Risk Parity and Rethinking Absolute Return 1. Kevin Kneafsey, Ph.D. Multi-Asset Investments, Senior...

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Risk Parity and Rethinking Absolute Return 1

Transcript of Risk Parity and Rethinking Absolute Return 1. Kevin Kneafsey, Ph.D. Multi-Asset Investments, Senior...

Page 1: Risk Parity and Rethinking Absolute Return 1. Kevin Kneafsey, Ph.D. Multi-Asset Investments, Senior Analyst Schroders Thomas K.R. Wilson, C.F.A Senior.

Risk Parity and Rethinking Absolute Return

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Page 2: Risk Parity and Rethinking Absolute Return 1. Kevin Kneafsey, Ph.D. Multi-Asset Investments, Senior Analyst Schroders Thomas K.R. Wilson, C.F.A Senior.

Kevin Kneafsey, Ph.D.Multi-Asset Investments, Senior AnalystSchroders

Thomas K.R. Wilson, C.F.ASenior Investment Manager and Managing Director of Institutional InvestmentsBrinker Capital

Presenters

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Kathleen M. McBride, AIFAManaging Director, The Family Wealth Alliance

Moderator

Page 3: Risk Parity and Rethinking Absolute Return 1. Kevin Kneafsey, Ph.D. Multi-Asset Investments, Senior Analyst Schroders Thomas K.R. Wilson, C.F.A Senior.

Risk Parity: Discerning Fact from Fiction

Family Wealth AllianceSeptember 25, 2013

Kevin Kneafsey, PhDMulti-Asset Investments, Senior Adviser

Prepared at the request of Family Wealth Alliance. Not for Redistribution Under Any Circumstances.

Page 4: Risk Parity and Rethinking Absolute Return 1. Kevin Kneafsey, Ph.D. Multi-Asset Investments, Senior Analyst Schroders Thomas K.R. Wilson, C.F.A Senior.

SchrodersAsset management is our sole business

Experience and independence Over 200 years of financial services experience Founding Schroder family still controls over 47%

of voting equity

Resources Well established teams in all key

investment regions Over 380 portfolio managers and

analysts worldwide Over 3,100 personnel in 27 countries

Financial strength $357.5 billion in AUM globally Approximately $1.6 billion surplus capital

available for building the business

Source: Schroders, as of June 30, 2013

BermudaCayman IslandsMexico CityNew YorkPhiladelphia

AmsterdamCopenhagenFrankfurtGenevaGibraltarGuernseyJerseyLondonLuxembourg

MadridMilanParisRomeStockholmZurich

BeijingHong KongJakartaSeoulShanghaiSingaporeSydneyTaipeiTokyo

Buenos AiresSantiagoSão Paulo

DubaiMumbai

Schroders offices(Investment offices in orange)

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• Risk Parity was born out of the realization that

– Returns are hard to forecast – the holy grail– Risk is easier to forecast

…plus the assumption that• Returns per unit risk are approximately

the same for all assets– So, if an asset provides 1% return for 2% risk– We can expect 5% return for 10% risk from

another asset and so on …

…the best thing to do in that world is• Allocate risk equally to all assets

– Maximize the benefits of diversification– Maximize return for the risk taken

…Risk Parity is born

Risk parity basics

Source: Schroders. For illustrative purposes only.

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• What risk parity has done well– Focus on diversification– Risk allocations vs capital allocations

• Assumptions embedded in a portfolio– Risk parity - No strong view

• Leverage– Concentration risk vs. leverage risk– Embedded leverage versus explicit leverage– Sourcing leverage

• Illiquidity• Leveraged bonds

• Return drivers vs. asset classes• Blind application of risk parity

– Risk parity is blind to asset valuations • WARNING: Risk parity can and will lose money at times

Risk parity hot buttons

Source: Schroders

Page 7: Risk Parity and Rethinking Absolute Return 1. Kevin Kneafsey, Ph.D. Multi-Asset Investments, Senior Analyst Schroders Thomas K.R. Wilson, C.F.A Senior.

Risk based portfolio constructionCapital allocation versus risk allocation

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Rolling five year correlations with equities & bonds2

60% Equity/40% Bond portfolio

1. Source: Schroders, for illustrative purposes only and should not be viewed as a recommendation to buy/sell.2. Source: Schroders, Global Financial Data for illustrative purposes only as of September 30, 2012. Equities are represented by the S&P 500 index, Bonds are US 10 year treasury returns, based on monthly data.

1846186318811898191619331951196819862003-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

Equities Bonds

Portfolio construction using capital based approaches fail to identify concentrations of risk

Traditional 60/40 equity/bond portfolios have high exposure to equity risk

Comparison of capital and risk1

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Leverage – the L-wordFinancial theory tells us how to create efficient portfolios

C

A

B

C’E

D’ D

C

A

B

C’E

D’ D

E(r)

Risk

F

Concentration risk vs. leverage risk

Explicit vs. embedded leverage

Sourcing leverage

Illiquidity

“Leveraged bonds”

Source: Schroders. For illustrative purposes only.

