turning theory into reality -...
TRANSCRIPT
Absolute return and alpha overlay
21 November 2007
Turning theory into reality
Jean-Charles Bertrand,Global Head of Fixed Income and Absolute Return strategies
Presentation only intended for professional investors
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g Portable alpha is the process that adds sources of return in excess of the underlying asset class (beta) while maintaining the systematic exposures
g Portable alpha has been more talked about than implemented but it is becoming a reality: Growing acceptance of the use of derivativesDevelopment of LDI approach
Portable Alpha and alpha overlay
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g Portable alpha can be generated mainly in two ways: Invest in a portable alpha strategy where the manager purchases securities and use derivatives in order to adjust the systematic exposures Invest in an alpha-generating portfolio consisting entirely of derivatives which uses very little cash and provides an alpha that can be applied over the strategic allocation (alpha overlay)
g Main advantages of alpha overlay strategies: Can be attached to any asset class. No need for liquid derivatives to take the beta exposureCan be easily calibrated in order to meet clients’ risk levels
Portable Alpha and alpha overlay
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g Numerous sources of alpha for a better diversification
g Sources of alpha should be uncorrrelated to each other
g Last but not least, they should also be uncorrelated to betas
When is alpha transportation optimal?
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g Alpha transportation has to be based on a very good knowledge of the sources of alphaSkills and faith in the manager’s abilityTransparency of alpha sourcesInformation advantage for the manager in using in-house sources
g Alpha sources can also be provided by third parties They really do exist…… but there is a need to know them well in order to efficiently manage related risk
Alpha diversificationWhich alpha to transport?
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Mixing uncorrelated alpha sources: A very simple rule
g When mixing uncorrelated alpha sources, the risk contribution of each alpha source should be proportional to its Sharpe ratio:
the global performance will then be maximised for a given total alpha risk budget
g Consider i ∈ [1, 2,…, n], a group of independent sources of alpha i has a Sharpe ratio of SRiThe total alpha risk budget is σTotal .The optimal individual risk budget is
TotalSR
SRi
ii
i σσ∑
=2
Alpha diversification
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Mixing uncorrelated alpha sources increases the Sharpe ratio
0.0
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0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%Sh
arpe
Rat
io o
f the
str
ateg
y Risk contribution of alpha source 1
Risk contribution of alpha source 2
Correlation = 0%
Correlation = 100%
g Hypothesis: SR of alpha source 1 = 1.5SR of alpha source 2 = 0.75
Highest SR = 1.68 with 67% of alpha source 1 and 33% of alpha source 2
Source: SINOPIA – For illustrative purpose only
Alpha diversification
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g When the alpha sources are not independent, one must take into account the correlation between the performance engines
⇒ Individual SharpeRatios
⇒ Correlationbetween drivers
allocation of risk budget
α source 1α source 2
α source 3
α source 4
α source 5
Sharpe ratio can be significantly improved by mixing numerous alpha sources
Alpha diversification
Source: SINOPIA
Mixing alpha sources
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Alpha diversificationMixing alpha sources: Structuring an optimal alpha portfolio
Source: Bridgewater Associates’ article: « Engineering Targeted Returns and Risks » written by Ray Dalio, President and Chief Investment Officer.
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Sources: EDHEC, Fung & Hsieh, Agarwal & Naik
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Fixed IncomeArbitrage
Convertible Arbitrage
MergerArbitrage
Distressed securities
Long/ShortEquity
Global Macro
CTA Global
Impliedvolatility
Change in impliedvolatility
Small Cap vsLarge CapS&P 500 Credit
spreadChange in credit
spreadLehman Global
Bond IndexOptionalstrategy
+
Traditional assets Credit Liquidity Volatility Options
Alternative strategies have systematic exposures to risk factors
How to differentiate between alpha and beta?
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g Alpha is the additional performance above the strategic portfolio’s strategic return:
g How to define « pure alpha »?
Specific Systematic
pure alpha and Σ betasj * alternative factors j
"alpha"
Cash return or rate that best neutralizes risk
Value added by investment manager
Excess market/asset class return over risk-free rate
Portfolio return = risk free rate + Σ betasj * traditional factorsj + alpha
g Only pure alpha is uncorrelated to betas…
How to differentiate between alpha and beta?
