IBA Annual Conference September 21, 2015 Presented By ... · IBA Annual Conference September 21,...
Transcript of IBA Annual Conference September 21, 2015 Presented By ... · IBA Annual Conference September 21,...
Presented By
THE INVESTMENT PORTFOLIO: WHAT MAKES SENSE TODAY?IBA Annual Conference September 21, 2015
Jason HaleyFixed Income Strategist
Agenda
• Overview of fixed income investment process– Development of philosophy and strategy– Walk-through of investment cycle
• Fundamental research of macro factors – Two types of research: macro and micro– Defining macro risk– Multi-dimensional risk analysis (MDRA)
• Assessment of current market themes
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Building A Portfolio
• When planning a meal, you don’t start with the grocery shopping
• You first decide:1. What are you looking to create? (defining portfolio objective)
• What is the duration and cost of my liabilities?• What spread / return do I need to maximize profitability given
specific risk limits?2. What are the best recipes for that meal? (selecting a strategy)3. What ingredients do I already have in the pantry?4. What ingredients do I need? (security selection)
• The ingredients should be thought of more as a collection of individual risks than a collection of individual securities
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Liability Driven Investing (LDI)
• Strategy typically associated with pension plans and life insurance portfolios, but applicable to depositories as well
• Develop a fixed income portfolio whose duration is the same as that of the institution’s liabilities
• Goals:1. Produce added returns to achieve long-term investment goals2. Keep portfolio’s macro risk profile aligned with liability structure
• Excess portfolio returns are generated via sector allocation / rotation and security selection
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Market Timing
The Investment Process – An Overview
• A well developed investment process has an:– Investment philosophy – Investment strategy
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The Investment Process – The Investment Philosophy
• A portfolio of fixed income securities with wide risk-adjusted spreads properly matched to the duration of the market produces a total return in excess of the market return
• The incremental return available from security selection, based on careful relative-value analysis and market research, is significantly greater and more consistent than the incremental return from predicting the direction of interest rates
• Within the investment grade fixed income market, the spread sectors offer the greatest opportunity for excess return through security selection
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The Investment Process – The Investment Philosophy (continued..)
• A strong commitment to market research and experienced fixed income professionals can provide a better understanding of fixed income security relative value, with the goal being the identification of high credit quality investments that generate risk-adjusted returns in excess of the market return
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The Investment Process – The Investment Strategy
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• The investment strategy is designed to generate a consistent and predictable return over the preferred benchmark
Investment Strategies Emphasize:
Sector Analysis:
Portfolios typically overweight the “spread sectors” (Agency commercial and residential MBS, CMOs, Agency debentures and some asset-backed sectors). Combinations of assets in these sectors offer competitive risk-adjusted returns over alternative “market” portfolios
Security Selection:
Selecting individual bonds that offer attractive risk-adjusted yields to alternative securities
Duration Targeting and Risk Management:
Don’t make significant “bets” on the direction of interest rates. Keep the portfolio’s duration matched closely to the benchmark duration at all times
The Investment Process – Summary
• Developing a well thought-out philosophy and strategy will provide a framework in which the portfolio manager can seek to earn greater returns on a risk-adjusted basis
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Strategy Investment ReturnPhilosophy Strategy Investment ReturnPhilosophy
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Institutional Fixed Income Portfolio Management
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Understanding Two Types of Research
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• Research can be broken down in macro and micro components
Fundamental (Macro)
Market Analysis
Economics
Sector Relative Value
Portfolio Risk
Relative Value
Portfolio Construction
Individual Security Selection
Portfolio Measurement and
Attribution
Quantitative (Micro)
Research
Fundamental (Macro)
Market Analysis
Economics
Sector Relative Value
Portfolio Risk
Relative Value
Portfolio Construction
Individual Security Selection
Portfolio Measurement and
Attribution
Quantitative (Micro)
Research
Defining Risk
• What are macro factor risks?– “Macro factor risks are market variables that contribute to an
assets yield, affect asset pricing and drive return and return variance”
– 5-way macro factor risk analysis typically includes • Level • Slope • Spread
– Swap spreads and asset spreads to swaps • Implied volatility• Prepayments
– 6-way analysis includes credit
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Macro Factor Sensitivity Analysis - MDRA
• Multi-dimensional risk analysis (MDRA) involves creating macro factor sensitivity tables designed to identify portfolio risks
• Duration risk is only one of many market risks that push around market values
• Measuring and understanding a portfolio’s risk positioning is critical in performance measurement