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• Asset classes: composed of one or more risk factors

• Rewarded risk factors: underlying drivers of asset returns

• Risk premium: expected return investors demand for assuming a source of risk

Breaking asset classes into risk premiaUS investment grade credit

Return drivers vs asset classesUnderstanding risk and return drivers

31 October 2008 30 April 20130

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4

6

8

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Duration Risk PremiumCredit Risk PremiumRisk-Free Rate

Source: Schroders, Bloomberg. US investment grade credit is represented by the BofA Merrill Lynch US Corporate Index. Shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell.

%Yield

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• Risk parity has done a great job of getting investors to– Focus on diversification– Consider risk allocations in addition to capital allocations

• Risk parity takes no strong view about relative outperformance• Leverage

– Risk Parity takes on leverage risk to avoid concentration risk– Almost all portfolios have some embedded leverage, Risk Parity employs

both embedded and explicit leverage– Leverage should be sourced where it is cheapest and easiest to manage

• Risk parity only makes sense when applied to return drivers, not to asset classes

• A diversification focus, like risk parity, is blind to asset valuations• Risk parity can and will lose money at times

Conclusion

Source: Schroders. The views and opinions are those of the Multi-Asset team and are subject to change.

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Past performance is not a guide to future returns. The value of investments can fall as well as rise as a result of market movements. Investments in smaller companies may be less liquid than in larger companies and price swings may therefore be greater than in larger company funds. Exchange rate changes may cause the value of overseas investments to rise or fall. Less developed markets are generally less well regulated than the US, they may be less liquid and may have less reliable custody arrangements. Investors should be aware that investments in emerging markets involve a high degree of risk and should be seen as long term in nature. The Strategy will invest in some higher-yielding bonds (non-investment grade). The risk of default is higher with non-investment grade bonds than with investment grade bonds. Higher yielding bonds may also have an increased potential to erode your capital sum than lower yielding bonds. The Strategy will invest in Property Funds and Property Investment Companies. It may be difficult to deal in these investments because the underlying properties may not be readily saleable which may affect liquidity.

The views and forecasts contained herein are those of the Multi-Asset Team and are subject to change. The information and opinions contained in this document have been obtained from sources we consider to be reliable. No responsibility can be accepted for errors of facts obtained from third parties. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.

The opinions stated in this presentation include some forecasted views. We believe that we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee that any forecasts or opinions will be realized.

This document is not an offer or a solicitation to acquire or dispose of an interest in securities or other investment instruments described herein. This document contains outline, indicative terms for discussion purposes only and is not intended to provide the sole basis for evaluation of the instruments described. Terms are purely indicative and may change in line with market conditions. Any recipient of this document agrees that the appropriateness of any described structure to its particular situation will be independently determined, including consideration related to the legal, tax and other related aspects of any transaction.

Further information about Schroders can be found at www.schroders.com/us.

© Schroder Investment Management North America Inc.875 Third Ave – 22nd Floor, New York, NY 10022(212) 641-3800

Important information

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Brinker Capital, a Registered Investment Advisor. For financial advisor use only. Not for distribution to the public.

Rethinking Absolute Return

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Agenda

Why Alternatives?

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Why Brinker Capital?

Why Absolute Return?

Page 14: Risk Parity and Rethinking Absolute Return 1. Kevin Kneafsey, Ph.D. Multi-Asset Investments, Senior Analyst Schroders Thomas K.R. Wilson, C.F.A Senior.

Brinker Capital, a Registered Investment Advisor. For financial advisor use only. Not for distribution to the public.

Why Alternatives?

Page 15: Risk Parity and Rethinking Absolute Return 1. Kevin Kneafsey, Ph.D. Multi-Asset Investments, Senior Analyst Schroders Thomas K.R. Wilson, C.F.A Senior.

The Market’s Roller-Coaster Ride Has Been Unnerving

For Many Investors

Source: Department of Global Studies and Geography, Hofstra University

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Source: Strategas Research Partners

Persistent Volatility has Caused Fear of the Equity Market

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There Must Be a Better Way

Recent markets have made many investors challenge traditional diversification.

Large pension plans and endowments have employed a better way for years.

Adding alternatives such as hedge funds, private equity and real assets to the mix improved the trade-off by boosting returns and lowering risk overall.

