Portfolio

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Calmar Ratio

Momentum Carry

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Momentum: Basket of equal-weighted JP Morgan Diversified Risk Premia Strategies capturing the momentum premia of single and cross assets, Carry: Short put strategy, i.e. writing (10% of notional daily) of97.5% OTM 2W puts on S&P 500, World Market Portfolio: Equal weighted basket of global equities (MSCI World in EUR) and global bonds (Barclays Global Aggregate Index hedged to EUR). Time period: Sep 21, 2007 – Aug 31, 2016 (left chart), Sep 17, 2008 – Aug 31, 2016 (right chart).Source: JP Morgan, Bank of America Merrill Lynch, Deutsche Asset Management Investment GmbH.

1yr Return / 1yr Max Drawdown (rolling)

What you see is what you get? (2/2)Select the right strategy for the right purpose ... and understand its distribution



Key take-aways

A special thanks to Peter Warken and Yannic Hegers who have been instrumental preparing this work.

Risk factor strategies can add value in a Multi Asset context• as portfolio building blocks, not stand-alone• as an alternative diversifier or as complementary alpha or betaThink and manage portfolios in terms of ‘risk and factor allocation’Don’t spend too much time on constructing large, seemingly ‘smart’ baskets of factors• …and don’t try to time the factor market*Better understand• single factor definition, construction and its distribution properties• Keep it simple and clear, understand the key drivers of performance and riskRemember• Nothing is ‘absolute’, a lot is relative…• …in particular wealth and performance are relative

* "Timing the market is a fool's game, whereas time in the market is your greatest natural advantage.“, Nick Murray.



Important information

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© October 2016 Deutsche Asset Management Investment GmbH

Deutsche Asset Management & Deutsche Bank Wealth Management (Deutsche Bank WM) represent the asset management and wealth management activities conducted byDeutsche Bank AG or any of its subsidiaries. Clients will be provided Deutsche Asset Management & Deutsche Bank WM products or services by one or more legal entities that will beidentified to clients pursuant to the contracts, agreements, offering materials or other documentation relevant to such products or services. Deutsche Asset Management & DeutscheBank WM offer wealth management solutions for wealthy individuals, their families and select institutions worldwide. Deutsche Asset Management & Deutsche Bank WM, throughDeutsche Bank AG, their affiliated companies and their officers and employees (collectively “Deutsche Bank”) are communicating this document in good faith and on the followingbasis.

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Important information (continued)

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© October 2016 Deutsche Asset Management Investment GmbH

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No assurance can be given that any investment described herein would yield favorable investment results or that the investment objectives will be achieved. Any securities or financialinstruments presented herein are not insured by the Federal Deposit Insurance Corporation („FDIC“) unless specifically noted, and are not guaranteed by or obligations of DeutscheBank AG or its affiliates. We or our affiliates or persons associated with us may act upon or use material in this report prior to publication. DB may engage in transactions in a mannerinconsistent with the views discussed herein. Opinions expressed herein may differ from the opinions expressed by departments or other divisions or affiliates of Deutsche Bank. Thisdocument may not be reproduced or circulated without our written authority. The manner of circulation and distribution of this document may be restricted by law or regulation in certaincountries. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or otherjurisdiction, including the United States, where such distribution, publication, availability or use would be contrary to law or regulation or which would subject Deutsche Bank to anyregistration or licensing requirement within such jurisdiction not currently met within such jurisdiction. Persons into whose possession this document may come are required to informthemselves of, and to observe, such restrictions.

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Risk Warning

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Investments are subject to investment risk, including market fluctuations, regulatory change, possible delays in repayment and loss of income and principal invested. The value of investments can fall as well asrise and you might not get back the amount originally invested at any point in time.Investments in Foreign Countries - Such investments may be in countries that prove to be politically or economically unstable. Furthermore, in the case of investments in foreign securities or other assets, anyfluctuations in currency exchange rates will affect the value of the investments and any restrictions imposed to prevent capital flight may make it difficult or impossible to exchange or repatriate foreign currency.Foreign Exchange/Currency - Such transactions involve multiple risks, including currency risk and settlement risk. 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These bonds are affected by interest rate changesand the creditworthiness of the issuers, and investing in high yield bonds poses additional credit risk, as well as greater risk of default.Hedge Funds - An investment in hedge funds is speculative and involves a high degree of risk, and is suitable only for "Qualified Purchasers" as defined by the US Investment Company Act of 1940 and"Accredited Investors" as defined in Regulation D of the 1933 Securities Act. No assurance can be given that a hedge fund's investment objective will be achieved, or that investors will receive a return of all orpart of their investment.Commodities - The risk of loss in trading commodities can be substantial. The price of commodities (e.g., raw industrial materials such as gold, copper and aluminum) may be subject to substantial fluctuationsover short periods of time and may be affected by unpredicted international monetary and political policies. 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Risk Factor Investing in a Multi Asset Contextmedialibrary... · * Momentum: Equal -weighted ......

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