netwealth educational webinar - the evolution of asset allocation

netwealth Educational Series

Strictly confidential

March 2016

Tracey McNaughton

The evolution of multi-asset investing

Executive DirectorHead of Investment StrategyUBS Asset Management

3

Markets have evolved

Bond yields can go negative

US can be the world's largest oil producer

Donald Trump can become US President

Official interest rates can go negative

Central banks can become asset managers

Multi-asset investing has similarly evolved…and must continue to do so

Section 1

A look back: "The Great Moderation"

http://www.economist.com/printedition/1998-02-07




5

Simpler timesIndustry structure and mindset

The structure The mindset· Two major asset classes

– Equities – Bonds

· Asset classes divided into specialized categories (growth, small cap, etc.)

· Industry dominated by domestic equities and bonds

· Regulation cut – repeal of Glass-Steagall Act (1933)

· Allocate to equities as much as risk budget would tolerate

· Risk-free returns· Market is liquid· Buy and hold· Investors spent 80% of their time

on selecting managers, and only 20% on asset allocation

· Outperform the benchmark

66

· Markets validated industry structure· Rise of the equity cult· Chasing performance

16.1%

6.6%

7.7%

2.6%

0% 5% 10% 15% 20%

US Equities,1990s

US equities,1925-2015

US Bonds,1990s

US bonds, 1925-2015

Source for left hand chart: MSCI, Barclays, Triumph of the Optimists (Elroy Dimson, Paul Marsh and Mike Staunton), Credit Suisse, UBS Global AM. Based on total returns adj. for US CPI. Global Equities/Global Bonds hedged to USDSource for right hand chart: UBS Global Asset Management, DataStream

Annualized real returns across asset classes Quarterly changes in the S&P500 Index during the 1990s

1990s – Those were the days… Large sell-offs in the 90s were rare

"The Great Moderation"

-15% to -10%

-10% to -5%

-5% to 0%

0% to 5%

5% to 10%

10% to 15%

15% to 20%

>20%02468

10121416

Freq

uenc

y

Drawdowns were rare and losses recouped quickly

77

Industry dynamics: Equities risk premium in the nineties

Source: UBS Global Asset Management, Bloomberg

0

100

200

300

400

500

600

Dec-89 Dec-91 Dec-93 Dec-95 Dec-97 Dec-99

Equit

y risk

prem

ium

US Treasuries S&P 500

Who wouldn’t invest in equities!

8

Benchmark6.9%

Active2.3%

Aus Eq

Int'l Eq

REIT

Aus/Global Bond

IG & HY

TAA

Currency

EquityBond

Total Risk= 9.2%

Benchmark6.9%

Active2.4%

Aus Eq

Int'l Eq

REIT

Aus BondGlobal Sov

IG & HY

TAACurrency

Equity

BondTotal Return= 9.3% p.a.

1st Generation of Diversified Funds· Basic Building Blocks (BBs) are

– Australian Shares– International Shares– Property Securities– Diversified Fixed Interest (Aus & Int'l)– Cash

· Each BB is often "actively managed" by different PMs from the same AM firm

· Asset Allocation decisions are made jointly by managers of BBs– Deviations from benchmark allocation typically

limited

· Majority of "Alpha" comes from active security selection within each BB

· Majority of portfolio "return" and "risk" come from benchmark

For illustrative purposes only Return and Risk characteristics are calculated based on 50% EQ / 50% Bond Benchmark (2006-2015) and typical active alpha / tracking errors of active managersSource: UBS Asset Management

9

Benchmark7.0%

Active1.9%

Aus Eq

Int'l Eq

REIT

Aus/Global Bond

IG & HY

TAA

CurrencyEquity

Bond

Total Risk= 8.9%

Evolution #1: Multi Manager Diversified Funds

· Basic Building Blocks (BBs) are often kept very similar to traditional balanced fund

· Each BB is constructed by combining multiple sub-funds, actively managed by specialist PMs from different AM firms

· Manager of the total fund has two roles– Making asset allocation decisions between BBs– Manager allocations within each BB among multiple

managers selected

· Asset Allocation decisions tend to be more around manager allocations and less on allocations between asset classes

· Aim of "multi manager" funds is to reduce volatility of "Alpha" from active security selection through diversification

· Majority of portfolio "return" and "risk" still come from benchmark

Reducing Volatility of "alpha"


Benchmark6.9%

Active2.4%

Aus Eq

Int'l Eq

REIT

Aus BondGlobal Sov

IG & HY

TAACurrency

Equity


Section 2

Where are we now: "The Great Volatility"







11

More complicated timesIndustry structure and mindset

The structure The mindset· Many asset classes

– Equities - DM and EM– Bonds – IG, HY, bank loans, cat

bonds– Infrastructure– Hedge funds– Private equity

· Industry dominated by many more players

· New risks – longevity, credit default risk, illiquidity

· Greater regulation – Basel III, Dodd Frank

· Return-free risk investing· Hunger for yield· Which benchmark is right?· Forget "set and forget"· Shorter investment horizons· More cost conscious· Investors spent 20% of their time

on selecting managers, and 80% on asset allocation

<-20% -20% to -15%

-15% to -10%

-10% to -5%

-5% to 0%

0% to 5%

5% to 10%

10% to

15%

15% to

20%

02468

1012141618

Freq

uenc

y

1212

"The Great Volatility"