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Macro Factor Sensitivity Analysis - MDRA
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UNBUNDLED MACRO FACTOR RISKSAssets Credit Level Slope Spread Vol Prepay
Cash - - - - - -US Treasury - - - -Agency Bullet - - -Agency Callable - -30-Year MBS -5-Year Corporate/Muni - -
2014-2015 Review
• Investors who stayed the course during / following the 2013 “taper tantrum” were rewarded with solid gross and net returns in late 2013 and 2014
• Agency fixed MBS well outperformed duration-matched rates in 2014
• High-quality MBS have struggled versus rates (agency bullets and Treasuries) in 2015 amid curve flattening and higher volatility
• Down-in-coupon (DIC) MBS and other convexity-protected collateral has produced more stable carry and total return in 2015
• Spreads have widened across sectors throughout 2015– IG credit spreads ~ 20 bps wider YTD– Agency OAS ~ 15 bps wider YTD
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Sector Returns
Bullet Agencies Gross Net * Gross Net * Fixed MBS Gross Net * Gross Net *1yr - 3yr Maturity 0.47% -0.12% 1.13% -0.27% 10yr New 2.71% 0.85% 0.14% -2.14%3yr - 5yr Maturity 2.34% -0.38% 2.15% -0.28% 15yr New 4.98% 1.62% 2.00% -0.96%
15yr Mod. Seas. 2.57% 1.09% 1.40% -1.14%Callable Agencies 15yr Seas. 2.12% 1.59% 0.65% -0.70%
1yr - 3yr Maturity 0.73% -0.12% 1.50% 0.29% 20yr New 7.33% 2.79% 2.04% -1.23%3yr - 5yr Maturity 3.54% 0.09% 3.00% -0.57% 30yr Mod Seas. 2.37% 0.92% 0.56% -1.62%
30yr Seas. 3.85% 2.94% 1.80% 0.17%Fixed CMO's
PAC 2.48% 0.34% 2.69% 0.72% Variable MBSSEQ 3.16% 0.37% 2.93% 1.22% FNMA P/S Resets 1.77% 1.50% 0.95% 0.51%
FNMA 5/1 Hyb. 2.73% 0.29% 1.26% -1.06%Variable CMO's FNMA 7/1 Hyb. 1.51% -0.07% 2.37% -0.25%PAC/SEQ Floaters 0.82% -0.07% 0.53% 0.36% GNMA P/S Resets 1.51% 1.00% 0.08% -1.11%
GNMA 3/1 Hyb. 1.21% -1.54% 1.55% -0.97%GNMA 5/1 Hyb. 1.45% -1.37% 1.58% -0.93%
* Net of duration-matched swaps ladder** 2015 returns annualized as of 8/31
2014 Returns 2015 Returns 2014 Returns 2015 Returns
MBS Coupon Stack (Citigroup BIG Returns)
Fannie Mae 30yr Fannie Mae 15yrCoupon 2014 2015 * Coupon 2014 2015 *2.50% 10.93 1.68 2.00% 5.80 0.773.00% 9.75 1.97 2.50% 5.28 1.493.50% 8.16 1.91 3.00% 4.32 1.714.00% 6.77 1.97 3.50% 3.47 1.584.50% 5.26 2.00 4.00% 2.28 0.185.00% 3.99 2.02 4.50% 1.16 1.015.50% 3.76 1.85 5.00% 1.18 0.026.00% 3.96 1.496.50% 4.72 2.83
Ginnie Mae 30yr Ginnie Mae 15yrCoupon 2014 2015 * Coupon 2014 2015 *3.00% 8.84 1.25 3.00% 5.18 0.413.50% 6.96 0.95 3.50% 3.88 0.754.00% 5.70 0.18 4.00% 2.36 0.324.50% 4.68 (0.18)5.00% 3.51 2.415.50% 2.76 2.886.00% 2.99 2.246.50% 4.18 3.03
* Annualized as of 8/31
Returns
Returns Returns
Returns
Stronger Dollar
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75
80
85
90
95
100
105
U.S. Dollar Index (DXY)
Source: Bloomberg
Inflation Expectations Falling
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1.00
1.20
1.40
1.60
1.80
2.00
2.20
2.40
2.60
5yr TIPS Breakeven (%)
Source: Bloomberg
Curve Flatter
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100
120
140
160
180
200
220
240
260
2yr/10yr UST Spread (in bps)
Source: Bloomberg
5yr Swap Spreads
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0
20
40
60
80
100
120
140
Bas
is P
oint
s
Source: Bloomberg
Option Premiums Falling
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50
60
70
80
90
100
110
120
Realized vs. Implied Volatility1yr x 10yr Swaption (in bps)
Implied Vol 90-day Trailing Vol
Source: Credit Suisse
Spreads Widening - Credit
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50
60
70
80
90
100
110
120
5yr Investment Grade CDX Index (in bps)
Source: Bloomberg
Spreads Widening - MBS
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-10
-5
0
5
10
15
20
25
30
Fannie 15yr CC Nominal Spreads to Swaps (in bps)
Source: Bloomberg
Summary of Current Themes
• Expected monetary policy divergence has:– Pushed U.S. dollar higher– Sparked volatility in currency and commodity markets– Pushed inflation expectations lower– Flattened U.S. rate curve– Induced greater rate volatility
• Spread widening has made spread sectors more attractive relative to early 2015, particularly for high-quality front-end assets
• Elevated volatility negative for assets with at-the-money options
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Portfolio Positioning
• Continue to favor up-in-credit duration barbell strategy (prefer to add leverage in more liquid sectors than go down in credit)
• Reduce vol exposure in MBS space via down-in-coupon 15yr and convexity-protected collateral
• Agency CMBS also less sensitive to high vol and spread pickup relative to debentures
• Auto and credit card ABS spreads at the wide end of 3-5yr trading ranges
• Investment-grade corporates trading at widest levels 2-3yrs• Dollar rolls have weakened but still offer attractive financing
alternative for many investors• Enhance cash returns via repo
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Conclusion
• Institutional investors should have well-developed investment framework centered with a clear philosophy and strategy
• Portfolio management is a continuous process that starts with establishing goals and guidelines that govern the overall selection and management of the portfolio
• Macro factor risks are 1) observable, 2) measurable, and 3) affect asset prices and returns
• In the current market, asset spreads are at recent wides, but rate volatility remains elevated
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Balance Sheet Cross Section
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Balance Sheet Cross SectionFDIC Reporting Region - Kansas City
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Balance Sheet Cross Section
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