Fixed income Alpha Discovery Cct. 2 2013

26
Permission to reprint or distribute any content from this presentation requires the prior written approval of S&P Capital IQ. Not for distribution to the public. Copyright © 2013 by Standard & Poor’s Financial Services LLC (S&P). All Fixed-Income Alpha Discovery Through Cross Asset-Class Analysis Ruben Falk Senior Director, Global Investment Management Product Segment Rick Kanungo, CFA, FRM Senior Director, Enterprise Solutions Jay Bhankharia, CFA Senior Manager, Investment Management Product Segment October 2, 2013

Transcript of Fixed income Alpha Discovery Cct. 2 2013

Page 1: Fixed income Alpha Discovery Cct. 2 2013

Permission to reprint or distribute any content from this presentation requires the prior written approval of S&P Capital IQ.Not for distribution to the public. Copyright © 2013 by Standard & Poor’s Financial Services LLC (S&P). All rights reserved.

Fixed-Income Alpha DiscoveryThrough Cross Asset-Class Analysis

Ruben FalkSenior Director, Global Investment Management Product Segment

Rick Kanungo, CFA, FRMSenior Director, Enterprise Solutions

Jay Bhankharia, CFASenior Manager, Investment Management Product Segment

October 2, 2013

Page 2: Fixed income Alpha Discovery Cct. 2 2013

2 Permission to reprint or distribute any content from this presentation requires the prior written approval of S&P Capital IQ. Not for distribution to the public.

Re-Thinking The Role Of Data, Models, And Analytics

• Information-driven investment managers are re-thinking the role of data, models, and analytics in their businesses

• When it comes to predicting the future accurately, a portfolio manager or investor should not miss an opportunity due to lack of

– Readily-accessible information required

– Full transparency on securities and issuers

– The ability to create rich scenarios utilizing new techniques and analyze the impacton portfolios

• What if certain equity strategy techniques were applied to fixed income portfolio management? Such as…

– Probability of defaults (PD) that incorporate equity price rankings

– Change in analyst expectations of earnings

– Price momentum (bond vs. equity)

For Fixed Income Portfolio Management

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Developing Bond Strategies Based On Credit And Equity Market Signals

• Universe of USD/U.S. bonds with PD coverage, duration of greater than six months, offering amount greater than $50 million, and amount outstanding greater than $25 million

– High yield 1,300 issues on average at any one time 500 of which with a unique associated public equity listing

– Investment grade 3,000 issues on average at any one time 1,600 of which with a unique associated public equity listing

– Includes subsequently retired and defaulted securities

• Back-test period– 02/28/2006 – 8/31/2013

• Transaction costs not directly considered

Two Hypothetical Case Studies

Source: S&P Capital IQ. Case Studies are provided for illustrative purposes only.

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Challenges To Approaching Such Work

• Depth and quality of financials and analyst estimates– Back-testing: Original filings vs. restatements

– Derived data and signals

– Market regimes

• Ability to quantify credit risk from various vantage points– Issuer credit ratings

– Determining probabilities of default

– Security to issuer, and issuer to corporate hierarchy linkages

• Access to market-based bond valuations

Access To Data, Models, And Analytics

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Critical To Enable A Proactive Bond Selection Methodology

Fundamentals

Connect to entity-level fundamental and

market data

• Compustat® GVKEY• CMA Entity ID • CUSIP/CINS Issuer ID“CC6”• D&B D-U-N-S® Entity Hierarchy• SIX Telekurs Parent GK Key• NAIC• TMC Company ID• CABRE• Markit™ Red Code• EDGAR® CIK Entity Code• ETFs

Credit Ratings

Connect to ratings and related research

• Standard & Poor’s• Moody’s• Fitch

Security Detail Sector Detail

Connect to entitysector categories

• GICS®

• Standard & Poor’sratings sectors

• SIC• NAIC

S&P Capital IQ Company ID – Ownership Relationship

Connecting Entities, Securities, Sectors And Information

Connect to terms and conditions, corporateactions and pricing

• CUSIP®

• CINS• ISIN• Symbols & Exchanges• Valor• QUICK• WKN/WPK• SEDOL

EstimatesResearch

and Transcripts

Indicesand

Derived Data

Securityand

Entity Reference

ValuationsRatings

andResearch

Fundamental and

SpecialtyAnalytics

Source: S&P Capital IQ.