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SINOPIA's pure alpha generation
g Alpha is created through relative value or tactical exposure to markets
g SINOPIA can extract alpha from all major international markets
g SINOPIA’s innovative alpha solutions are designed to be:lowly correlated with other asset classes to improve the portfolio’s risk-return profilebased on the conviction that active management of selected performance drivers and consistent investment process will lead to stable outperformancestrongly focused on risk management
How do we do it?
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g Long/short positions in OECD equity marketsg Zero betag Currency risk hedged
g Overall long or short position on global equity (MSCI world)Equities
g Long/short positions in developed OECD currencies (11)Currency Overlay
g Capture the volatility risk premium by taking short option positions (equity markets)
g Market risk systematically hedgedVolatility
SINOPIA’s alpha sources
* Breakeven inflation: difference between the nominal yield of a bond and the real yield of an ILB with the same maturity and issued in the same country / region - ** credit spread: difference between the yield of a corporate bond and the yield of a government bond with the same maturity, denominated in the same currency - *** Emerging credit spread: difference between the yield on an emerging-market nominal bond issued in a hard currency (EUR or USD) and the yield on a developed-country nominal bond with the same maturity and denominated in the same currency
Relative Value Tactical exposure
g OECD government bond marketsg Long and short positions / shift and rotation factorsg Zero duration and beta
g Overall long or short position on the shift and rotation factors in the global bond market (JP Morgan Global)
Nominal government bonds (NBs)
g OECD government bond marketsg Long and short positionsg Near-zero sensitivity to breakeven inflation *
g Overall long or short position in breakeven inflation in all OECD countries
Inflation-linked bonds (ILBs)
g Investment grade (euro zone)g Long and short positions on sectorsg Near-zero sensitivity to the overall credit spread **
g Overall long or short position on the overall credit spreadCorporate bonds
g EMBI universeg Long and short positionsg Near-zero sensitivity to the emerging market spread***
g Overall long or short position on the emerging sovereign spreadEmerging bonds
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SINOPIA Global Macro (open-ended fund)
Tactical ExposureVolatility
Tactical Exposure
Relative ValueCurrencyOverlay
Tactical Exposure
Relative ValueEquities
Tactical Exposure
Relative ValueEmergingBonds
Tactical Exposure
Relative ValueCorporateBonds
Tactical Exposure
Relative ValueInflation linkedbonds
Tactical Exposure
Relative ValueGovernmentBonds
Multi Fixed Income Strategies (open-ended fund)
Tactical ExposureVolatility
Tactical Exposure
Relative ValueCurrencyOverlay
Tactical Exposure
Relative ValueEquities
Tactical Exposure
Relative ValueEmergingBonds
Tactical Exposure
Relative ValueCorporateBonds
Tactical Exposure
Relative ValueInflation linkedbonds
Tactical Exposure
Relative ValueGovernmentBonds
Customized solutions
?Tactical ExposureVolatility
?Tactical Exposure
?Relative ValueCurrencyOverlay
?Tactical Exposure
?Relative ValueEquities
?Tactical Exposure
?Relative ValueEmergingBonds
?Tactical Exposure
?Relative ValueCorporateBonds
?Tactical Exposure
?Relative ValueInflation linkedbonds
?Tactical Exposure
?Relative ValueGovernmentBonds
Through open funds or via a customised solutionExamples of multiple alpha solutions
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g Client's needs and constraints:A global fixed-income overlay mandate20 millions Euros ex-ante 95% 1 mth VaR as a risk budget
g Sinopia’s proposal:A Pure Alpha Strategy – ability to go long and short. Any Beta exposure is based on outright Active Risk (or tactical positions)Multiple alpha sources on the different fixed income markets giving an uncorrelated profile of returns
Case studyRFP for a major European pension fund (2006 - 2007)
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Multi Fixed Income StrategiesSinopia’s proposal
Relative Value Tactical exposure
OECD government bond marketsLong and short positions / shift and rotation factorsZero duration and betaFutures, swaps, government securities
Overall long/short position on the shift androtation factors in the global bond market (JP Morgan Global)Futures, swaps
Nominal governmentbonds (NGBs)
OECD government bond marketsLong and short positionsZero sensitivity to breakeven inflation1
Inflation swaps
Overall long/short position in breakeven inflation in OECD countriesInflation swaps
Inflation-linked bonds (ILBs)
Investment grade (euro zone)Long and short positions on sectorsZero sensitivity to the overall credit spread2
Credit DefaultSwaps
Overall long/short position on the overall creditspreadCredit Default Swaps
Corporate bonds
