Managing the Asset Allocation of Complex Portfolios

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• Managing the Asset Allocation of Complex
  Portfolios

Oscar Vermeulen
www.altis.ch
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Evolution in Investment Management

• Conventional Portfolio
• Single team responsible for stock picking
  asset allocation

1995

• Multi-Manager Portfolio
• Mix of Specialist Managers
• Consultants perform Manager Selection

2005

• Multi-Asset Investing
• Core/Satellite Mix of Specialist Managers,
  Passive Product and Alternatives
• See-Through and VaR Risk Decomposition
  translate manager mix into asset allocation
  exposures
• CIO manages exposure through manager allocations

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• OpinionAfter four years of tremendous returns
  in Peripheral Markets (in Hedge Funds,
  Emerging Market Debt, High Yield, Small Caps) it
  becomes all the more important to know the true
  extent of exposure to peripheral performance
  factors
• FactMulti-Manager Investing, with its lack of
  transparency, makes your asset allocation much
  more vulnerable to this issue. We will illustrate
  this using one single theme the abundance of
  Small Cap exposure in portfolios today
• SolutionTools to bring an asset allocator or
  CIO back into control over his complex portfolio

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Contents

• Style Bias in Manager Selection
• Multi Asset Investing Portfolio Diversification
  or a New Bubble?
• Efficient Implementation
• Summary Bringing the Asset Allocator back into
  Portfolio Management

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Style Biasin Manager Selection
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1. Most Managers Underperform

• Especially in the most developed core markets
• Survivorship Bias only products with good track
  records survive

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We have a hard time understanding the
consequences of Survivorship Bias
Source John Bogle, Vanguard Group Lipper Data
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2. Most Investors Are Poor Asset Allocators

• Studies repeatedly show investors falling far
  short of market returns
• Illustration the Morningstar/FundMinder Study
• Reproducing the study over different periods, in
  different markets, shows very similar picture

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Case 1 A Conventional Multi Manager
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Multi Asset InvestingPortfolio Diversification
or a New Bubble?
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Valid Strategic Reasons to go Multi Asset
MULTI-ASSET PORTFOLIO
BALANCED PORTFOLIO
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20022005 A Run Towards the Periphery
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20012005 A Run Towards the Periphery
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Peripheral Bull Market?

• Returns in EUR from January 2002 October 2005
• MSCI World -4
• JPM Global Govt Bonds 5 (20 LC)
• Listed Property 69
• Emerging Markets Equity 58
• Emerging Markets Debt 32
• European High Yield 39 (since Jan. 2003)
• European Small Caps 60

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Risk of Buying Past Performance is Real

• Study, September 2005 Analysis of 10 Family
  Offices/Endowments, investing in a
  total of 67 equity managers
• Aggregated holdings 32 overweight in Small Caps
• Explicit hiring of Small Cap specialists
• Auto-selection bias towards Large Cap managers
  with a Small Cap drift
• Conscious asset allocation or by-product of
  manager selection?

Holdings analysed as of March-July 2005. Study
published in Families in Business, Sept/Oct 2005
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Risk of Buying Past Performance is Real

• Sources of Performance
• 2000-2005 is a very special situation one of
  the longest and most constant style cycles in
  history,making the separation of sustainable
  alpha and bias all the more important

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Case 2 Selling Style for Alpha
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Efficient Implementation
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Manager Selection Asset Allocation

• Manager Selection should not be done in
  isolation.
• Rather, Manager Selection serves Portfolio
  Construction
• Not on past performance
• But on (1) Desirable market exposures (2)
  Sustainable alpha generation skills
• And on the suitability within a Multi-Manager
  portfolio
• Avoiding diwastification ? requires
  concentrated portfolios
• or good Equity L/S managers
• In this field, investment consultants are out
  of their depth

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Manager Selection Asset Allocation
Peer Group Monitoring understand what the best
managers in a category are doing in their
portfolio
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Summary
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Summary Conclusions

• In the past few years, did we forget about the
  importance of managing portfolios top-down?
• The emergence of widespread Multi-Asset investing
  at least coincided with (maybe was even partly
  responsible for) the bull market in the
  periphery
• Everybody is long Small Caps (and credit, EM,
  )
• May set the stage for high risk and disappointing
  returns
• Yet, relatively simple tools can be employed to
  understand, control, and manage Multi-Asset
  portfolios through the coming years
• Hopefully, this will be The Return of the Asset
  Allocator