Source: Fact Set, Brinker Capital. Inc. (1998-2012). Allocation created by Brinker Capital. Indexes and weights of the traditional portfolio are as follows: U.S. Stocks: 55% S&P 500 Total Return; U.S. Bonds: 30% Barclays U.S. Aggregate; International stocks: 15% MSCI EAFE Gross Return. Indexes and weights of the more diversified portfolio are as follows: Equity Market Neutral: 8.3% HFRI Equity Hedge, Equity Market Neutral; Commodities: 8.3% DJ UBS Commodities Total Return; REITs: 8.3% FTSE NAREIT Equity REITs Total Return; U.S. Stocks: 22.2% S&P 500 Total Return; Small Cap Stocks: 8.8% Russell 2000 Total Return; International Stocks: 13.2% MSCI EAFE Gross Return; Emerging Markets: 4.4% MSCI EMF Gross Return; U.S. Bonds: 26.5% Barclays U.S. Aggregate. Charts are for illustrative purposes only. Past returns are no guarantee of future results. Diversification does not guarantee investment returns and does not eliminate risk of loss.

Page 18: Risk Parity and Rethinking Absolute Return 1. Kevin Kneafsey, Ph.D. Multi-Asset Investments, Senior Analyst Schroders Thomas K.R. Wilson, C.F.A Senior.

Brinker Capital, a Registered Investment Advisor. For financial advisor use only. Not for distribution to the public.

Why Absolute Return?

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Tackling “Volatility Fatigue”

Absolute Return Portfolios Seek to:

● Manage Volatility

● Enhance Diversification

● Provide Consistent Return Potential

Source: Fact Set and Brinker Capital, Inc.

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Spotlight on Absolute Return Strategies

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Strategic + Absolute Return Investment Strategies

STRATEGIC RETURN ABSOLUTE RETURN

Seeks to outperform the market, which could mean delivering a negative return.

Seeks to deliver a positive return regardless of market behavior.

Seeks to outperform the market.

Seeks to deliver positive returns.

Closely mirrors the volatility of the market.

Seeks significantly lower volatility than the market.

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Falling markets

Rising markets

Volatile markets

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Brinker Capital, a Registered Investment Advisor. For financial advisor use only. Not for distribution to the public.

Why Brinker Capital?

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*Source: Brinker Capital. As of 6/30/13.

Brinker Capital: Six Asset Class Methodology

We allocate capital across six asset classes and use highly focused stock selection

• A national independent firm headquartered in suburban Philadelphia

• $14.5 billion under management*

• SEC-registered investment manager since 1987

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The Best of Both Worlds

Savvy, like a hedge fund...

Multi-SectorAccess to the same broad and highly diversified approach typically used by endowments and institutional investors

Unconstrained Flexibility to preserve capital and beat inflation with controlled volatility

TacticalAchieve reliable portfolio gains over time

...in an investor-friendly SMA platform

LiquidNo required fixed investment term or hidden lock-up periods

TransparentSee exactly what you own, how it’s performing, and what our management team has to say about it

Cost-EffectiveFee structure that’s more competitive than traditional hedge funds

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Brinker Capital: Suite of Absolute Return Investment Solutions

Crystal Strategy I

Seeks to achieve “equity-like” capital appreciation and outpace inflation by 3-5% over a full market cycle.

Crystal Diversified

IncomeAn income solution that seeks to generate yield and appreciation with managed volatility.

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Crystal Strategy I

An absolute return portfolio offered within a separately managed account structure. Utilizing both tactical and strategic processes, the portfolio seeks to outpace inflation by 3-5% over a full market cycle.

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Source: Brinker Capital, Inc.. As of 8/31/13.

Manage Volatility

● Seeks to reach a targeted return over a three-year market cycle

● Achieve “equity-like” capital appreciation with an emphasis on absolute (positive) returns and low correlation to the S&P 500 Index

Six Asset Class Diversification

● Active and passive vehicles (mutual funds, ETFs, ETNs, stocks)

● Highly focused stock selection

● This portfolio uses multi-sector strategies that are transparent and offer daily liquidity

Active Risk Management

● Strategic perspective

● Tactical overlay

● Hedging capabilities

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Crystal Diversified Income

An income-based absolute return solution that seeks to provide meaningful yield, active risk management and potential growth in principal.

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Source: Brinker Capital, Inc.. As of 8/31/13.

Diversified Income from Multiple Sources

● Goal is to exceed a blended yield of 50% stocks and 50% bonds

● Multi-strategy approach focusing on various sources of income

● Supplemented with capital appreciation potential

Six Asset Class Diversification

● Active and passive vehicles (mutual funds, ETFs, ETNs, stocks)

● Highly focused stock selection

● This portfolio uses multi-sector strategies that are transparent and offer daily liquidity.

Active Risk Management

● Strategic perspective

● Tactical overlay

● Hedging capabilities

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Summary

Why Alternatives?Better, more diversified way to invest

Why Brinker Capital?Experience and sophisticated investment solutions

Why Absolute Return?Seeks to tackle “Volatility Fatigue”

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Brinker Capital, Inc.A Registered Investment Advisor800.333.4573www.BrinkerCapital.com

Rethinking Absolute Return

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Thank You!

A recorded version of this webinar will be available at www.FWAlliance.com and http

://familyoffices.hubinternational.com/resource-center/