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QMS Advisors - Liability Driven Investments and Portable Alpha Solutions
QMS Advisors - Liability Driven Investments and Portable Alpha Solutions
QMS Advisors - Liability Driven Investments and Portable Alpha Solutions
QMS Advisors - Liability Driven Investments and Portable Alpha Solutions
QMS Advisors - Liability Driven Investments and Portable Alpha Solutions
QMS Advisors - Liability Driven Investments and Portable Alpha Solutions
QMS Advisors - Liability Driven Investments and Portable Alpha Solutions
QMS Advisors - Liability Driven Investments and Portable Alpha Solutions
QMS Advisors - Liability Driven Investments and Portable Alpha Solutions
QMS Advisors - Liability Driven Investments and Portable Alpha Solutions
QMS Advisors - Liability Driven Investments and Portable Alpha Solutions
QMS Advisors - Liability Driven Investments and Portable Alpha Solutions
QMS Advisors - Liability Driven Investments and Portable Alpha Solutions
QMS Advisors - Liability Driven Investments and Portable Alpha Solutions
QMS Advisors - Liability Driven Investments and Portable Alpha Solutions
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QMS Advisors - Liability Driven Investments and Portable Alpha Solutions

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Liability Driven Investments & Portable Alpha Solutions: Efficient Deployment of Capital to Alpha Sources Improve plans’ funded ratio …

Liability Driven Investments & Portable Alpha Solutions: Efficient Deployment of Capital to Alpha Sources Improve plans’ funded ratio
Maintain stable contribution levels
Improve return per unit of surplus risk
Reduce drawdown risks
Quasi-costless beta exposure results in lower overall fees: achieving a higher uncorrelated alpha/fees ratio
A new focal point for pension plans: liabilities’ sensitivities to interest rates
Minimization of asset-liability mismatches to reduce interest rate risks
Altering pension funds’ liability profile to minimize surplus volatility
Alternative strategies as the new main generator of returns
Pension plan managers’ reduced opportunity set and the new alpha imperative
Transferring out of equity market overexposure to uncorrelated alpha strategies
Increased allocation to uncorrelated alpha vehicles: a necessity to help reaching funding ratio requirements
Efficient asset allocation combined with active liability management
Hedge interest rate risks and cash-flow mismatches
Constrain equity market beta to the pension plan manager’s utility function
Increase exposure to uncorrelated sources of alpha
Introduce assets with built-in inflation hedges

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  • 1. Liability Driven Investments & Portable Alpha Solutions: Efficient Deployment of Capital to Alpha Sources Q M S Advisors . . Av. C.-F. Ramuz, 85 | 1009, Pully | CH This material does not constitute investment advice and should not be viewed as tel: 078 922 08 77 | 021 711 40 89 a current or past recommendation or a solicitation of an offer to buy or sell any e-mail: info@qmsadv.com securities or to adopt any investment strategy. website: www.qmsadv.com
  • 2. Liability Driven Investments And Portable Alpha Capability Efficient Deployment of Capital to Alpha Sources This material does not constitute investment advice and should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy.
  • 3. LDI And Portable Alpha Capability Efficient Deployment of Capital to Alpha Sources Approach To assist Private and Institutional clients’ in structuring TARGET optimal investment solutions by making efficient use of capital to meet the following criteria Improve plans’ funded ratio Maintain stable contribution levels Improve return per unit of surplus risk Reduce drawdown risks Quasi-costless beta exposure results in lower overall fees: achieving a higher uncorrelated alpha/fees ratio Q.M.S Advisors Av. C.-F. Ramuz, 85 | 1009, Pully CH | tel: 078 922 08 77 | 021 711 40 89 | e-mail: info@qmsadv.com | website: www.qmsadv.com Page 2
