LMG Asset Allocation June 2010

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Presentation of the LMG Emerge Asset Allocation System.

Attention is paid to the flagship Mix strategy as well as to specialized AllEquity, Global Bonds and Emerging Markets Equity strategies.

Live performance for the period 2005(7) - 2010(5) is added as well.

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  • Once a quarter update the AUM
  • GTAA blue, the rest grey
  • LMG Asset Allocation June 2010

    1. 1. The LMG Emerge Asset Allocation System A Structured Approach Tailor-made Solutions to Portfolio Management Problems
    2. 2. Abstract <ul><li>GTAA is the 'linking pin' between the ALM/SAA and the ‘security picks' </li></ul><ul><li>LMG Emerge adheres to a structured bottom-up/top-down approach based on an innovative optimization methodology that can easily incorporate client constraints and tailor-making </li></ul><ul><li>Our GTAA advisory system is one of the most extensive in its kind . </li></ul><ul><li>It encompasses 5 asset classes (Equities, Bonds, Cash, Currencies and Gold) and 50 countries </li></ul><ul><li>Add-ons include: </li></ul><ul><ul><li>Direct link to LMG Emerge Manager Selection Approach </li></ul></ul><ul><ul><li>Extension with 50 additional countries (Frontier Markets) </li></ul></ul><ul><ul><li>Incorporation of Alternatives as an Asset Class </li></ul></ul><ul><li>The LMG Emerge GTAA framework has generated risk-adjusted out-performance </li></ul>
    3. 3. Abstract (2) <ul><li>Result: </li></ul>LMG Emerge Structured GTAA Extra layer for &quot;Alpha Generation&quot; Better &quot;Pension Fund Governance&quot; Improved &quot;Risk Control“ Can easily incorporate client requests and constraints Valuable source of important information that can be used elsewhere in the investment process
    4. 4. Presentation Outline Page  LMG Emerge Asset Allocation LMG Emerge GTAA: General, Process and Product Performance and Asset Class Allocation of Strategies 1 2 3 4 An Example: What we did and what we think today Appendix 1: Deliverables Appendix 2: How we would work together with your firm 5 A1 A2
    5. 5. 1. LMG Emerge * This chart does not represent a company organizational chart ** Based on a research cooperation started in 1997 (see also Markowitz, van Dijk; FAJ March-April 2003 and Mark Kritzman c.s., MIT working paper, February 2007) LMG Emerge: areas of expertise* Consultancy and Education/Training LMG Emerge GTAA LMG Emerge Manager Selection Markowitz-van Dijk Near Optimization ** LMG Emerge Emerging Markets
    6. 6. 1. LMG Emerge (2) <ul><li>LMG Emerge Global Tactical Asset Allocation (GTAA) </li></ul><ul><ul><li>Institutional and High Net-Worth clientele </li></ul></ul><ul><ul><li>Tailor-made strategies have been developed for end users in the US, UK, Switzerland, France, Germany, the Netherlands and Singapore </li></ul></ul><ul><ul><li>Further expansion into Asia and Emerging Markets envisioned </li></ul></ul><ul><ul><li>Integrated with LMG Emerge’s Manager Selection approach </li></ul></ul>
    7. 7. 2. Asset Allocation <ul><li>Gary Brinson et al.: &quot;The bulk of investment success or failure can be explained by asset allocation decisions&quot; </li></ul>
    8. 8. 2. Asset Allocation (2) <ul><li>Current practice: </li></ul><ul><li>Asset Allocation </li></ul><ul><ul><li>Asset-Liability Management (ALM Study) </li></ul></ul><ul><ul><li>Strategic Allocation (SAA) </li></ul></ul><ul><ul><li>Tactical Asset Allocation (GTAA) </li></ul></ul><ul><li>But….. </li></ul><ul><ul><li>Contrary to ALM and SAA; </li></ul></ul><ul><ul><li>Tactical Asset Allocation often ad-hoc and unstructured </li></ul></ul>
    9. 9. 2. Asset Allocation (3) ? ? ? ALM/ SAA Equities Bonds Other Current Practice Alpha At Risk Risk Control Gap Better structure for increased risk-adjusted returns: ALM/ SAA Equities Bonds Other Structured GTAA
    10. 10. 3. LMG Emerge GTAA <ul><li>What does our GTAA product look like? </li></ul><ul><li>LMG Emerge GTAA; </li></ul><ul><ul><li>Introduction </li></ul></ul><ul><ul><li>The Process </li></ul></ul><ul><ul><li>Product Details </li></ul></ul><ul><ul><li>Performance (see chapter 4) </li></ul></ul>