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Enabling Use Of Bond, Equity, And Entity Data Sets

• Credit Rating• Bond Pricing**• Terms & Conditions• Market Activity

• Credit Rating• Probability of Default• Company Financials• Brokers’ Estimates*

• Equity Price• Brokers’

Estimates*

Leveraging S&P Capital IQ Linkages

• Credit Rating• Probability of default

Source: S&P Capital IQ. *S&P Capital IQ Estimates Data. **Provided by Standard & Poor’s Securities Evaluations, Inc. (SPSE), a subsidiary of McGraw-Hill Financial and part of S&P Capital IQ . SPSE is a registered investment adviser with the U.S. Securities and Exchange Commission (SEC).

Bond

Bond Issuer

Public Entity

Primary Equity Issue

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Case Study Universe Vs. Benchmarks

Investment Grade – Total Returns

Source: S&P Capital IQ’s ClariFI. Information as of 8/31/2013. For illustrative purposes only. Note: JNK=SPDR ETF tracking the Barclays High Yield Very Liquid Index. LQD=iShares ETF tracking the Markit iBoxx USD Liquid Investment Grade Index. Universe returns are aggregated geometrically from individual bond returns and weighted by amount outstanding. Universe refers to information provided on slide 3. Past performance is no guarantee of future results.

High Yield – Total Returns

3/1/20

06

8/2/20

06

1/3/20

07

6/6/20

07

11/7/

2007

4/9/20

08

9/10/2

008

2/11/2

009

7/15/2

009

12/16

/2009

5/19/2

010

10/20

/2010

3/23/2

011

8/24/2

011

1/25/2

012

6/27/2

012

11/28

/2012

5/1/20

13-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

LQD (ETF) Universe

3/3/20

08

6/23/2

008

10/13

/2008

2/2/20

09

5/25/2

009

9/14/2

009

1/4/20

10

4/26/2

010

8/16/2

010

12/6/

2010

3/28/2

011

7/18/2

011

11/7/

2011

2/27/2

012

6/18/2

012

10/8/

2012

1/28/2

013

5/20/2

013

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

JNK (ETF) Universe

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Case Study 1Bond Returns vs. Bond Risks

Return Risk

• Market Risk– Interest Rate: Eff. Duration– Volatility: 20-day σ of bond prices

• Credit Risk– Daily Probability of Default

• (Lack of) Market Activity– Daily Market Activity Score

Yield-to-Maturity

Evaluated bond price, Yield-to-Maturity, and Market Activity Scores are provided by Standard & Poor’s Securities Evaluations, Inc. (SPSE), a subsidiary of McGraw-Hill, and a part of S&P Capital IQ and a registered investment adviser with the U.S. Securities and Exchange Commission (SEC). SPSE’s advisory services include evaluated pricing and model valuation of fixed income securities, valuations of OTC derivatives, and analyses of certain U.S. and European fixed-income securities using its proprietary Risk-to-Price scoring methodology. Products and Services provided by SPSE may not be available in all countries or jurisdictions.

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Probability Of Default (PD) Factors

Fundamental

Market

• GDP Change %• Industry delinquency rates• Industry median Y-o-Y change in sales

• Distance to default• 1-year stock price rank

• Debt/EBITDA• FFO/Total debt• EBITDA/Interest expense• EBITDA/Revenue• Assets• (Current Assets – Inventories)/Current liabilities

Macro/Industry

Elements Incorporated Factor Categories

Source: S&P Capital IQ.* Standard & Poor’s Ratings Services is analytically and editorially independent from any other analytical group within McGraw Hill Financial.

S&P Capital IQ’s PD measure went up sharply in the weeks prior to a Standard & Poor’s CreditWatch Negative action*

Entity Name CountryPD 7 weeks

prior to Watch Neg

(%)

PD 1 day prior to

Watch Neg (%)

PD Increase

(%)

Rating when put on Watch

CreditWatch Date

Eventual Rating

Eventual Rating

Action Date

Rating Action Days

CreditWatch

Dun & Bradstreet Corp. (The) USA 0.02 0.05 237 A- 5/23/2012 BBB+ 7/13/2012 51 NEGThompson Creek Metals Co. USA 0.04 0.08 137 B+ 3/6/2012 B- 5/7/2012 62 NEGChesapeake Energy Corp. USA 0.13 0.32 134 BB 4/26/2012 BB- 5/15/2012 19 NEGDigital Generation Inc. USA 0.52 1.08 109 BB- 7/18/2012 B+ 9/10/2012 54 NEGCentral European Distribution Corp. USA 9.74 18.16 86 CCC+ 6/8/2012 CCC 11/16/2012 161 NEGNavistar International Corp. USA 3.54 6.33 79 B+ 6/7/2012 B 7/9/2012 32 NEGPatriot Coal Corp. USA 11.11 17.63 59 CCC 5/23/2012 D 7/10/2012 48 NEG

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Does Bond Yield Efficiently Capture Risk?