  • 4. LDI And Portable Alpha Capability Profiting From New Constraints Originating From Regulatory Changes Catalyst A new focal point for pension plans: liabilities’ sensitivities to interest rates • Minimization of asset-liability mismatches to reduce interest rate risks • Altering pension funds’ liability profile to minimize surplus volatility Alternative strategies as the new main generator of returns Pension plan managers’ reduced opportunity set and the new alpha imperative • Transferring out of equity market overexposure to uncorrelated alpha strategies • Increased allocation to uncorrelated alpha vehicles: a necessity to help reaching funding ratio requirements Efficient asset allocation combined with active liability management Hedge interest rate risks and cash-flow mismatches Constrain equity market beta to the pension plan manager’s utility function Increase exposure to uncorrelated sources of alpha Introduce assets with built-in inflation hedges Q.M.S Advisors Av. C.-F. Ramuz, 85 | 1009, Pully CH | tel: 078 922 08 77 | 021 711 40 89 | e-mail: info@qmsadv.com | website: www.qmsadv.com Page 3
  • 5. LDI And Portable Alpha Capability Efficient Deployment of Capital to Alpha Sources Approach Model the dynamics of plans’ assets and liabilities in a simulation framework Introduce levered instruments to extend duration, enhance curve duration and convexity hedges to Minimize asset-liability tracking error Maximize information ratio Apply Portable Alpha principles to allow for a flexible and efficient use of capital to diversify across all sources of uncorrelated alpha Optimal utilization of Plans’ Risk Budget Assess the impact of introducing alternative investments to Defined Benefit plans’ assets and its implications on expected risks and returns in surplus space Introduction of bespoke baskets of Alternative Investments Q.M.S Advisors Av. C.-F. Ramuz, 85 | 1009, Pully CH | tel: 078 922 08 77 | 021 711 40 89 | e-mail: info@qmsadv.com | website: www.qmsadv.com Page 4
  • 6. LDI And Portable Alpha Capability Efficient Deployment of Capital to Alpha Sources LDI Implementation Duration lengthening strategies can provide enhanced returns Benefits to be had by leveraging duration exposure (assets’ parallel and twist duration) 7.4 Portfolio 3 7.3 Portfolio 2 7.2 Total Return (% ) Portfolio 1 7.1 7 6.9 6.8 Current Portfolio 6.7 5.3 5.4 5.5 5.6 5.7 5.8 5.9 Surplus Risk (%) Cash based instruments do not provide an appropriate venue: Lack of long term bonds to match liabilities of ultra long durations Liquidity intensive Solution (sub-efficient use of capital) Derivative instruments: the capital efficient solution to mitigating interest rate risks For illustrative purposes only Q.M.S Advisors Av. C.-F. Ramuz, 85 | 1009, Pully CH | tel: 078 922 08 77 | 021 711 40 89 | e-mail: info@qmsadv.com | website: www.qmsadv.com Page 5
  • 7. LDI And Portable Alpha Capability Efficient Deployment of Capital to Alpha Sources LDI Implementation – Interest Rate Futures The price of interest rates futures contracts are negatively correlated to changes in interest rates; buying an interest rate future contract increases a portfolio’s sensitivity to interest rates, increasing the total portfolio’s duration An efficient instrument for duration management Liquidity (Depth of the futures market) Cost Effectiveness (Low transaction costs) Duration Management Specification of a duration target (Duration of the Plan’s liabilities or index) Offsetting or hedging the Pension Plan’s existing interest rate exposure • Introduces basis risk (between the liability exposure and futures price) To minimize basis risks, Q.M.S’ methodology aims at hedging the changes in both the level and twist of the yield curve Simultaneously hedging the price response to both level and twist scenarios or “Two Bond Hedge”, to provide further accuracy to the hedging strategy. Q.M.S Advisors Av. C.-F. Ramuz, 85 | 1009, Pully CH | tel: 078 922 08 77 | 021 711 40 89 | e-mail: info@qmsadv.com | website: www.qmsadv.com Page 6
