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CIEBA 9/04 Telediscussion: SAA vs TAA Moderated by: Marie Pillai, Siemens Corp., USA Panel Discussion: Portfolio Asset Allocation – Strategic vs Tactical

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Page 1: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

CIEBA 9/04 Telediscussion: SAA vs TAA

Moderated by: Marie Pillai, Siemens Corp., USA

Panel Discussion:

Portfolio Asset Allocation – Strategic vs Tactical

Page 2: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

SAA vs. TAA – Key Issues

� SAA and TAA complement each other

� Active management can lower risk/enhance returns

– How to develop rules to manage drifts from benchmark?

� Typical comments:

– “do not actively manage assets” – already are (implicitly) active

– “not as smart as asset managers” – neither are they!

– “do not have resources” – easily overcome; leverage existing resources

� AlphaEngineTM: empower clients to make better decisions

Page 3: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

All Pension Portfolios Are Active

� Portfolio is active soon after investments are made (more so with external managers and “misfit risk”)

� All portfolio decisions (explicit or implicit) impact returns; Must make decisions in an informed manner

� Implement state-of-the-art framework for all decisions– Identify decisions/responsibility at every level of fund

– Develop rules to guide each decision

– Set a consistent evaluation process for all decisions

– Evaluate aggregate impact of decisions on risk/return

� Easy to do – leverage staff and available resources– External managers, published research, investment banks etc.

Page 4: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

Key to Success Key to Success –– Effective DecisionsEffective Decisions

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Page 5: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

Liabilities

Investment Benchmark

Staff Structuring

Actual Portfolio/ External Managers

1.28%

1.68%

18.09%

ρ = -0.45

2%

17.76%

Risk: SAA is Critical; TAA can Lower

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Page 6: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

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Frequent Pension Plan Decisions

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Page 7: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

Case Study - Client Portfolio Structure

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Page 8: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

Effective Decision Making Steps

� Low asset correlations allow “informed decision making”

� Identify rule ideas to allocate across asset classes

� Select criteria for rule/strategy evaluation (excess return, information ratio, skill, success rate, drawdown)

� Analyze rule performance, test different strategies (rule combinations) - diversification benefits not obvious

� Test alternative policies to see cost of constraints

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Page 9: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

Simple/Intuitive Rules Tested

Overweight equity market with the stronger currency (higher interest rate)US/EAFE: LIBOR Rates

Overweight equity market which has underperformed over past year (i.e., buy the laggard)

US/EAFE: Favor Underperformer

Rule DescriptionRule

Buy stocks when the unemployment rate is falling (good for economy)Unemployment Rate

When equity yield is higher than treasury yield then buy equity, else sell equityFed Model

Value rule for equity (vs FI) using the S&P 500 P/EP/E Ratio Rule

Rising oil prices affect the economy and tend to depress equities.Oil and Economy

Low equity volatility in a rising stock environment is bullish for equities.Market Volatility

Equities undervalued when inflation rises (Modigliani-Cohn insight); equities favored when industrial production is increasing

Stocks vs Bonds: Inflation/Growth

Stocks tend to underperform bonds between June and Sept - apparently works in 16 out of 18 stock markets, so underweight stocks during this period

Stocks vs Bonds: Halloween Effect

Duration choice based on price of gold. If the spot price of gold is higher than it was a year ago, overweight cash, otherwise overweight bonds

Cash vs. Bonds, based on Gold

Page 10: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

Rule Performance (1998-2004)

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Page 11: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

Strategies (Mix of Rules) Tested

3 Highest αααα and 3 Lowest Risk - Cash vs Bonds, Halloween Effect, P/E Ratio, Unemployment Rate, US/EAFE: LIBOR Rates, US/EAFE: Favor Underperformer (all equally weighted)

Combination of

Rules: Strategy 3

6 Lowest Annualized Standard Deviation (Risk) - Cash vs Bonds, Oil and Economy, P/E Ratio, Unemployment Rate, US/EAFE: LIBOR Rates, US/EAFE: Favor Underperformer (all equally weighted)

Combination of

Rules: Strategy 2

Strategy DescriptionStrategy Name

Quarterly Rebalancing to Benchmark Weights

6 Best Excess Annualized Returns (αααα) and Information Ratios –Cash vs Bonds, Halloween Effect, Inflation/Growth, Fed Model, Unemployment Rate, US/EAFE: Favor Underperformer (all equally weighted)

Combination of

Rules: Strategy 1

Rebalance to Benchmark Weights when Range of +/-5% BreachedRebalancing II

Rebalancing I

Page 12: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

Strategy Performance (1998-2004)

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Page 13: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

Small Allocation Deviations

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Page 14: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

Relaxing Asset Limits to +/- 10%

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Page 15: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

Case Study is Tip of Iceberg

� Each decision is an opportunity for more returns/risk management

� More tiers = greater diversification, efficacy = more returns

– Within asset classes (Fixed Income, Equities, Currencies)

– Managers: Active versus passive and across managers

� Leverage asset managers to generate research ideas for decisions

� Rule were equally weighted; opportunity to further improve

� Evaluate ideas in isolation as well as part of a total portfolio(aggregation produces results that are not obvious)

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Page 16: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

Multi-Tiered Alpha Aggregation

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Page 17: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

AlphaEngineTM: Empower Clients

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Page 18: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

Summary

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Page 19: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

AppendixAppendix

Page 20: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

Pension Fund Risks: Measure & Manage

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Page 21: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

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Decision Process and Framework

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Page 22: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

Stocks vs. Bonds: Halloween Effect

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Page 23: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

Investment Grade vs. HY: Equities

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Page 24: Portfolio Asset Allocation – Strategic vs Tactical · SAA vs. TAA – Key Issues SAA and TAA complement each other Active management can lower risk/enhance returns – How to develop

Appendix: Correlations (1998-2004)

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