• Hypothesis: Yields may not be representative of risk profile

• Build a dynamic model of risk implied yield by cross-sectionally regressing the observed yield against PD, duration and bond price volatility

• Risk Implied Yield = Intercept + a*PD + b*Duration + c*Volatility

Methodology And Hypothesis

• Rank universe into five quintiles according to the factor score

• Looking for the largest positive divergence between yield and risk-implied yield

Please note: a, b, c are regression coefficients. Quintile 1 = highest score and quintile 5 = lowest scores.

Risk-Implied Yield =f (PD, Duration, Volatility)

Yield-to-Maturity:Corresponding to evaluated price

Difference = Opportunity?

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Example: Evaluate Two Bonds Through Risk Implied Yield Similar At Face Value, Different Upon Investigation

Category Feature Quintile 1 (Attractive) Quintile 5 (Unattractive)

Descriptive Information

Issuer Unum Group Capital One Financial Corp

Offering Amount $350 Million $1 Billion

Coupon 7.125% 7.375%

Seniority Senior Notes Senior Notes

Maturity Date 9/30/2016 5/23/2014

Risk Analysis

S&P Rating Services Long-Term Credit Rating BBB BBB

Duration 4.8 2.76

PD .0346% .0665%

Volatility .005 .004

ReturnsYield 3.94% 2.08%

Risk Implied Yield 3.53% 2.95%

Yield – Risk Implied Yield 0.41% 0.87%

Source: S&P Capital IQ Risk Solutions and Standard & Poor’s Securities Evaluations, Inc. As-of April 30, 2011. For illustrative purposes only.

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Consistent Outperformance Of Investment-Grade Strategy

Source: S&P Capital IQ’s ClariFI. Information as of 8/31/2013. For illustrative purposes only.Note: Cumulative spread is the cumulative geometric sum of one-month spreads between bonds in Quintile 1 and Quintile 5 as ranked by the “Yield - Risk Implied Yield” score and equally weighted.

4/1/20

06

10/1/

2006

4/1/20

07

10/1/

2007

4/1/20

08

10/1/

2008

4/1/20

09

10/1/

2009

4/1/20

10

10/1/

2010

4/1/20

11

10/1/

2011

4/1/20

12

10/1/

2012

4/1/20

13-20%

0%

20%

40%

60%

80%

100%

First Quintile IG Index

Investment Grade Long Only Strategy –Quintile 1 Performance vs. Benchmark

Investment-Grade Cumulative Spreads –Quintile 1 Minus Quintile 5

4/1/20

06

10/1/

2006

4/1/20

07

10/1/

2007

4/1/20

08

10/1/

2008

4/1/20

09

10/1/

2009

4/1/20

10

10/1/

2010

4/1/20

11

10/1/

2011

4/1/20

12

10/1/

2012

4/1/20

130%

200%

400%

600%

800%

1000%

1200%

80

90

100

110

120

130

140

150

160

170

180

Top-Bottom Spread Universe (RHS)

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Ineffective Signal For High-Yield

Source: S&P Capital IQ’s ClariFI. Information as of 8/31/2013. For illustrative purposes only. Past performance is not indicative of future results.Note: Cumulative spread is the arithmetic sum of one-month spreads between bonds in Quintile 1 and Quintile 5 as ranked by the “Yield - Risk Implied Yield” score and equally weighted

4/1/20

06

10/1/

2006

4/1/20

07

10/1/

2007

4/1/20

08

10/1/

2008

4/1/20

09

10/1/

2009

4/1/20

10

10/1/

2010

4/1/20

11

10/1/

2011

4/1/20

12

10/1/

2012

4/1/20

13-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

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80

100

120

140

160

180

200

220

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260

Top-Bottom Spread Universe (RHS)

High-Yield Cumulative Spreads –Quintile 1 Minus Quintile 5

High-Yield Long-Only Strategy –Quintile 1 Performance Vs. Benchmark

4/1/20

06

10/1/

2006

4/1/20

07

10/1/

2007

4/1/20

08

10/1/

2008

4/1/20

09

10/1/

2009

4/1/20

10

10/1/

2010

4/1/20

11

10/1/

2011

4/1/20

12

10/1/

2012

4/1/20

13-40%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

160%

First Quintile HY Index

Page 14: Fixed income Alpha Discovery Cct. 2 2013

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Market-Activity Score

For corporate and government bonds, market-activity scores are based on trades from FINRA’s Trade Reporting and Compliance Engine® (TRACE®) and Xtrakter, and quotes from Xtrakter Quotes, S&P Capital IQ Quote, Tullet Prebon Government Bonds, and (planned for 1Q 2014) ISDA (Japan Securities Dealers Association).

