Transcript btaconf.kz
Alternative Fund Linked Derivatives
Portable Alpha, Absolute Return Strategies & Capital Preservation Techniques VIII ALMATY INTERBANKING CONFERENCE 27
th
September 2007
Agenda 1. What do we mean by Alpha
α
2. Absolute Return Strategies 3. Capital Preservation Techniques
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What do we mean by Alpha?
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What do we mean by Alpha?
An actively managed traditional long only fund (or portfolio’s) return is broadly based on two constituents: The first is beta, i.e. the extent to which such fund moves with the market - thus representing the passive return or increase in the value along with the overall market; and fund’s The second is alpha, i.e. a measure of a manager’s ability to generate returns by choosing investments that out perform the market.
“Alpha” can be considered the “excess return” generated by an actively managed fund vis à-vis a particular market index (or risk free rate) and is increasingly a common way of assessing such manager’s performance.
In simple terms, “manager skill” can be expressed as follows:
Fund Alpha α = Fund Performance – Market Beta β
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What do we mean by Alpha?
The following example demonstrates how a relatively small amount of alpha can accumulate over time to make a meaningful impact on overall performance.
However, since alpha can be both positive or negative, an active manager that fails to generate returns in excess of the market - but instead under-performs the market - can be thought to generate negative alpha.
Accordingly, manager selection is crucial to the success of an alpha strategy.
Fund Return
100%
Out-performance / Under-performance + Benchmark Return (i.e. Asset Class Performance) = alpha = beta alpha = Out-performance over benchmark 160% 140% 120% 100% 80% 60% 40% 20% Total Return -20% Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Fund Performance Benchmark Jan-06
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What do we mean by Alpha? Positive alpha can be generated in different market conditions:
Fund delivers higher return than benchmark in up markets.
Performance Fund delivers positive return when benchmark delivers negative returns.
Fund delivers less negative return than benchmark in down markets.
Performance Performance Fund Return Asset Class Return (beta ) Out-Performance (alpha)
In this example, alpha represents the out-performance of a fund relative to the market and may be positive in both up and down markets as long as the manager is able to out-perform its benchmark.
Manager Skill can generate alpha in rising, falling & side-ways markets
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Case Study #1: Isolating Alpha
α
EM Bond Alpha α
Alpha
α
seeks to capture the “ manager skill ” or out- performance of the Insight Emerging Market Bond Fund USD (EM Bond) over the JP Morgan EMBI Global Insight EM Fund USD
200% 180% 160% 140% 120% 100% Insight EM Alpha 80% Aug-03 Feb-04 Aug-04 Feb-05 Aug-05 Feb-06 Aug-06 Feb-07 Aug-07
A long notional position in EM Bond coupled with a short notional position in the EMBI Global powers the Alpha
α
engine.
160%
JP Morgan EMBI Global
Index 140% 120% N.B. Graphs are for illustrative purposes only and are gross of any fees. Past performance is not indicative of future results.
Source: ABN AMRO 100% 80% 60% Aug-03 Feb-04 Aug-04 Feb-05 Aug-05 Feb-06 Aug-06 Feb-07 Aug-07
Alpha α
200% 180% Index Insight EM Alpha 160% 140% 120% 100%
Alpha
80% Aug-03 Feb-04 Aug-04 Feb-05 Aug-05 Feb-06 Aug-06 Feb-07 Aug-07
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Case Study #1: Insight Investment Management
Insight Alpha α
The Insight Fund has consistently delivered significantly more positive than negative alpha vis à -vis the Index.
For the period observed, the Alpha
α
has on average yielded 0.4% a month.
Monthly Returns Aug-03 10% Feb-04 Aug-04 8% 6% 4% 2% 0% -2% Feb-05 -4% -6% Cumulative Outperformance Aug-05 Feb-06 Aug-06 Feb-07 Aug-07
N.B. Graphs are for illustrative purposes only and are gross of any fees. Past performance is not indicative of future results.