EMBI universeLong and short positionsZero sensitivity to the emerging market spread3
Credit Default Swaps, government securities
Overall long/short position on the emerging sovereign spreadCredit Default Swaps, government securities
Emerging sovereignbonds (ESBs)
1 Breakeven inflation: difference between the nominal yield of a bond and the real yield of an ILB with the same maturity and issued in the same country / region2 Credit spread: difference between the yield of a corporate bond and the yield of a government bond with the same maturity, denominated in the same currency3 Emerging sovereign credit spread: difference between the yield on an emerging-market nominal bond issued in a hard currency (EUR or USD) and the yield on a developed-country nominal bond with the same maturity and denominated in the same currency
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Allocating the risk budgetSinopia’s proposal
Source: Sinopia - * These values are not fixed limits and may be exceeded
⇒ Individual Sharperatios
⇒ Correlation between tacticadriversl
Average strategic allocation of the risk budget
Tactical allocation of the risk budget
Corporate spread - Tactical ILBs
- Tactical
NGBs- Tactical
ILBs - Relative Value
NGBs- Relative Value
ESBs - Relative Value
Corporate spread - Relative Value
ESBs - Tactical
9% 13%7%
6%
38%
9%9%
9%Expected performance (tactical and relative)
of the differentfixed income asset classes
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Use of the risk budgetSinopia’s proposal
g The risk budget should not be constant but should vary depending on the strength of opportunities
g The strategy is calibrated by taking into account an average value of 20 millions Euros for the monthly 95%
g A maximum value for the VaR is defined (for example 25 millions) in order to avoid excessive risk-taking
g Methodology for VaR calculation: RiskmetricsMultivariate GARCH approach
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Fund Segregated account/mandate
g All-in solution
g Operational process (derivatives handling) as well as all the legal aspects fully taken care of by the asset manager
g Client name can remain confidential to market counterparts
g Stronger external control (the fund accounts are audited by external auditors)
g Custodian and fund administration done by third parties and included within the fees
g Daily NAV and positions available
g One line accounting might be possible … but depending on the client applicable accounting rules, a dedicated fund may need to be consolidated in the client accounts
g Lower cash requirements because credit worthiness of sponsor can be used in negociating swaps… but mechanical commitment to provide margin calls or swap collateral if needed
g Full transparency on positions… provided the client (and/or its custodian) has the required capacity
Advantages
g Higher cash requirements (collateral, margin calls) g A solution requiring client’s involvement in the operational process (OTC counterparts approval process, legal aspects, NAV calculation), and line by line integration of the portfolio positions in the client’s accounting.
g Heavier operational set-up
Drawbacks
The structure: Fund vs segregated account/mandate
Sinopia’s proposal
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Tasks description and responsibilities
xxReconciliation with Clearer statementsxCheck costs/interestxAuthorise payment cost/interestxSend payment instruction to the Bank (for cost/interest) and a copy to HSS France
xTransfer payment (of cost/interest) to Clearer
xTransfer capital to the bank accountxSend capital call to Client when cash balance is not sufficientxGeneral: check if the cash balance is sufficient to process a payment
xAccountingxxSend daily NAV to Client
xCheck Daily NAV (incl. Monthly)xxDaily NAV (incl. Monthly)
xTransfer payment (of margin call) to ClearerxSend payment instruction to the Bank (for Margin call) and a copy to HSS FrancexAuthorize margin callxCheck margin call (+ consistency checks of clearer statement)
xSend margin call and statementxSettle transaction
xCheck confirmationxSend transaction to HSSxCheck transactionxExecute Transaction
xInitiate transaction
ClientClient ClearerClient CustodianHSBC Securities ServicesSinopiaSteps in the process
ResponsibleFutures
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Tasks description and responsibilities
xTransfer payment to the counterpartyxSend monthly interest statements to client
xCheck interest statement
xCredit event notification: when the mandate has bought the protectionxCredit event notification: when the mandate has sold the protection
xCredit event: notify client about credit eventxCredit event: payment check and authorisationxCredit event: transfer payment instruction to the bank
xxCredit event: payment to / from the counterpartyxGeneral: check if the cash balance is sufficient to process a payment
xAuthorise payment
xInitiate swap unwind
xSend payment instruction to the Bank (collateral)
