The Rise of Sovereign Wealth Funds: New Investment …...The rise of sovereign wealth funds (SWFs)...
Transcript of The Rise of Sovereign Wealth Funds: New Investment …...The rise of sovereign wealth funds (SWFs)...
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APPLIED FINANCE CENTREFaculty of Business and Economics
The Rise of Sovereign Wealth Funds: New Investment Strategies
ROLAND WINN
Angel Place Campus, 22 June 2018
APPLIED FINANCE CENTREFaculty of Business and Economics
1. Beyond Strategic Asset AllocationLONG HORIZON INVESTING
Long Horizon InvestingADVANTAGES OF A SOVEREIGN WEALTH FUND
Average Institutional Investor
• Shorter or truncated horizon
• Limited, possibly declining, liquidity
• Time varying risk profile – staff/leadership, customers, governance, liquidity
Sovereign Fund
• Long Horizon
• Ample Liquidity
• Stable Risk Aversion
• Other potential factors – governance, tax, cost, intellectual property
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Portfolio Construction Comparison
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SAA VS. REFERENCE PORTFOLIO
Traditional Strategic Asset Allocation
Reference Portfolio
Source: Illustrative Purposes Only for Typical Growth Mandate
What? A low cost, passive, easily tracked, listed investment portfolio.
Why?Fewer assumptions,
greater certainty.
Cash
FixedIncomeEquities
Alternatives
Real Estate
Reference Portfolio Concept
“The CPP Reference Portfolio … portfolio of publicly traded securities that could be readily implemented using a low cost passive investment program.“
“will earn capital market returns over the long term”
“equilibrium concept”
“reflects the amount of risk that Government is prepared for the GIC to take in its long-term investment strategies”
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Example Reference Portfolios
Source: CPPIB, GIC, NZSF, UTAM.
55%
80% 85%
65%75%
50%
10%
5%
10%
5%
20% 15%
35%20%
30%40%
CPPI B '15 CPPI B '18 CPPI B '19 GI C NZSF UT AM
Equities - Int. Equities - Dom.Fixed Income - Int. Fixed Income - Dom.
Portfolio Construction Comparison
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Traditional Strategic Asset Allocation
Reference Portfolio Actual, Target or Policy Portfolio
Source: Illustrative Purposes Only for Typical Growth Mandate
α
Cash
FixedIncomeEquities
Alternatives
Real Estate
Making it work in practice
• Importance of long term asset class returns.
• Need strong belief in mean reversion.
• Well defined liquidity parameters― Belief that the underlying risks of the portfolio not correlated; or― Sufficient liquidity that correlated drawdowns are survivable.
• Strong governance mechanism.
• Ideally an independent business unit that allows for critical thinkers away from traditional asset classes and the market model.
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APPLIED FINANCE CENTREFaculty of Business and Economics
2. Case Example in Risk ArbitrageUNBUNDLING A HEDGE FUND STRATEGYAND TARGET ALPHA
APPLIED FINANCE CENTREFaculty of Business and Economics
Evolution of Hedge Funds
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THE OLD VS. THE NEW
High idiosyncratic risk that’s different
Unconstrained, high absolute return seeking
High leverage, high fees – 2/20
Correlations? We’ll make so much who cares!
Becoming more systematic
Target cash+ return
Can still be high leverage, fees falling
Purportedly uncorrelated return stream
What is Merger Arbitrage?
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EXAMPLE: OFFER OF $28 BY VARIAN MEDICAL FOR SIRTEX
$10$12$14$16$18$20$22$24$26$28$30
1. Merger Arbitrage buys
post-announcement
deals
3. A premium is derived from a discount to the
offer price
Source: Bloomberg
2. Investors may short the
acquirer or the market or not at
all
What could possibly go wrong?
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WHAT’S ON THE LABEL …
Source: S&P IQ
Cancelled vs. Completed Deals Russell 3000 (2001-17)
Source: Bloomberg, Big Mountain Capital
ρ = 42% β < 0.2
-150-100
-500
50100150200250
R3000 HFRX
MO
NTH
S
Up month Down month
Win/LossNo. Months Positive/Negative Jan-98 to Mar-18
Skewness and Downmarket Beta
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WHAT YOU’RE REALLY PAID FOR …
Normal Market Distribution(Actual vs. Assumed Returns)
0
10
20
30
40
50
60
-3.1
%-2
.7%
-2.3
%-1
.9%
-1.5
%-1
.1%
-0.8
%-0
.4%
0.0%
0.4%
0.8%
1.2%
1.6%
2.0%
2.4%
2.8%
3.2%
Source: Big Mountain Capital, Bloomberg
Negative Skew & Left Tail RiskHFRX Merger Arbitrage (Jan-98 to Mar-18)
Merger Arbitrage Return Behaviour
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KNOW WHAT YOU’RE BUYING
Source: Big Mountain CapitalNotes: Fees set at alpha for illustrative purposes only
Building Blocks of Expected Returns
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%Single Factor (CAPM) Model:
Two Factor Model:
Multi-Factor Model:
R2
18%
24%
>40%
IR*
1.0
0.8
0.4
*IR (Information Ratio Gross of Fees)
Alternative Implementation
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INVESTMENT STRATEGY UNBUNDLING THE ALPHA
Building Blocks of Expected Returns(Illustrative Only, Not to Scale)
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
Available to most
investors
Target the “alpha”
Implementation Strategy
• Hire a manager - anybody willing to pay fees can do this
• Replicate with combination of credit and option selling –requires liquidity and some skill
• Target the alpha – systematic program to capture excess for volatility and liquidity premium and alpha signals – takes liquidity / long horizon / skill / dataSource: Big Mountain Capital
Notes: Fees set at alpha for illustrative purposes only
Applications
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INVESTMENT STRATEGIES
Re-Constituted Premia
Hedge Funds
Alternatives e.g.
Royalties
Alt/Smart Beta
Active index huggers
Dynamic asset
allocation
Asset allocation (e.g. Risk
Parity)
Summary
• Horizon is not an aspiration, it is your state of being.
• Long horizon provides greater degrees of freedom and some advantages but ultimately same talent pool.
• Increasing availability of data, ETFs and swaps creates target alpha opportunities.
• Disaggregation of returns is a useful discipline for everyone but hard to implement in practice. At least it helps you to know what you’re paying for.
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APPLIED FINANCE CENTREFaculty of Business and Economics
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Thank you for attending today’s talk
Background Materials
The rise of sovereign wealth funds (SWFs) has created an investor class with some particular attributes not available to the average investor. Chief amongst these is a truly long term horizon and strong liquidity profile in addition to tax and cost advantages. This has seen the development of alternative forms of portfolio construction and investment strategy designed to best use these endowments. This workshop will discuss:- The move away from Strategic Asset Allocation at some of these SWFs;- An alternative approach to developing investment strategy; and - Discuss a case example of how a traditional hedge fund strategy might be unbundled.
Video Link Used: https://www.youtube.com/watch?v=brTVoslt-hA
Pros and Cons in Practice
• Anchoring & relative value thinking – hugging the benchmark.
• Pervasiveness of market model.
• Does it allow for true risk neutral investors ~ NPV concept to your portfolio?
• Implementation mismatch and manager selection.
• Need personnel or unit that allows for independent critical thinkers away from traditional asset classes and the market model.
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