Source: ABN AMRO 200% 180% 160% 140% 120% 100% 80% Jun-03 Outperformance Index Insight EM Alpha 40% 35% 30% 25% 20% 15% 10% 5% 0% Feb-04 Sep-04 Apr-05 Nov-05 Jun-06 Feb-07
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Absolute Return Strategies
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Absolute Return Strategies
Absolute Return Strategies differ from traditional relative return strategies in that they are concerned with the actual return of a particular asset and do not generally compare to any other measure or benchmark.
A mutual fund typically seeks to produce returns that are better that its peers, its fund category, and/or the market as a whole. This type of fund management approach is referred to as relative return. An Absolute Return Strategy seeks to make positive returns by employing investment management techniques that differ from traditional mutual funds.
Absolute return investment techniques include using short selling, futures, options, derivatives, arbitrage, leverage and unconventional assets.
Alfred Winslow Jones is credited with establishing the first absolute return fund in New York in 1949. More recently, approach to absolute return fund investing has become one of the fastest growing investment products in the world and is more commonly known today as Hedge Funds!
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Absolute Return Strategies Why invest in Absolute Return Strategies
Superior and Sustainable Risk Adjusted Returns Uncorrelated to Traditional Asset Classes (Zero Beta) Market Neutral Investment Strategies Access to alternative and sophisticated investment techniques:
Absolute return investment techniques include short selling, futures, options, derivatives, arbitrage, leverage and unconventional assets.
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Certain strategies within the Hedge Fund space have tended to outperform others over time
Diversification enables consistent outperformance through time and lower volatility than pure single strategy exposure
Variety of Absolute Return Styles
Hedge Fund Strategies
250% 200%
Equity Neutral Event driven Dedicated Short Bias Managed Futures Convertible Arbitrage
150% 100% 50% 0%
Jan-00 Oct-00 Jul-01 Apr-02 Jan-03 Oct-03 Jul-04 Apr-05 Jan-06 Oct-06 Jul-07 Diversification 1000% 900% 800% 700% 600% HFRI Composite MSCI World Equity 500% 400% 300% 200% 100% 0% Aug-90 Nov-91 Feb-93 May-94 Aug-95 Nov-96 Feb-98 May-99 Aug-00 Nov-01 Feb-03 May-04 Aug-05 Nov-06 12
Case Study #2: Diversified Fund of Hedge Funds Why choose a large diversified Fund of Hedge Funds?
Cover a wide range of strategies, regions, sectors and investment objectives in order to create stable returns.
Allocate assets to established and new independent investment managers to diversify risk and gain exposure to a range of investment opportunities.
Fund updates including asset allocation and top managers are made available on a monthly basis.
Typically no leverage on fund of funds level.
Diversification by inclusion of up to 100 underlying funds, 11 different strategies and four investment regions both developed and emerging over all asset classes.
Superior historical returns compared to traditional asset classes with relatively lower associated volatility as measured by standard deviation.
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Case Study #2: Permal Investment Management
US Long.Short
30%
Multi-Manager Multi-Strategy Multi-Style Global diversification Balanced, diversified exposure to U.S. and global financial markets employing long/short and global macro strategies.
Event Driven 7% Europe Long/Short 8% Japan Long/Short 7% Global Macro 16% Other 2% Global Equity Long 15% Emerging Markets 6% US Emerging Grow th 9% Annualised Return Vs Traditional Investments 1 Year 3 Years 5 Years Inception Date (March 1992) Permal Investment Holdings 16.57% 13.23% 11.87% 11.14% AEX Index 17.60% 17.39% 7.99% 9.24% Volatility Citigroup World Bond Index 5.06% HFR FoF Hedge Fund Index 15.04% 4.50% 6.71% 10.78% 9.18% 6.61% 9.26% 1 Year 3 Years 5 Years Inception Date (March 1992) 3.12% 5.68% 5.74% 8.85% 8.38% 10.24% 19.34% 19.00% 5.95% 5.87% 6.76% 6.33% 2.29% 3.89% 3.49% 5.57% Returns shown are net after fees. Past or projected performance is not necessarily a guide to future results. The value of the investment may go down as well as up. Data as of July ’07.