PriceStaleness

Number of Market Makers

• Number of Trades over a rolling 30 business day period

• Number of Quotes over a rolling 30 business day period

• Number of market makers over a rolling30 business day period

• Number of business days since a security was last traded

• Number of business days since a security was last quoted

Number of Trades and

Quotes

Elements Incorporated Factor Categories

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Model Performance Does Not Appear To Be Diminished By Lack Of Market-Activity

Source: S&P Capital IQ’s ClariFI. Information as of 8/31/2013. For illustrative purposes only. Past performance is not indicative of future results.

High Yield: Risk Implied Yield – Quintile

Mar

ket-A

ctiv

ity

Scor

e

1 2 3 4 5 60%

10%20%30%40%

Market-Activity Score Distribution(1=Most Activity 5=Least Activity 6=No Score)

Investment Grade High Yield

Investment-Grade: Risk-Implied Yield – Quintile

Mar

ket-A

ctiv

ity

Scor

e

Page 16: Fixed income Alpha Discovery Cct. 2 2013

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Case Study 2:

• Credit Rating• Probability of Default• Credit Ratios• Equity Value to Book Value• Dividend Yield

• Price momentum (bond vs. equity)• Analyst expectations (earnings) Alpha Factors

Using Risk And Alpha Factors To Determine Outperformance

Risk Factors

Page 17: Fixed income Alpha Discovery Cct. 2 2013

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Credit-Quality Regimes In The Equity Market

Source: S&P Capital IQ’s Alpha Factor Library. Information as of 8/31/2013. For illustrative purposes only.

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Risk Factors As Bond Selection Signals

Source: S&P Capital IQ’s ClariFI. Information as of 8/31/2013. For illustrative purposes only.Cumulative spread is the cumulative geometric sum of 1-month spreads between bonds in Quintile 1 and Quintile 5 as ranked by the individual factors and equally weighted. Past performance is not indicative of future results.

High-YieldCumulative Quintile Spreads

Investment-GradeCumulative Quintile Spreads

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

60

80

100

120

140

160

180

200

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240

2/1/20

06

11/1/

2006

8/1/20

07

5/1/20

08

2/1/20

09

11/1/

2009

8/1/20

10

5/1/20

11

2/1/20

12

11/1/

2012

-30%

-20%

-10%

0%

10%

20%

30%

40

60

80

100

120

140

160

180

Descending Ratings

Interest Cov Descending

PD (Bond)

Book to Price

Universe (RHS)

Page 19: Fixed income Alpha Discovery Cct. 2 2013

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Dividend Yield: Another Risk Factor?High-Yield Universe

Source: S&P Capital IQ’s ClariFI. Information as of 8/31/2013. For illustrative purposes only. Past performance is not indicative of future results.

Annualized ReturnHigh (Q1) vs. Low (Q5) Dividend Yield Cumulative Spreads

Q1 Q2 Q3 Q4 Q50%

2%

4%

6%

8%

10%

12%

14%

2/28/2006 – 8/31/2013

2/1/20

06

8/1/20

06

2/1/20

07

8/1/20

07

2/1/20

08

8/1/20

08

2/1/20

09

8/1/20

09

2/1/20

10

8/1/20

10

2/1/20

11

8/1/20

11

2/1/20

12

8/1/20

12

2/1/20

13-40%

-20%

0%

20%

40%

60%

80%

Q1-Q3 Q5-Q3 PD (Bond)

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Bond Alpha Factors?Equity Price Momentum and Analyst Earnings Revisions

Source: S&P Capital IQ’s ClariFI. Information as of 8/31/2013. For illustrative purposes only. Past performance is not indicative of future results.