  • 8. LDI And Portable Alpha Capability Efficient Deployment of Capital to Alpha Sources LDI – Interest Rate Risk Immunization Mitigating interest rate risks by extending duration can allow for a EXAMPLE OF AN INTEREST Duration Full Liability Risk Contribution - more efficient use of the plan’s RATE RISK MITIGATION Current Portfolio Extension Driven Solution STRATEGY Example Example tracking error budget Reallocation to uncorrelated Net Interest Rate Risk 66.2% 58.6% 0.0% strategies with high expected Risk from Investment Policy 31.8% 39.0% 92.1% Unhedgeable Liability Risk 2.0% 2.4% 7.9% information ratios can help the Surplus Risk 14.0% 13.3% 10.8% plan meet its objective Expected Return -1.0% -1.0% -0.6% Risk Contribution - Current Portfolio Duration Extension Duration Extension Full Liability Driven Solution 39.0% 39.0% 31.8% 7.9% 92.1% 66.2% Duration Gap: 0 2.0% 58.6% 58.6% 2.4% 2.4% Net Interest Rate Risk Net Interest Rate Risk Net Interest Rate Risk Net Interest Rate Risk Risk from Investment Policy Risk from Investment Policy Risk from Investment Policy Risk from Investment Policy Unhedgeable Liability Risk Unhedgeable Liability Risk Unhedgeable Liability Risk Unhedgeable Liability Risk Duration Gap: 9.1 Duration Gap: 7.9 Duration Gap: 0 For illustrative purposes only Q.M.S Advisors Av. C.-F. Ramuz, 85 | 1009, Pully CH | tel: 078 922 08 77 | 021 711 40 89 | e-mail: info@qmsadv.com | website: www.qmsadv.com Page 7
  • 9. LDI And Portable Alpha Capability Derivatives Overlay Program CASH-BASED APPROACH OVERLAY-BASED APPROACH Liability hedging: futures or swap overlay strategy The swap portfolio is managed as a passive fund with the objective of tracking Asset-liability and the liabilities via a portfolio of interest rate asset management futures or swaps and inflation linked swaps have to be accommodated in Asset management: active alpha one process generation • typically achieved through mix of high The manager can implement active grade credit / strategies to their full extent government bonds The fund can be invested in asset classes • Subject to limitations that are independent of the liabilities, of cash market therefore providing better diversification and increased investment opportunities For illustrative purposes only Overall risk adjusted return is improved Q.M.S Advisors Av. C.-F. Ramuz, 85 | 1009, Pully CH | tel: 078 922 08 77 | 021 711 40 89 | e-mail: info@qmsadv.com | website: www.qmsadv.com Page 8
  • 10. LDI And Portable Alpha Capability Optimal Allocation of Active Risk Defining the Optimal Active Risk Exposure 18% 100% 16% Total Required Risk 90% (LHS) 14% 80% Total Required Risk (%) Equity Allocation (%) 70% 12% 60% 10% Optimal Equity Allocation 50% 8% (RHS) 40% 6% 30% 4% 20% Optimal Active Risk (LHS) 2% 10% 0% 0% 0.00 0.10 0.20 0.30 0.40 0.50 0.60 0.70 0.80 0.90 1.00 Active Risk Information Ratio Required Total Risk (LHS) Optimal Active Risk (LHS) Optimal Equity Allocation (RHS) Return / Risk OPTIMAL ACTIVE RISK ALLOCATION: Equity Market Beta and Total Active Risk Exposure As a Function of Active Risk Information Ratio For illustrative purposes only Q.M.S Advisors Av. C.-F. Ramuz, 85 | 1009, Pully CH | tel: 078 922 08 77 | 021 711 40 89 | e-mail: info@qmsadv.com | website: www.qmsadv.com Page 9
  • 11. LDI And Portable Alpha Capability Optimal Allocation of Active Risk Portable Alpha Implementation: Optimal Allocation Of Active Risk Transport alpha efficiently to virtually any asset class or market Market Returns Alpha/ Skill Returns Portfolio Returns = = Benchmark Returns Value Added Synthetic strategies allow for flexible and efficient use of capital when porting alpha Long Index Futures (= b) Fixed Incom e Return on Index Total Absolute Return Return 40% Strategy Current + Alpha (= a + b) Long on 10% Long Alpha Port- Portfoli Index Strategies (= a) Futures folio o (= a + 20% Beta + Overlay Managers Rf) Equity 10% Futures Return on 40% Collateral (Rf) Collateral (Rf) Improving portfolio efficiency by making optimal use of capital to increase active risk For illustrative purposes only. These materials do not contain any recommendation to buy or sell or a solicitation of an offer to buy or sell any securities or investment services. Q.M.S Advisors provides no determination of suitability or assurances or guarantees regarding the performance of any investment or investment strategy. You are responsible for conducting your own independent investigation and analysis, taking into account your particular circumstances, before deciding upon a particular investment or investment strategy. Investments in certain asset classes, including hedge funds, carry significant additional risks that you should consider prior to investment. You accept complete responsibility for any investment decisions you may make as a result of your use of this material. Q.M.S Advisors Av. C.-F. Ramuz, 85 | 1009, Pully CH | tel: 078 922 08 77 | 021 711 40 89 | e-mail: info@qmsadv.com | website: www.qmsadv.com Page 10