    11. 11. 3.1. Introduction LMG Emerge GTAA Optimal structure for higher and TAILOR-MADE risk-adjusted returns: Client-specific risk profiles & Other constraints LMG Emerge GTAA Link to LMG Emerge Manager Selection ALM/ SAA Equities Bonds Other Structured GTAA
    12. 12. 3.1. Introduction (2) LMG Emerge GTAA <ul><li>Harry M. Markowitz & Erik L. van Dijk </li></ul><ul><li>Financial Analysts Journal, March-April 2003 </li></ul><ul><li>&quot;Optimal Portfolio Construction is not the same as Textbook Mean-Variance Optimization&quot; </li></ul>
    13. 13. 3.2. Process LMG Emerge GTAA <ul><li>LMG Emerge’s GTAA product is the result of more than 20 years of research </li></ul>Essential underlying principles of the process are: “ Man-Machine” “ Near Optimization” “ Be active when you can, but passive when you have to” ‘’ Fundamental instead of purely Market Value-based Indexing’’ ‘’ Do not fight structural, long-term tendencies of markets’’ ‘’ Monitoring tool for short-term trend discrepancies (Early Warning System)’’
    14. 14. 3.2. Process (2) <ul><li>“ Man-Machine” </li></ul><ul><li>Market prices are ultimately the result of supply and demand by human buyers and sellers. Structuring these complex market processes by using computers is fine, but we do have to capture this human factor as well. </li></ul><ul><li> Quantitative, fundamental and behavioral /technical factors do all play a role in the LMG Emerge GTAA framework </li></ul>
    15. 15. 3.2. Process (3) <ul><li>“ Near Optimization” </li></ul><ul><li>Traditional optimization techniques don’t work well for GTAA. The innovative “near optimization” technique created by Markowitz-Van Dijk works better.* </li></ul><ul><li> More efficient incorporation of risk </li></ul><ul><li> No problems with new asset classes / non-normal return distributions </li></ul><ul><li>* = See also: </li></ul><ul><li>Mark Kritzman (MIT, State Street), Simon Myrgren (State Street) and Sebastien Page (State Street), MIT/State Street Working Paper, February 2007 for proof of the qualities of ‘near optimization’ (available at LMG Emerge ) </li></ul>
    16. 16. 3.2. Process (4) <ul><li>“ Be active when you can, but passive when you have to” </li></ul><ul><li>Beating financial markets is not easy (market efficiency) </li></ul><ul><li>But it is definitely not impossible: </li></ul><ul><ul><li>Skill </li></ul></ul><ul><ul><li>Hard work </li></ul></ul><ul><ul><ul><li>Monthly model updating </li></ul></ul></ul><ul><ul><ul><li>Annual recalculation of underlying national return- and risk models </li></ul></ul></ul><ul><li>Know yourself and your skill set and go passive when necessary </li></ul><ul><li> Realistic, pragmatic approach essential </li></ul><ul><li> Take into account GTAA peculiarities (large average bet size!) </li></ul><ul><li> Avoid unnecessary risks </li></ul>
    17. 17. 3.2. Process (5) <ul><li>“ Fundamental Indexing’’ </li></ul><ul><li>‘ Market Value-based Indices have an innate tendency to overreact and incorporate large-cap tilts’. </li></ul><ul><li> Fundamental Indices try to capture who will be the winners in the future </li></ul><ul><li> Market Value-based Indices capture who were yesterday’s winners </li></ul><ul><li>= See also: </li></ul><ul><ul><li>R. Arnott, J Hsu and Ph. Moore: ‘’Fundamental Indexation’’, Financial Analysts Journal, 2005 </li></ul></ul>
    18. 18. 3.2. Process (6) <ul><li>“ Do not fight structural long-term tendencies of markets’’ </li></ul><ul><li>There are some strong, underlying longer-term macro laws driving markets. These laws provide a linkage to Strategic Allocation / ALM. Incorporate them in your strategy instead of trying to fight them. </li></ul><ul><li>Follow / Incorporate structural economic and monetary growth stories </li></ul><ul><li>Emerging Markets are here to stay in this Changing World </li></ul><ul><li>Globalization and growing focus on Governance </li></ul><ul><li>Mean Reversion / Overreaction: Markets do often overreact </li></ul>
    19. 19. 3.3. Product Details <ul><li>LMG Emerge: </li></ul><ul><li>“ In a period in which Emerging Markets are getting more important, part – but not all – of our success is related to the incorporation of all countries in the MSCI World and MSCI Emerging Markets indices” </li></ul>
    20. 20. 3.3. Product Details (1) – Countries in the Base Model