xCalculate payments (unwind payment, initial premium for iTraxx)xCalculate interest paymentsxCheck payment with the counterparty
xSend payment instruction to the bank (interest, unwind, premium)xTransfer payment to counterparty
xTransfer capital to the bank accountxSend capital call to Client when cash balance is not sufficient
xCredit follow-upxAccountingxSend daily NAV to Client
xCheck Daily NAV (incl. Monthly)xDaily NAV (incl. Monthly)
xExecute swap unwind
xNetting of all swaps collateral payments with counterpartiesxSend daily collateral statements & margin request to client
xSend daily MtM to the clientxCalculate MtM swaps
xConfirm via Swaps Wire (IRS) or DTCC (CDS)xSend transaction ticket to HSSxCheck transactionxExecute TransactionxInitiate transaction
ClientCounterpartiesClient CustodianHSBC SecuritiesServices
Sinopia Fund ManagerSteps in the process
ResponsibleSWAP & CDS
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Calculating the return of an equivalent funded strategyPerformance measurement
g Definition of a Notional Amount (NA) based on a volatility assumption (3%) :NA = VaR 95% 1 yr /(1.65*3%)
g Equivalent Funded AUM (EFAUM) and Equivalent Funded Strategy market Value (EFSVM) defined as :
EFAUM = NA + Cumulated P&L since inceptionEFVSM = EFAUM – Sum of [Daily Assets Provided * daily risk free rate] since inception + Sum of [Daily NA * Daily Risk Free rate] since inception
( )
month beginning
month beginning
month beginningend-month
EFSMV
Pr&100
EFSMVEFSMV-EFSMV
100Re
∑ −×+×=
×=
ovidedAssetsdailyNAdailyrateFreeRiskdailyLP
monthaforturn
monththeover
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g Growing interest in Portable Alpha strategiesA concept which has turned into existing investment solutionsAn efficient way to implement it: alpha overlay strategies
g There are multiple solutions and essential considerations requiring a good knowledge of the sources of alpha to find the best customised solution
g What makes Sinopia a legitimate player in alpha overlay managementAbility to deliver pure alphaTransparencyAbility to fit the clients' constraints: financial aspects, risk management, operations (counterparts, custodians, etc.)Flexible implementation adapting to the evolution of the clients’ needs
Turning theory into realityAbsolute return and alpha overlay
SINOPIAAsset Management
Quantitative specialist of the HSBC Group
26 janvier 200
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HSBC Group Investment Businesses
HSBC Investments
Halbis
SINOPIA
Core business
256.4 billion euros in assets under management1
Source: HSBC Investments (France) – 1 as of 29 June 2007
Recognised within the HSBC Group as the specialist quantitative asset manager
HSBC’s core investment and distribution platform
Specialist businesses
A fundamental active investment specialist
A leader in quantitative asset management
SINOPIA Asset Management
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g Founded in 1989, member of the HSBC Group since 2000
g Forerunner in introducing active quantitative management to Europe
g Headquartered in Paris with international subsidiaries in London and Hong Kong
g Over EUR 33.4 billion assets under management as of 29 June 2007
Company overview
Billion euros
68
1416
21
32.5 33.4
0
5
10
1520
25
30
35
40
2001 2002 2003 2004 2005 2006 June 20071
Source: SINOPIA Asset Management – 1 as of 29 June 2007
SINOPIA Asset Management
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SINOPIA Asset Management
Source: SINOPIA Asset Management – 1 allocation as of 29 June 2007
Guaranteed and structured products
18.9%
Absolute Return 25.8%
Equity41.7%
Fixed Income13.6%
Intermediaries50%
Institutionals50%
A single core business: quantitative asset management
g Providing innovative investment solutions with the aim of delivering consistent outperformance while minimising trading costs in a risk-controlled environment
g Over EUR 33.4 billion assets under management as of 29 June 2007
Assets Under Management by investment type1
Assets Under Management by client type1
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SINOPIA is a key player in Absolute Return Strategiesg Launch of the first single strategy Absolute Return fund in March 2001 (Global Bond
Market Neutral strategy)
g Launch of two Multi-Strategy funds in 2006 (Global Macro, Multi Fixed Income Strategies)
g Dedicated Absolute Return team created in 2004
g Top 5 Europe Hedge Funds (Institutional Investor Jan-Feb 2006)
SINOPIA has been awarded "Best Alternative Investment Manager of the Year" at the UK Pensions Awards 2007*
The awards aim to recognise the providers that offer the highest level of service to occupational pension schemes and their members. Nominees were judged against set criteria - innovation, communication, performance and service standards - and also asked to submit a general overview. Innovation was the most significant criteria (30% of the total). The submissions were being considered by a panel of judges made up of professionals from across the occupational pensions industry.