  • 12. LDI And Portable Alpha Capability Formulation of Client-Specific Alpha Solutions: Spectrum of Potential Sources of Alpha Downward sloping strategies offer negative correlation to traditional 60/40 portfolios Assessing the simultaneity of extreme values (tail dependencies) Evaluating assets’ cyclicality and shifts in correlations Dedicated a t e d S h o r t B ia s D e d ic Short Bias ManagedM a n a g e d FFixed e s Futures u t u r Income Arbitrage c o m e Ar b it r a g e F ix e d In Multi-Strategy M u lt i- S t r a t e g y Convertible Arbitrage Informationo n I n fo r m a ti -0.17 -0 . 1 7 0.49 0.49 1.85 1.85 2.07 2.07 1.81 Ratio o R a ti 4 25 4 4 2 3 10 20 2 F ix e d In c o m e A rbitrag e retu rn s (% ) C o n v e rtib le A rb itra ge re tu rn s (% ) D ed ic ated S h ort B ias returns (% ) 2 15 0 M an a ge d F utu re s re turns (% ) M u lti-S tra teg y retu rn s (% ) 5 1 10 0 0 -2 0 5 -1 -4 -2 -2 0 -5 -3 -6 -4 -5 -4 -10 -10 -8 -5 -6 -10 -8 -6 -4 -2 0 2 4 6 8 -10 -8 -6 -4 -2 0 2 4 6 8 -8 -6 -4 -2 0 2 4 6 -8 -6 -4 -2 0 2 4 6 -10 -5 0 5 10 60/40 portfolio returns (%) 60/40 portfolio returns (%) 60/40 portfolio returns (%) 60/40 portfolio returns (%) 60/40 portfolio returns (%) Global Macro Equity Market Neutral Emerging Markets Event Driven Long/Short Equity Information 1.34 3.44 0.45 2.01 1.18 Ratio 20 6 4 25 20 15 4 20 3 2 10 15 10 E quity M ark et N eutral returns (% ) E m erging M ark ets returns (% ) 0 Long/S hort E quity returns (% ) 10 G lobal M ac ro returns (% ) E v ent D riv en returns (% ) 2 5 -2 5 0 0 -4 1 0 -6 -5 -5 -10 0 -8 -10 -10 -20 -10 -15 -1 -15 -12 -20 -20 -30 -25 -2 -14 -10 -8 -6 -4 -2 0 2 4 6 8 -8 -6 -4 -2 0 2 4 6 -8 -6 -4 -2 0 2 4 6 -10 -8 -6 -4 -2 0 2 4 6 8 -10 -5 0 5 10 60/40 portfolio returns (%) 60/40 portfolio returns (%) 60/40 portfolio returns (%) 60/40 portfolio returns (%) 60/40 portfolio returns (%) Source: Credit Suisse First Boston/Tremont. Return calculations based on unadjusted CSFB/Tremont historical returns from Apr 1994 to May 2005. Bivariate return distributions modeled as mixture of multivariate Normal distributions. Q.M.S Advisors Av. C.-F. Ramuz, 85 | 1009, Pully CH | tel: 078 922 08 77 | 021 711 40 89 | e-mail: info@qmsadv.com | website: www.qmsadv.com Page 11
  • 13. LDI And Portable Alpha Capability Formulation of Client-Specific Alpha Solutions: Optimal Combination of Uncorrelated Sources of Alpha Seek alpha managers with little or no beta Hypothetical Backtested Performance Analysis exposure: Evaluate each strategy’s potential exposure to systematic risks and market cycles 8.0% R2 = 0.0053 Include all explicit and implicit costs inherent Current Portfolio in Asset-Liability space 6.0% to alpha extraction 4.0% Analyze interactions among alpha managers: Define the origin of returns and risk for each 2.0% source of alpha 0.0% Identify risk and return relationships in -4.0% -3.0% -2.0% -1.0% 0.0% 1.0% 2.0% 3.0% 4.0% -2.0% different market cycles Allocate active risk across uncorrelated sources of -4.0% return for optimal diversification: -6.0% The less dependent or correlated the assets, -8.0% the more the potential gains from CS' Optimal Model Alpha Solution* diversification. Addition of uncorrelated assets results in a reduction of portfolio-level volatility, thus enhancing risk-adjusted returns For illustrative purposes only. These materials do not contain any recommendation to buy or sell or a solicitation of an offer to buy or sell any securities or investment services. Q.M.S Advisors provides no determination of suitability or assurances or guarantees regarding the performance of any investment or investment strategy. You are responsible for conducting your own independent investigation and analysis, taking into account your particular circumstances, before deciding upon a particular investment or investment strategy. Investments in certain asset classes, including hedge funds, carry significant additional risks that you should consider prior to investment. You accept complete responsibility for any investment decisions you may make as a result of your use of this material. Q.M.S Advisors Av. C.-F. Ramuz, 85 | 1009, Pully CH | tel: 078 922 08 77 | 021 711 40 89 | e-mail: info@qmsadv.com | website: www.qmsadv.com Page 12