3.8%

6.6%

5.3%

2.6%

0% 1% 2% 3% 4% 5% 6% 7%

US Equities,2000-2015

US equities,1925-2015

US Bonds, 2000-2015

US bonds, 1925-2015

Source for left hand chart: MSCI, Barclays, Triumph of the Optimists (Elroy Dimson, Paul Marsh and Mike Staunton), Credit Suisse, UBS Global AM, Merrill Lynch. Based on total returns adj. for US CPI. Global Equities/Global Bonds hedged to USDSource for right hand chart: UBS Global Asset Management, DataStream. Financial Times, 2/10/12

Annualized real returns across asset classes Quarterly changes in the S&P500 Index 2000-15

Sell offs more present in the 2000s …

1313

Industry dynamics: forget "set and forget"Equity risk premium in the noughties

Source: UBS Global Asset Management, Bloomberg

Jan-00 Jan-04 Jan-08 Jan-12 Jan-160

50

100

150

200

250

S&P 500US Treasuries

Equi

ty ri

sk p

rem

ium

14

Evolution #2 – Adding Dynamic Allocation


· Each BB is typically "actively managed" by different PMs, often from the same AM firm

· Asset Allocation decisions are made independently by a specialist PM – Deviations from benchmark allocation can change in

dynamic fashion reflecting asset allocator's outlook for each asset class

– With increased use of derivatives, asset allocation specialist can add additional layers of active positions to add alpha and control risk

· Aim of this evolution is to increase sources of "alpha" including not only active security selection but also active asset allocation


Increasing "alpha" through Active Allocation

Benchmark6.9%

Active3.9%

Aus Eq

Int'l Eq

REIT

Aus Bond

Global SovIG & HY

TAA

Currency

Equity


Benchmark6.8%

Active2.8%

Aus Eq

Int'l EqREIT

Aus/Global Bond

IG & HY

TAA

Currency

Equity BondTotal Risk= 9.6%


15

Evolution #3 – Efficient product design to keep cost down


· Each BB is made up of "passively managed" sub-funds / sleeves

· Asset Allocation decisions can be "active" or "passive"– UBS Tactical Beta Funds employ dynamic

active allocation with derivative overlay to generate alpha

– Other competitor funds are managed with fixed allocation against benchmark which is reviewed periodically (eg. Annual)

· Aim of this evolution is to minimise the cost for investors


Minimising cost at expense of some "alpha"

Benchmark6.9%

Active1.9%

Aus Eq

Int'l Eq

REIT

Aus BondGlobal Sov

IG & HY

TAA

CurrencyTotal Return=8.8% p.a.

Benchmark7.0%

Active1.7%

Aus Eq

Int'l Eq

REIT

Aus/Global Bond

IG & HY

TAA

CurrencyTotal Risk= 8.7%


16

Comparison of Return / Risk ProfileBenchmark is Important

Return Risk SR EQ Bond Asset Alloc CurrencyGlobal Balanced 9.3% 9.2% 0.52 √ √ √ √Multi Manager 9.3% 8.9% 0.54 √√√ √√√ √ √Dynamic Allocation 10.8% 9.6% 0.65 √√ √√ √√√ √√√Lower Cost 8.8% 8.7% 0.49 X X √√√ √√√Benchmark 6.9% 7.4% 0.32* based on 50% EQ + 50% Bond Mix, using index data for Jan 2006 - Dec 2015 and typical active alpha / tracking errors of active managers

10 yr Simulation* Active Management

For illustrative purposes only Source: UBS Asset Management

80100120140160180200220240260280300

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Benchmark Global Balanced Multi ManagerDynamic Alloc Lower Cost

17

Diversified Funds: Effective choice for long term InvestorsPortfolio Outcome links closely with "Return / Risk" characteristics of benchmark

Source: Bloomberg, UBS Asset Management*Inception date: 3 November 1992. **Inception date: 15 June 1992. Performance data has been prepared in accordance with 2011 GIPS standards. Performance is quoted gross of fees and expenses. The performance data quoted are historical. Performance can be volatile and future returns can vary from past returns.