SINOPIA has been awarded "Best Alternative Investment Manager of the Year" at the UK Pensions Awards 2007*
The awards aim to recognise the providers that offer the highest level of service to occupational pension schemes and their members. Nominees were judged against set criteria - innovation, communication, performance and service standards - and also asked to submit a general overview. Innovation was the most significant criteria (30% of the total). The submissions were being considered by a panel of judges made up of professionals from across the occupational pensions industry.
Past performance is no guarantee of future results
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This presentation is produced and distributed by HSBC Investments (France) and is only intended for professional investors as defined by the European Directive, MIFID. It is incomplete without the oral briefing provided by the representatives of HSBC Investments (France) and/or the management company.
The commentary and analysis presented in this document reflect the opinion of Sinopia Asset Management on the markets, according to the information available to date. They do not constitute any kind of commitment from Sinopia Asset Management. Consequently, neuther Sinopia Asset Management nor HSBC Investments (France) will be held responsible for any investment or disinvestment decision taken on the basis of the commentary and/or analysis in this document. All data from Sinopia Asset Management unless otherwise specified. Any third party information has been obtained from sources we believe to be reliable, but which we have not independently verified.
The funds presented in this document may not be registered and/or authorised for sale in your country. Capital is not guaranteed. Fluctuations in the rate of exchange of currencies may have a significant impact on fund performance. Unless stated otherwise, equity indices are not with dividends reinvested.Please note that according to article 314-13, performance for periods of less than 12 months cannot be shown to non-professional investors, as defined by the MIFID directive.
HSBC Investments represents Sinopia throughout the world; it is responsible for the business relationship and provides client services both in France and abroad, as part of a strategic partnership.
This presentation is not intended for general distribution, it is provided on specific request.
Transactions in derivatives are likely to make considerable profits, but they also entail substantial risks. An investment in the SINOPIA Alternative Funds (SAF) should be considered in the light of the financial condition of the investor. Since an investment in such a Fund represents an above average risk, the Fund in question is only suitable for those persons who can afford to take such risks; it is advisable for sophisticated investors to invest therein only a part of the sums such investor intends for a long-term investment.
The term Sinopia Asset Management ("Sinopia") refers to a business engaged in fund management activities, which are ultimately owned by HSBC Holdings plc. Sinopia's registered office is in Paris: Immeuble Ile de France - 4 place de la Pyramide - La Défense 9 - 92800 Puteaux - France, and has subsidiaries in London and Hong Kong: Sinopia Asset Management UK Limited - Sinopia Asset Management Asia Pacific Limited - Portfolio management company - 379 837 800 RCS NANTERRE - AMF authorisation no. GP97142.
All subscriptions in any fund presented in this document are accepted only on the basis of the current prospectus, available on request from HSBC Investments (France), the centralisation agent, the financial department or the usual representative. Before subscription, investors should refer to the prospectus for more detailed information on the risks associated with this fund.
"HSBC Investments (France) - 421 345 489 RCS Nanterre. Portfolio management company authorised by the French regulatory authority AMF (no. GP99026) Postal address: 75419 Paris cedex 08Offices: Immeuble Ile de France - 4 place de la Pyramide - La Défense 9 - 92800 Puteaux - France"www.hsbcinvestments.fr
Non contractual document, updated on : 15/11/2007