Performance creates trust Liquid Alternatives Dr. Jan Viebig,
CFA CEO Harcourt / Head Alternatives Vontobel 11 November 2014
Slide 2
For institutional investors use only / not for public viewing
or distribution Agenda Traditional Investments: The Volatility
Problem What are Liquid Alternatives? Strategy-Specific Risks of
Alternative Risk Premium Strategies Benefit from Intelligent
Combination of Risk Premia Portfolio Diversifier Summary Page
2
Slide 3
For institutional investors use only / not for public viewing
or distribution Traditional Asset Classes: The Volatility Problem
Volatility Jumps & Contagion Sources: Bloomberg, Engle, R.
(1982). Autoregressive Conditional Heteroscedasticity with
Estimates of the Variance of United Kingdom Inflation".
Econometrica 50 (4): 9871008 Annualized Volatility of Equity
Markets Jan 1900 Oct 2014 3 Empirical Findings 1.Risk is
time-varying (volatility clustering) 2.Viewed in a longer
historical context, 2008 is not so unusual 3.Contagion between
risky asset classes Page 3
Slide 4
For institutional investors use only / not for public viewing
or distribution Agenda Traditional Investments: The Volatility
Problem What are Liquid Alternatives? Strategy-Specific Risks of
Alternative Risk Premium Strategies Benefit from Intelligent
Combination of Risk Premiums Liquid, Cost-Efficient and Transparent
Portfolio Diversifier Summary Page 4
Slide 5
For institutional investors use only / not for public viewing
or distribution Comparison: Liquid Alternatives vs Hedge Funds
Liquid Alternatives Traditional Alternatives (Hedge Funds)
Ownership structureMutual Fund Private Placement / Offshore
Corporation Regulation UCITS / Investment Company Act of 1940 AIFMD
/ Securities Act of 1933 Daily liquidity / Daily rebalancing
possible YesNo Investment minimumLowHigh Transparency / Sales
documents Sales prospectus Private placement offering memorandum
& subscription documents Custody of assets Commercial Bank /
Custodian Brokerage Firm/ Prime Broker Legal restrictions on
leverage YesNo Page 5
Slide 6
For institutional investors use only / not for public viewing
or distribution Examples Liquid Alternatives as a Replacement for
Hedge Funds? Non exchange-traded assets monthly unobservable prices
Highly liquid, exchange-traded assets Managed Futures / CTA Global
Macro Long/Short Equity Equity Market Neutral Non-traditional Bond
Event Driven: Merger Arbitrage Relative Value Verifiable daily
prices Event Driven: Distressed Securities Private Equity Real
Estate Liquid alternatives as replacement for hedge funds Page
6
Slide 7
For institutional investors use only / not for public viewing
or distribution Agenda Traditional Investments: The Volatility
Problem What are Liquid Alternatives? Strategy-Specific Risks of
Alternative Risk Premium Strategies Benefit from Intelligent
Combination of Risk Premiums Liquid, Cost-Efficient and Transparent
Portfolio Diversifier Summary Page 7
Slide 8
For institutional investors use only / not for public viewing
or distribution Alternative Risk PremiaTraditional Risk Premia
Illiquidity Risk Premium Merger Arbitrage Risk Premium Equity Risk
Premium Bond Risk Premia (Duration, Credit...) Momentum Risk
Premium Convertible Arbitrage Risk Premium FX-Carry Risk Premium
Value Risk Premium Volatility Risk Premium Risk Premium Approach
Real Estate Risk Premium Commodity Risk Premium Page 8
Slide 9
For institutional investors use only / not for public viewing
or distribution Strategy selection Three strategies suitable for a
risk premium portfolio Page 9 LowHigh Low High Robustness in
Periods of Stress Merger Arbitrage Convertible Arbitrage FX Carry
Illiquidity Momentum Value Volatility* * Tail-risk hedged
volatility strategy
Slide 10
For institutional investors use only / not for public viewing
or distribution StudyStrategy Maximum R 2 (%) Model components Fung
and Hsieh (1997)All70.0 Factor analysis is used to extract five
dominant style factors representing five qualitative style
categories, option-based factors Fung and Hsieh (2001) Managed