    21. 21. 3.3. Product Details (2) <ul><li>Asset classes: Equities, Bonds, Cash, Currencies and Gold </li></ul><ul><li>Integrated risk model ( ExpecTAA® ) that looks at Volatility, Beta, VIX, Interest Rate Sensitivity and Inflation Risk </li></ul><ul><li>Tailor-making of the solution to incorporate your risk profile and constraint set </li></ul>
    22. 22. 3.3. Product Details (3) <ul><li>Model structure </li></ul>* = Derivative Overlay can be capped according to client’s needs / constraints LMG Emerge GTAA– Model Structure I. Top-down (asset class level) & Bottom-up (country level) II. Integrated Annual, monthly and intra-month modules III. Integration of risk & return (Utility, Sharpe, Treynor) IV. Active Base Model plus Derivative Overlay based on Index Products* V. Factor models derived using a stepwise methodology VI. Transparent structure: no black box
    23. 23. 3.3. Product Details (4) Factor Blocks Variables Technical Momentum Overreaction Seasonality Fundamental Dividend Yield Risk Beta Volatility VIX Macro Inflation Economic Growth Interest Rates Inter-market Flows Several flow variables
    24. 24. 4. Performance <ul><li>General observations about Performance </li></ul>LMG Emerge GTAA– Performance Main strategies deliver outperformance without excess risk taking Both the timing and picking components of the model contributed Live performance (see next pages) confirms results of the 1994-2005 back tests Strategic decision to add Gold to Mix Strategy was good, but ex-post we could have allocated more. I.e. underperformance in Gold-Only Strategy
    25. 25. 4. Performance(2) Mixed Strategy Live – Returns in US$ : 2005(7) – 2010(5)
    26. 26. 4. Performance(3) Mixed Strategy Live – Asset Class Weights: 2005(7) – 2010(5)
    27. 27. 4. Performance(4) Global Equities Strategy Live – Returns in US$: 2005(7) – 2010(5)
    28. 28. 4. Performance(5) Global Equities Strategy Live – Asset Class Weights: 2005(7) – 2010(5)
    29. 29. 4. Performance(6) Emerging Equities Strategy Live – Returns in US$: 2005(7) – 2010(5)
    30. 30. 4. Performance(7) Emerging Equities Strategy Live – Asset Class Weights: 2005(7) - 2010(5)
    31. 31. 4. Performance(8) Global Bonds Strategy Live – Returns in US$: 2005(7) – 2010(5)
    32. 32. 4. Performance(9) Global Bonds Strategy Live – Asset Class Weights: 2005(7) – 2010(5)
    33. 33. 4. Performance(10) Performance Indicators of Base and Mix Strategies - I 2005 (7) – 2010 (5)
    34. 34. 4. Performance(11) Performance Indicators of Base and Mix Strategies - II 2005 (7) – 2010 (5)
    35. 35. The LGM Emerge GTAA System An Example What do we think of the situation as of June, 2010?
    36. 36. 5. Example: Current Situation as of June 2010 <ul><li>Although we are positive about Equities MLT and LT, we are still slightly underweighted </li></ul><ul><li>Gold performed well, but we brought our weight back to zero now that prices are at a record high </li></ul><ul><li>Notwithstanding the low money market rates, the allocation to Cash is large. This is partly done to reduce the duration of the Fixed Income portfolio </li></ul><ul><li>Liquid position to expand equity weightings once VIX stabilizes at lower level and Euro finds new equilibrium vis-à-vis the US Dollar </li></ul><ul><li>But be on the alert to grab the opportunity when it appears </li></ul>
    37. 37. 5. Example: Current Situation as of June 2010 (2) Top-10 Holdings Equities <ul><li>Equities underweight slightly reduced. EM’s even in overweight. </li></ul><ul><li>VIX and Euro nervousness translates into more or less ‘normal’ equity portfolio </li></ul><ul><li>Two Emerging countries, BRA and CHIN, made it into top-10 </li></ul><ul><li>ITA presence in top-10 remarkable: we believe it suffered from overreaction to Greece / Euro issues </li></ul><ul><li>Smaller countries / Non-top10: 23.5% of weight </li></ul><ul><li>Larger focus on market timing than on country picking </li></ul>
    38. 38. 5. Example: Current Situation as of June 2010 (3) Top-10 Over-/Underweights Equities <ul><li>Anglo-Saxon underweights create a relatively flat distribution </li></ul><ul><li>CHIN and BRA EM overweights; ISR remarkable overweight after the country was admitted to the MSCI Developed Index </li></ul><ul><li>ITA and SPA can benefit from a solution for GRE according to us. </li></ul>
