Case Study – Alaska Permanent Fund...SEATTLE 999 Third Avenue Suite 4200 Seattle, Washington 98104...
Transcript of Case Study – Alaska Permanent Fund...SEATTLE 999 Third Avenue Suite 4200 Seattle, Washington 98104...
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Case Study – Alaska Permanent Fund Asset Allocation to Risk Allocation
October 2011
Jeffrey C. Scott, CFA Chief Investment Officer
P R O B L E M : M E A N - V A R I A N C E O P T I M I Z A T I O N
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Diversification?
Company Exposure Risk
Home Country Bias
Growth & Prosperity Economic Environment
Geography
Risk and Return Contribution
P R O B L E M
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Fat Left Tail Distribution
Normal Distribution
Markets exhibit larger drawdowns with greater frequency than normal distribution would suggest.
H O W D I D W E G O F R O M M O V E F R O M A S S E T A L L O C A T I O N T O R I S K A L L O C A T I O N ?
Education • Risk • Risk allocation • Recruited help
Governance • Principles • Philosophy • Policies
Implementation • Portfolio construction • Active risk budgeting • Oversight and
communication
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Model
Principal
Investment Income
Active Risk
Leverage
Commitment
Concentration
Liquidity Volatility
Real Estate
Interest Rate
Political
Credit
Company
Deflation Inflation
Spending Rule
Counterparty
Business Partner
Peer
Country
Currency
Turnover
Pricing
Asset Allocation
Refinancing
Headline Risk
Operational
Staff
Fiduciary
Sample List
Margin
Liabilities
T H E W O R L D O F R I S K S
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Derivatives
Culture
Alignment of Risk &
Objectives
Defining Boundaries
Communication Tool
Risk Response
Seizing Opportunities
Deployment of Capital
Not a System!
§ Risk is NOT just the standard deviation of returns!
§ Risk is first and foremost the risk of losing principal. At what point is the drawdown too deep?
§ Risk is failing to meet the
demands of the organization.
§ Risk is an unexpected negative event.
W H A T I S R I S K M A N A G E M E N T ?
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Passive Information reporting on aggregate risk
Defensive Controlling risk through limits
Active Managing risk through capital allocation
A P P L I C A T I O N S F O R R I S K M A N A G E M E N T
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A S S E T S C O N T A I N M U L T I P L E R I S K F A C T O R S
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Bonds for Safety? NOTE: Not all are created equal
Rates
Domestic
International
Emerging Markets
Curve
Duration
Liquidity
Country
Credit
Investment Grade
High Yield
Emerging Markets
Private
Curve
Duration
Liquidity
Country
Sector
Equity
Domestic
International
Emerging Markets
Private
Country
Value
Momentum
Sector
Size
Inflation
TIPS
Commodities
Private
Country
Curve
Duration
Liquidity
Currency
Developed
Emerging Market
Country
Carry
Primary Risk Factors
Secondary Risk Factors
Tertiary Risk Factors
R I S K F A C T O R B U I L D I N G B L O C K S
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A C T I V E R I S K B U D G E T I N G
Size § Fear of regret vs fear of losing money § Peer risk § Reputational risk/career risk
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Superior Portfolio Construction
“True” Diversification § Risk factors § Geography § Manager § Economic sensitivity § Return contribution
Active Risk Budgeting
Managers with sound risk management philosophy Diversification of alpha risk factors
Tail Risk Hedging Opportunistically purchase relative inexpensive insurance Actively harvest gains
Who has the proven skill? § Board § Staff § External Managers
Monitor & Oversee
Mission & Philosophy
Delegation of Authority
Policies • Spending • Asset Allocation • Management • Manager • Compensation etc.
Education
Communication
Corrective Action
S O U N D G O V E R N A N C E I S T H E K E Y
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I N V E S T M E N T P R I N C I P L E S
Principles
Valuation
Risk
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Diversification
Security Selection
Manager Selection
Active Risk Budgeting
Risk Allocation
Risk Framework
I N V E S T M E N T P H I L O S O P H Y
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In the past… The Board focused on implementation, e.g. manager selection and termination
Today… The focus is on governance, risk tolerances, policies, processes and oversight
P O R T F O L I O C O N S T R U C T I O N
Diversification
• Economic sensitivity • Risk factors • Geography • Return contribution
Active Risk Budgeting
• Valuation assessment • Risk factor tilts • Opportunistic tail risk hedging • Manager allocations
Risk Assessment • Scenario • Stress • Relative risks
Implementation
• Smart cost-effective allocation to beta exposures
• Judicious allocation to alpha sources
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I M P L E M E N T A T I O N
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‘Liquid’ Beta & Alpha
Illiquid Beta & Alpha
Liquid Beta & Alpha
High Fees
Moderate Fees
Hedge Funds and Real Return Managers
Real Estate Infrastructure
Timber Agriculture
Energy
Private Equity
Distressed
Debt
Bank Loans
Mezzanine Debt
Rates Credit Equity Real
Assets Currency
K E Y T A K E - A W A Y S
• Risk is more than standard deviation of returns
Risk Culture
• “True” diversification
Risk Allocation not Asset Allocation
• Preservation of capital in down markets
Dynamic Allocation by Proven Professionals
• Oversight and communication; not implementation
Governance & Policy Focused Board
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