High YieldCumulative Quintile Spreads

Investment GradeCumulative Quintile Spreads

2/1/20

06

10/1/

2006

6/1/20

07

2/1/20

08

10/1/

2008

6/1/20

09

2/1/20

10

10/1/

2010

6/1/20

11

2/1/20

12

10/1/

2012

6/1/20

13-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

40

60

80

100

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180

1M Price Momen-tum1M Bond Momen-tum3M Rev FY2Universe (RHS)

2/1/20

06

8/1/20

06

2/1/20

07

8/1/20

07

2/1/20

08

8/1/20

08

2/1/20

09

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09

2/1/20

10

8/1/20

10

2/1/20

11

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11

2/1/20

12

8/1/20

12

2/1/20

13-50%

0%

50%

100%

150%

200%

250%

300%

70

90

110

130

150

170

190

210

230

250

Page 21: Fixed income Alpha Discovery Cct. 2 2013

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Effectiveness Of Analyst Expectations In Equity Markets Around The World

Source: S&P Capital IQ’s Alpha Factor Library. Information as of 8/31/2013. For illustrative purposes only.

Unattractive Attractive

Page 22: Fixed income Alpha Discovery Cct. 2 2013

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Case-Study: Summary Of Key Performance Measures

• All the strategies outperformed their respective benchmarks although risk implied yield worked best for investment grade and equity-price momentum best for High Yield

• The long-short spreads were higher than the active returns for IG which implies there was value in the strategies both with regard to which bonds to buy and which to sell. Equity momentum worked well on a one-month holding period but its value decayed after that.

• Turnover was significantly higher for the equity-price momentum than for the risk-implied yield strategies. This is reinforced by increased effectiveness of longer holding periods only for risk-implied yield

Source: S&P Capital IQ’s ClariFi. Note: Annualized active return is the annualized excess return of the respective equal weighted First Quintile strategies vs. the respective universe indices. Annualized Q1-Q5 Spread is the average spread between Quintile 1 and Quintile 5. Annualized turnover is the average turnover of the respective First Quintile strategies. For illustrative purposes only. Past performance is not indicative of future results.

Strategy AnnualizedActive Return

AnnualizedQ1–Q5 Spread

AnnualizedTurnover

Investment Grade 1m 6m 1m 6m 1m 6m

Risk-implied yield 5% 4% 10% 7% 52% 8.6%

6M Equity-Price Momentum 3% 1% 5% 1% 80% 13%

High Yield

6M Equity-Price Momentum 5% 2% 7% -4% 81% 13%

Page 23: Fixed income Alpha Discovery Cct. 2 2013

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Case-Studies Findings

• The equity market appears to contain signals which may favorably informbond selection

– PDs (equity price volatility, leverage on equity market value)

– Equity-price momentum

• The risk implied yield methodology appears to consistently add value as a bond selection strategy for U.S. investment-grade bonds. This result does not appear to be influenced by recent market regimes and or indicators of market activity

• Equity-price momentum on its own appears to work well as a bond selection signal both in the Investment Grade and High Yield universes, however with very high turnover

• Analyst-expectation signals also appear to add value to bond selection particularly for high-yield

• More traditional equity market signals such as book-to-price or dividend yield appear to act more like risk factors for the purpose of bond selection

Summary

Page 24: Fixed income Alpha Discovery Cct. 2 2013

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Concluding Thoughts

• Both equity and fixed-income investors may benefit from systematic components to create a disciplined and efficient investment process

– Traditional fundamental-investment processes can be enhanced by quantitative techniques backed up with relevant data sets, security linkages, and history

• Model portfolios may in some cases be investable using a quantitative process, but in other cases simply serve as a way of supplementing

– Security selection

– Portfolio monitoring

• S&P Capital IQ provides integrated data and desktop solutions to answer these needs

Page 25: Fixed income Alpha Discovery Cct. 2 2013

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Feed, API, Excel® Plug-in, Web, Mobile, Real-Time

Supporting Financial Services NeedsCapabilities And Solutions

Clie

nt E

nviro

nmen

t

Estimates

Solu

tions

Cap

abili

ties

Researchand

Transcripts

Indicesand

Derived Data

Securityand

Entity Reference

ValuationsRatings

andResearch

Fundamental and

Specialty

Client Site Engineers

Business Operations

Application Consultants

Content Specialists Solutions Architects

Product Specialists Modeling Team

Custom Solutions Group

Platform Management

Analytics

Sales and Trading

Investment Banking

Asset/Wealth Management

Risk Management

and Reporting

Security Detail and Reference

Account Managers

Client Services Team

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