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Case Study #3: Thematic Fund of Hedge Funds Why focus on emerging managers?
2.5% 2.0% 1.5% 1.0% 0.5% 10 50 100
AUM
（
US$1 Million
） 500 1000
Source: Infiniti Capital AG
Emerging Hedge Fund Mangers have demonstrated an ability to outperform:
Easier to deploy capital in profitable trades More agile and faster with their investments Significant personal net worth in their fund Eager and hungry - Investing in future capacity Non-correlated to established managers 15
Case Study #3: Infiniti Capital
300%
Simulated Historical Returns (Jan-00 to May-07)
250% 200% 150% 100% 50%
Conquistador II Sub Trust Credit Suisse Tremont Investable Hedge Fund Index Citigroup World Govt Bond Index S&P 500
0% Aug-99 Feb-00 Aug-00 Feb-01 Aug-01 Feb-02 Aug-02 Feb-03 Aug-03 Feb-04 Aug-04 Feb-05 Aug-05 Feb-06 Aug-06 Feb-07 Aug-07 Source: ABN AMRO, Infiniti Capital AG, Bloomberg, Data as of July 07
Risk / Return Profile
14% 12% 10% 8% 6% 4% 2% 0% 0% -2% 2% 4% 6% 8% 10% 12% 14% Conquistador II Sub Trust Credit Suisse Tremont Investable Hedge Fund Index Citigroup World Govt Bond Index S&P 500 Source: ABN AMRO, Infiniti Capital AG, Bloomberg, as of July 07 16% The Conquistador II Fund has
outperformed
both the Credit Suisse Tremont Investable Hedge Fund Index and the S&P 500 Index The Fund also offers
low volatility…
1.
Please note all data referring to the Conquistador Fund II is simulated prior to January 2007, and is provided by Infiniti Capital AG. Simulated past performance is not indicative of future results
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Capital Preservation Techniques
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Capital Preservation Techniques
Static guarantee with fund exposure
Static guarantee with call option exposure
Vanilla dynamic guarantee (CPPI)
Continuous dynamic guarantee (PCPI)
Dynamic versus Static comparison
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Static guarantee with fund exposure Structure Overview:
Investor purchases Medium Term Note (MTN) Issuer allocates X% of the issuance proceeds to Zero Coupon Notes priced to mature at Par 100% Issue price less X% ZCN is allocated/committed Component (or to “risky asset”) the Fund Investor receives 100% + value of the Fund Component at maturity
Why choose Bond & Fund Structure?
Cost effective guaranteed structure for illiquid or hard to mark assets Medium Term Notes can be rated (per Issuer), listed, transferable, marked to market, pledged as collateral, repo’d –
but can not be typically unwound prior to intended maturity
Cash X%
Guarantee Component Investor Issuer
Notes 100% - X%
Fund Component 19
Static guarantee with call option exposure Structure Overview:
Investor purchases Medium Term Note (MTN) Issuer allocates X% of the issuance proceeds to Zero Coupon Notes priced to mature at Par 100% Issue price less X% ZCN is used to purchase Call Options on the risky asset Investor receives 100% + value of the Fund Component at maturity
Why choose Bond & Call Structure?