futures 60.7Lookback straddles Mitchell and Pulvino (2001) Merger
arbitrage 42.4 Value-weighted portfolio of long announced targets
and short the acquirers Fung and Hsieh (2002a)All89.0 Zurich
Capital Markets Trend-Follower index, option-based trend- following
factor, traditional asset-class factors Fung and Hsieh (2002b)
Fixed income arbitrage 79.0 Long position in Baa corporate bonds,
short position on 10-year Treasury bonds, also swap, mortgage and
yield-curve spreads Agarwal and Naik (2004) Equity-oriented hedge
funds 91.6 Buy-and-hold factors, option-based factors, spread
factors (HML, SMB), momentum factor. Fung and Hsieh (2004a) Funds
of hedge funds 84.0 S&P500, spread Wilshire 1750 Small Cap
Wilshire 750 Large Cap, change in Fed 10-year constant maturity
yield, change in spread between Moodys Baa yield and portfolio of
lookback straddles on bond futures, portfolio of lookback straddles
on currency futures, portfolio of lookback straddles on commodity
futures. Source: Viebig, Jan (2012): What Do We know About the Risk
and Return Characteristics of Hedge Funds?, Journal of Derivatives
& Hedge Funds. Strategy-specific Risks of Alternative
Strategies Asset-Based Style Factor Models Empirical Studies (1/2)
Page 10
Slide 11
For institutional investors use only / not for public viewing
or distribution StudyStrategy Maximum R 2 (%) Model components Fung
and Hsieh (2004b)L/S Equity87.1FamaFrench three factor model,
Carhart momentum factor Capocci and Hubner (2004)All92.0FamaFrench
HML, Carhart momentum factor, credit spread factors Dor et al
(2006)All87.6 Wilshire 5000, CBOE Volatility Index, US SMB, US HML,
EM Telecom Index Kuenzi and Shi (2007)L/S EquityS&P500, SMB,
HML, volatility factors Racicot and Theoret (2008)All93 S&P500,
SMB, HML, momentum factor, 1-month short put on the S&P500
Agarwal et al (2011) Convertible arbitrage 62.6 Volatility
arbitrage (delta-neutral long gamma position, hedged credit and
interest rate risk), credit arbitrage (hedged equity and interest
rate risk), and positive carry (delta-neutral position, positive
interest income, hedged equity risk) Strategy-specific Risks of
Alternative Strategies Asset-Based Style (ABS) Factor Models
Empirical Studies (2/2) Source: Viebig, Jan (2012): What Do We know
About the Risk and Return Characteristics of Hedge Funds?, Journal
of Derivatives & Hedge Funds. Page 11
Slide 12
For institutional investors use only / not for public viewing
or distribution Case study 1: Momentum / Trend-Following Strategies
Convex Payout Profile Market Price Page 12 Source: AQR. A Century
of Evidence on Trend-Follow Investing. Fall 2012 2. Oscillating
Markets Trend- following strategies generate convex payout
profiles. Trend-following strategies perform well in both bull
& bear markets. Risk: Choppy, trend-less markets.
Slide 13
For institutional investors use only / not for public viewing
or distribution Case study 2: Merger Arbitrage Large Losses in
Periods of Stress! Data: Bloomberg Page 13
Slide 14
For institutional investors use only / not for public viewing
or distribution Agenda Traditional Investments: The Volatility
Problem What are Liquid Alternatives? Strategy-Specific Risks of
Alternative Risk Premium Strategies Benefit from Intelligent
Combination of Risk Premiums Liquid, Cost-Efficient and Transparent
Portfolio Diversifier Summary Page 14
Slide 15
For institutional investors use only / not for public viewing
or distribution Why Liquid Alternatives? Bond DiversifierPortfolio
Diversifier e.g. Relative Value: Fixed Income (Asset Backed,
Convertible Arbi-trage, Corporate, Sovereign ) Non-traditional bond
Intelligent combination of strategies can diversify away
strategy-specific risks Equity Diversifier e.g. Equity Market
Neutral Long/Short Equity Short Bias Trend-following Page 15
Slide 16
For institutional investors use only / not for public viewing
or distribution Intelligent Combination of Strategy-Specific Risk
Premia Market gains Straddle-type Payoff Pure Momentum Strategy
Time-series momentum strategy profits from strong trends.