  • 14. LDI And Portable Alpha Capability Enhancing Portfolio Returns In A Risk Controlled Framework By Introducing Uncorrelated Alpha Efficient Redeployment Of Liquidity In Uncorrelated Active Risk Historical Returns: Asset–Liability space Historical Risks: Asset–Liability space 4.0% 3.73% 6.1% 6.03% Historical Portfolio Standard Deviation (%) 3.5% 3.35% 6.0% 5.98% Historical Portfolio Returns (%) 2.98% 3.0% 2.61% 5.94% 6.0% 2.5% 2.24% 5.91% 2.0% 1.87% 5.9% 5.88% 1.50% 5.85% 1.5% 1.13% 5.9% 5.84% 5.83% 5.84% 5.83% 5.83% 1.0% 0.77% 5.8% 0.5% 0.40% 0.03% 0.0% 5.8% 30% of Fixed 60% of Fixed 90% of Fixed ported to CS' ported to CS' ported to CS' ported to CS' 0% of Fixed notional ported notional ported notional ported notional ported 30% of Fixed 60% of Fixed 90% of Fixed to CS' Alpha to CS' Alpha to CS' Alpha to CS' Alpha 0% of Fixed Strategy Strategy Strategy Strategy notional notional notional notional Income Income Income Income Alpha Alpha Alpha Alpha Strategy Strategy Strategy Strategy Income Income Income Income For illustrative purposes only. These materials do not contain any recommendation to buy or sell or a solicitation of an offer to buy or sell any securities or investment services. Q.M.S Advisors provides no determination of suitability or assurances or guarantees regarding the performance of any investment or investment strategy. You are responsible for conducting your own independent investigation and analysis, taking into account your particular circumstances, before deciding upon a particular investment or investment strategy. Investments in certain asset classes, including hedge funds, carry significant additional risks that you should consider prior to investment. You accept complete responsibility for any investment decisions you may make as a result of your use of this material. Q.M.S Advisors Av. C.-F. Ramuz, 85 | 1009, Pully CH | tel: 078 922 08 77 | 021 711 40 89 | e-mail: info@qmsadv.com | website: www.qmsadv.com Page 13
  • 15. LDI And Portable Alpha Capability Defining An Optimal Uncorrelated Alpha Risk Exposure To Reach Pension’s Risk Budget And Return Target Efficient Redeployment Of Liquidity In Uncorrelated Active Risk Porting alpha to traditional beta exposure Equity Exposure Risk-Return Frontier: Asset–Liability space ensures additional diversification at the 4.0% portfolio level, without significantly altering the 3.5% original risk profile Historical Returns (% ) The less dependent or correlated the 3.0% assets, the more the potential gains from 2.5% diversification 2.0% Porting alpha drastically improves the portfolio’s return per unit of risk 1.5% Optimal allocation of active risk in surplus 1.0% space : Addition of uncorrelated assets 0.5% results in a reduction of portfolio-level volatility, thus enhancing risk-adjusted 0.0% returns 5.80% 5.85% 5.90% 5.95% 6.00% 6.05% Historical Standard Deviation (%) For illustrative purposes only. These materials do not contain any recommendation to buy or sell or a solicitation of an offer to buy or sell any securities or investment services. Q.M.S Advisors provides no determination of suitability or assurances or guarantees regarding the performance of any investment or investment strategy. You are responsible for conducting your own independent investigation and analysis, taking into account your particular circumstances, before deciding upon a particular investment or investment strategy. Investments in certain asset classes, including hedge funds, carry significant additional risks that you should consider prior to investment. You accept complete responsibility for any investment decisions you may make as a result of your use of this material. Q.M.S Advisors Av. C.-F. Ramuz, 85 | 1009, Pully CH | tel: 078 922 08 77 | 021 711 40 89 | e-mail: info@qmsadv.com | website: www.qmsadv.com Page 14

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