Higher (geared) exposure to risky assets & certainty of payout (vis à-vis dynamic structures) Medium Term Notes can be rated (per Issuer), listed, transferable, marked to market, pledged as collateral, repo’d –
and offer improved liquidity, typically with associated break costs
Cash X%
Guarantee Component Investor Issuer
Notes 100% - X%
Call Option 20
Vanilla dynamic guarantee (CPPI) Structure Overview:
Investor purchases Medium Term Note (MTN) Issuer employs Constant Proportion Portfolio Insurance (CPPI) technique to allocate Note’s issuance proceeds amongst the three components that typically comprise the “CPPI Index”: The Fund Component (
FC
) consists of a notional investment in the risky assets The Cash Component (
CC
) consists of a notional loan extended by the Issuer to provide leveraged exposure to the
FC
or a cash deposit (e.g. when de-leverage has occurred) The Bond Component (
BC
) consists of a notional investment in Zero Coupon Notes to ensure that in a “cash-out” event a minimum of 100% is repaid at maturity
Cash
Fund Component (FC) Investor Issuer Bond Component (BC)
Notes
Cash Component (CC) 21
Vanilla dynamic guarantee (CPPI)
Participation typically = Min ( CAP , ( EG x M ) )
If the ratio of the
FC
(or Participation) over the Equity Gap (
EG)
decreases below pre-defined trigger levels (e.g. 4.5) a reallocation from
CC
to
FC
will occur.
where EG = Equity Gap between the CPPI Index and the price of the implied bond floor (or“zero”), M = Multiplier (e.g. 5), & CAP = Leverage Cap (typically 150%)
If the ratio of the
FC
pre-defined trigger levels (e.g. 5.5) an allocation (or the
FC
to the least, a (or Participation) over the Equity Gap increases above
CC
will follow.
“de-allocation”) from The Issuer guarantees against Gap Risk, thus ensuring that, at the very Client’s initial principal investment is returned at maturity.
Positive returns above the principal amount protected by the Note are paid to Note holders at maturity.
N.b. the maximum leverage cap for fund-linked CPPI is dependant on the volatility of the underlying investments
Participation
G M
, where
M
= 5.
Then rebalancing would typically be triggered if
M
= (<4.5, >5.5)
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Vanilla dynamic guarantee (CPPI) Why choose vanilla CPPI?
Controlled leverage : more than 100% of the typically Note’s issuance proceeds are invested in
FC
at inception Soft landing: should Note NAV decline, exposure to the risky asset is reduced via the CPPI’s de-leveraging strategy Gap risk protection: should the Fund NAV decline sharply, a full allocation to
BC
may occur (i.e. a “cash-out” will be called) and the Issuer will cover any “short-fall” to ensure full 100% protection at maturity (Scenario 2) CPPI rewards good performance: embedded dynamic Leverage can help boost the Note NAV to out perform (Scenario 1) the Fund NAV 200%
NAV
100%
Equity Gap
Implied Bond Floor Protected Amount
Gap Risk
0% 0 Sample simulation 1 2 3 4
Time
(in Years) 5
This graph is for illustration purposes only.
6 7 Maturity
Note NAV (Scenario 1) Fund NAV (Scenario 1)
Note NAV (Scenario 2) Fund NAV (Scenario 2)
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Continuous dynamic guarantee (PCPI) Structure Overview:
Investor purchases Medium Term Note (MTN) Issuer employs Partial Continuous Portfolio Insurance (PCPI) technique to allocate Note’s issuance proceeds amongst the two components that typically comprise the “PCPI Index”: The Fund Component (
FC
) consists of a notional investment in the risky assets The Cash Component (
CC
) consists of a notional loan extended by the Issuer to provide leveraged exposure to the
FC
or a cash deposit (e.g. when de-leverage has occurred).
Cash
Fund Component (FC) Investor Issuer
Notes
Cash Component (CC) 24
Continuous dynamic guarantee (PCPI)
Participation typically = Min ( CAP , ( EG adj x M ) )
If the ratio of the
FC
(or Participation) over the “Partial” Equity Gap (
EG adj
) decreases below pre-defined trigger levels a reallocation from
CC
to
FC
will occur.
where EG adj = “Partial” Equity Gap between the adjusted CPPI Index and an agreed percentage of highest NAV, M = Multiplier, & CAP = Leverage Cap (typically 150%)
If the ratio of the
FC
FC to the CC will follow.