Cross-sectoral momentum strategy as additional alpha source. Market
gains Call-type Payoff Pure Dividend Strategy Target beta increases
to 0.5 in a bull market environment. Manages tail risk by
decreasing target beta to 0 in a bear market environment. Pure
Premium Strategy Collects option premium from selling at- the-money
options profiting from flat markets. Manages tail risk by buying
out-of-the- money options. Maximalverlust Butterfly-type Payoff
Market gains Page 16
Slide 17
For institutional investors use only / not for public viewing
or distribution 7.67% return p.a. (9.82% vol. p.a.) Pure Momentum
Strategy 8.04% return (8.80% vol. p.a.) Pure Dividend Strategy
5.21% return (4.50% vol. p.a.) Pure Premium Strategy RDS Portfolio
7.20% return p.a. (4.35% vol. p.a.) 1/3 Portfolio Allocation
Backtesting: After bid-ask spreads, after fees, monthly
rebalancing, analysis period 2003-2013 1/3 Diversification among
strategies* Page 17 Source: Bloomberg, Datastream *Currency of
returns: USD
Slide 18
For institutional investors use only / not for public viewing
or distribution Combination of Strategy-Specific Risk Premia Leads
to a More Stable Payout Profile Data until October 15, 2014. The
performance is calculated with an investment of 1/3 in the VF Pure
Momentum Strategy, 1/3 in the VF Pure Dividend Strategy and 1/3 in
the VF Pure Premium Strategy and daily rebalancing. The VF Pure
Momentum and the VF Pure Dividend were launched on October 21, 2013
and the VF Pure Premium was launched on December 9, 2013. The last
data point for the HFRX Global Hedge Fund Index was not reported
yet at the time of writing. Page 18
Slide 19
For institutional investors use only / not for public viewing
or distribution Agenda Traditional Investments: The Volatility
Problem What are Liquid Alternatives? Strategy-Specific Risks of
Alternative Risk Premium Strategies Benefit from Intelligent
Combination of Risk Premiums Liquid, Cost-Efficient and Transparent
Portfolio Diversifier Summary Page 19
Slide 20
For institutional investors use only / not for public viewing
or distribution Portfolio Diversifier: Diversify Across Strategies!
A Look at the Investment Process is Key. Learning cycle
Re-evaluation of the strategy taking into account real life
experience with the fund. Data Portfolio construc- tion Execu- tion
Contro l Liquid universe Time-Series Momentum Cross- Sectional
Momentum Page 20
Slide 21
For institutional investors use only / not for public viewing
or distribution Combination of Different Momentum Premia
Performance and Correlation Value Return (SI)10.10%
Return(YtD)12.35% Ann. StD (SI) 6.11% Correlation (MSCI World)
0.001 Correlation (Barclays Global Bond) -0.060 Correlation
(Bloomberg Commodity) -0.195 Total Return YTD Source: Bloomberg.
The performance and correlation data are calculated since inception
of the VF Pure Momentum Strategy on October 21, 2013 until October
15, 2014. Past performance is no guarantee for future returns. Page
21
Slide 22
For institutional investors use only / not for public viewing
or distribution Comination of Momentum Risk Premia versus Stocks
and Bonds (October 2013 October 2014) Data since the launch of the
VF Pure Momentum Strategy on October 21, 2013 until October 15,
2014. Return Oct 21, 2013-Oct,15, 2014 Ann. StD Oct 21,
2013-Oct,15, 2014 VF Pure Momentum Strategy10.10%6.11% MSCI TR Net
World Index1.68%8.74% Barclays Global Bond Index6.42%1.89% HFRX
Global Hedge Fund Index-0.44%3.15% MSCI TR Net World Index HFRX
Global Hedge Fund Index Barclays Global Bond Index VF Pure Momentum
Strategy Page 22
Slide 23
For institutional investors use only / not for public viewing
or distribution Summary You can use liquid alternatives to
diversify the time-varying risk of traditional asset classes
(equity diversifier, bond diversifier and portfolio diversifier).
Advantages of Liquid Alternatives: liquidity, transparency,
cost-efficiency. Be aware that the risks of (liquid) alternatives
are strategy-specific and often nonlinear in nature. Look for
strategies with convex payout profiles, if you want to hedge
traditional asset class risks. Look for solutions which
intelligently combine different trading strategies to diversify
strategy-specific risks and generate more stable payout profiles.
Page 23
Slide 24
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