    39. 39. 5. Example: Current Situation as of June 2010 (4) Top-10 Holdings Bonds <ul><li>Large component of bond portfolio characterized by Quality focus </li></ul><ul><li>But some remarkable speculative elements create a U-shaped portfolio. </li></ul><ul><li>More speculative top-10 holdings include HUN (EMD play), ITA, SPA (EU solves its issues and/or ITA/SPA should not be part of the PIGS group or be associated with it) and even GRE ! </li></ul><ul><li>About 50 percent of weight in just 3 countries. Contrary to equity portfolio skewed solution here. </li></ul><ul><li>Larger focus on country picking than amongst Equities </li></ul><ul><li>Below average durations. </li></ul>
    40. 40. 5. Example: Current Situation as of June 2010 (5) Top-10 Over-/Underweights Bonds <ul><li>US underweight in Equities partly compensated by overweight in Bonds </li></ul><ul><li>Although big, quality countries dominated the top-10 we do see some large overweights in smaller countries including SPA, GRE and HUN speculation </li></ul><ul><li>Scandinavian play brought back to neutral position </li></ul><ul><li>NLD overweight is speculating on increased focus on the economy among major parties in the elections (June 2010), but it is partly compensated by an equity underweight </li></ul>
    41. 41. Appendix A Add-Ons <ul><li>Which add-ons are available? </li></ul><ul><li>“ Style” </li></ul><ul><ul><li>Equities opportunity set to include Value-Blend-Growth and Large-Mid-Small in major areas </li></ul></ul><ul><li>“ Currency Hedge Information” </li></ul><ul><ul><li>Local currency, fully-hedged version of the system with separate currency overlay strategy </li></ul></ul><ul><li>“ Manager Selection” </li></ul><ul><ul><li>Direct link to LMG Emerge Manager Selection database </li></ul></ul><ul><li>“ Additional Asset Classes” or ‘’More Countries’’ </li></ul><ul><ul><li>The possibility to add asset classes or countries of your choice to the model </li></ul></ul><ul><ul><li>Available: </li></ul></ul><ul><ul><ul><li>Alternatives 1 (Hedge Funds) </li></ul></ul></ul><ul><ul><ul><li>Emerging Market Debt </li></ul></ul></ul><ul><ul><ul><li>Alternatives 2 (Commodities) </li></ul></ul></ul><ul><ul><ul><li>Real Estate </li></ul></ul></ul><ul><ul><ul><li>Frontier Markets </li></ul></ul></ul>
    42. 42. Deliverables <ul><li>What is included when using LMG Emerge for your GTAA advice? </li></ul><ul><li>Customized monthly Fact Sheets with strategy results </li></ul><ul><ul><ul><li>The 4 base strategies (see chapter 4) </li></ul></ul></ul><ul><ul><ul><li>Your tailor-made Mixed strategy / strategies </li></ul></ul></ul><ul><li>Individual Country Fact Sheets </li></ul><ul><li>Monthly conference call to discuss and analyze model output and tactical advice (optional) </li></ul><ul><li>Quarterly General Outlook </li></ul>
    43. 43. Portfolio Output <ul><li>Customized monthly Fact Sheets with strategy results </li></ul><ul><ul><li>The 4 base strategies (see chapter 4) </li></ul></ul><ul><ul><li>Your tailor-made strategy / strategies </li></ul></ul>
    44. 44. Country Information <ul><ul><li>Individual Country Fact Sheets </li></ul></ul>
    45. 45. ExpecTAA (add-on product) <ul><ul><li>Attribution and Risk Analyses based on the underlying GTAA Regression Framework (ExpecTAA® software tool) </li></ul></ul>
    46. 46. General Outlook <ul><li>Monthly Market Report </li></ul>
    47. 47. Appendix B You and Us <ul><li>How would LMG Emerge work together with your firm or fund? </li></ul><ul><li>We believe that a tailor-made, transparent GTAA solution that is directly linked to your strategic / ALM guidelines is one of the most important elements explaining the difference between investment success and failure </li></ul><ul><li>LMG Emerge’s GTAA product is made to give you the tools to be successful </li></ul><ul><li>The robust basis of our system (e.g. close cooperation with a Noble Prize laureate), the integrated attention that is given to return and risk, and the ongoing updating of the system ensure that you are ready for a changing (investment) world </li></ul><ul><li>Various Service Packages possible, </li></ul><ul><li>Ranging from system-only to more tailor-made </li></ul>
    48. 48. LMG Emerge Oirschotlaan 19-21 3704 HK Zeist, The Netherlands http://www.lmg-emerge.nl Thank you for your attention!

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