(or Participation) over
EG adj
defined trigger levels (e.g. 5.5) an allocation (or increases above pre “de-allocation”) from the The Issuer guarantees against Gap Risk, thus ensuring that, at the very least, a certain minimum percentage of highest NAV is available to the Client on an ongoing basis.
N.b. the maximum leverage cap for fund-linked CPPI is dependant on the volatility of the underlying investments
Participation
G
adj
M
, where
M
= 5.
rebalancing would typically be triggered if
M
= (<90% x M, >110% x M)
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Continuous dynamic guarantee (PCPI) Why choose vanilla PCPI?
In addition to the typical benefits of CPPI, the PCPI offers: Flexibility: Open ended structure Continuous Offering Immunity: No ‘pull-to-par’ effect of the Bond Floor No Interest Rate Sensitivity No permanent cash-out event Protection: percentage protects of the a certain highest investment value achieved since inception Funding: when issued as a Fund issuance proceeds can remain with the Issuer of the Fund 200%
NAV
100% 80% Equity NAV
Equity Gap
Minimum Protected Amount
Fund NAV
0% 0 Sample simulation 1 2 3
Time
(in Years) 4 5 6
This graph is for illustration purposes only and assumes a continuous protection level of 80%
7 Maturity
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Dynamic versus Static Comparison
Dynamic CPPI Structures Static Structures
The vast majority of Fund Linked Structured Products comprise of ”CPPI” style Principal Protected Notes.
Path-dependant Participation variable Initial participation usually >100% Participation increases with performance and/or tenor Interest rates relevant over lifetime Leverage & Participation variable Greater flexibility to incorporate coupons & distribution fees Pay-out at maturity is the greater of par and Note NAV
Path-independent Participation fixed Initial participation usually <100% Participation increases with the tenor of the Note Interest rates relevant at inception Leverage & Participation fixed Pay-out at maturity is equal to Par plus a pre-defined percentage of any out-performance of the underlying asset
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Delivered in:
MTN
SPV
Certificate
Schuldschein
TRS
Summary Overview
Protected Products
Securities, Derivatives or Funds providing participation to the performance of an underlying Fund, whilst protecting part or all of initial investment
Pass-Through Products
Securities linked to the performance of underlying Fund (or Fund-of-funds) No principal protection or leverage – mirrors performance of underlying Fund 1:1 (gross of fees)
Potential Benefits
Limited downside on actively managed investments Lowers the barrier of entry into new asset classes Regulatory treatment Reduces reputation risk Tax treatment Flexibility – possibility to include leverage and modify cash flow profile
Potential Benefits
Operationally easy access to fund investments – especially alternative investments Increased liquidity Possibility of hedging currency risk Regulatory treatment Tax treatment Mitigation of reputation risk
Leveraged Products
Securities, Derivatives or Funds providing leveraged participation to the performance of underlying Funds (or Fund-of-funds) Maximum loss is limited to the initial investment (limited liability)
Potential Benefits
Yield enhancement Limited recourse leverage Efficient use of capital Efficient risk budgeting – between asset classes and within a fund of funds portfolio Cost of leverage is still low – but increasing!!
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Contacts
Fund Linked Derivatives Marketing Team (Europe) Stephen Kingham
Global Head London +44 207 678 5449 [email protected]
Richard Patey
Director London +44 207 678 6137 [email protected]
James Galvin
Assistant Director London +44 207 678 5851 [email protected]
Fund Linked Derivatives Marketing Team (Asia) Pieter Oyens
Head of Asia Hong Kong (852) 2700-3170 [email protected]
Jackie Lin
Vice President Hong Kong (852) 2700-3165 [email protected]
Thomas Jamet
Vice President Hong Kong (852) 2700-3026 [email protected]
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