100

200

300

400

500

600

700

800

Sep 9

2Se

p 93

Sep 9

4Se

p 95

Sep 9

6Se

p 97

Sep 9

8Se

p 99

Sep 0

0Se

p 01

Sep 0

2Se

p 03

Sep 0

4Se

p 05

Sep 0

6Se

p 07

Sep 0

8Se

p 09

Sep 1

0Se

p 11

Sep 1

2Se

p 13

Sep 1

4Se

p 15

Sep 1

6

Wea

lth In

dex A

$

Balanced Investment Fund

Neutral Allocation

Since Inception:Gross Returns 8.78% paNeutral Allocation 8.27% paActual Volatility 7.63% pa

100

200

300

400

500

600

700

Jun 9

2Ju

n 93

Jun 9

4Ju

n 95

Jun 9

6Ju

n 97

Jun 9

8Ju

n 99

Jun 0

0Ju

n 01

Jun 0

2Ju

n 03

Jun 0

4Ju

n 05

Jun 0

6Ju

n 07

Jun 0

8Ju

n 09

Jun 1

0Ju

n 11

Jun 1

2Ju

n 13

Jun 1

4Ju

n 15

Jun 1

6

Wea

lth In

dex A

$Defensive Investment Fund

Neutral Allocation

Since Inception:Gross Returns 8.05% paNeutral Allocation 7.51% paActual Volatility 4.27% pa

FundAvg Risk Budget

(standard dev %pa)LT Performance

Characteristics %paInvestment

HorizonUBS Balanced Investment Fund 9-10% pa CPI plus 6-8% 3-5 yearsUBS Defensive Investment Fund 5-6% pa CPI plus 4.5-6.5% 3-5 years

Section 3

Unchartered territory – from ZIRP to NIRP







19

1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 2015-6

-4

-2

0

2

4

6

8

10

123-month US T-Bill yield minus US CPI inflation (% yr/yr)

Lower real rate regime here for "protracted" periodCentral bank regimes are visible

Source: Federal Reserve and Bureau of Labor Statistics via Haver; UBS Global Asset Management. Sample: 1970-2014.

20

Risks are higher- bonds "safe-haven" status at risk

Australia 10yr U.S. 10yr U.K. 10yr Italy 10yr France 10yr Germany 10yr Japan 10yr

30

21

1816

6

21

Source: Bloomberg, UBS, Data as at 31 March 2016

How much would yields need to rise in a year before you get a negative total return on bonds (bpts)?

Choice of benchmark matters

Source: Merrill Lynch Global Broad Market Index, Bloomberg; Global Balanced is 50/50 Global Broad Market, Global MSCI Past performance does not ensure against loss.

-500

50100150200250300350

Dec-89 Dec-93 Dec-97 Dec-01 Dec-05 Dec-09 Dec-13

Global equities - Rolling 10-year periods

26 down periods out of 293: 8.9%

Match your investment time horizon to your benchmark horizon

05

1015202530354045

Dec-99 Dec-02 Dec-05 Dec-08 Dec-11

0 down periods out of 173: 0%

Global Composite Bond – Rolling 3-year returns

012345678

Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-11 Jan-14

0 down periods out of 220: 0%

Cash- Annual returns

-20-10

0102030405060

Dec-03 Dec-06 Dec-09 Dec-12

6 down periods out of 125: 4.8%

Global Balanced– Rolling 7-year returns

22

Increases the importance of risk managementWinning by not losing

Successful long-term investing is more to do with avoiding catastrophic losses than it is to do with capturing unrealised

gains

S&P/ASX 200 relative to pre-crisis peak

05 06 07 08 09 10 11 12 13 14 1540

50

60

70

80

90

100

Inde

x Oc

t-07=

100

Source: Bloomberg, UBS,

Loss percentageGain percentage

required

-10% 11%

-20% 25%

-30% 43%

-40% 67%

-50% 100%

-60% 150%

-70% 233%

-80% 400%

-90% 900%

Section 4

New Generation MAI: Outcome Oriented Solutions

24

New Generation MAI: think smarter & look further for ideas

1. Unconstrained - broaden opportunity set– Long and short positions– Wide asset class bands– Choice of benchamrk

2. Need to flexible– Flexible in choice of instrument– Nimble tactical asset allocation– Liquid

3. Risk risk management – manage the journey– Tail/event risk hedges– Scenario analysis– Stress testing

Lower for longer environment– implications for investors

25Lin

ear D

irectio

nal Eq

uity

Non-Lin

ear Dire

ctiona

l Equ

ity

IG Credit

Duratio

n Man

agemen

t

L Germ

an vs

. Swed

ish Eq

ui...

L Nort

h Asia

vs. E

M Equit

ies

L Aust

ralia

3yr vs

. US 2

yr

Italian

Flatt

ener T

rade

Active

Currenc

y

Portfo

lio Risk

0%

2%

4%

6%

8%

10%

12%

14%

16%

6.78% Diversification

benefit

Portfolio Risk 6.17%

Equity optionsEquity linear

Directional fixed incomeRelative value market

Relative currency

Unconstrained + flexible = efficient risk allocation

Direc-tional equity25%

Direc-tional credit25%

Relative value

markets25%

Relative value

currency25%

Trade diversification Time diversification

0 – 6 months

22%

7 – 18 months52%

> 18 months

26%

For illustrative purposes only

Instrument diversification

Equity fu-tures65%

Equity op-tions 35%

26

The cost of constraints – benchmark risks can change

Jun-00 Jun-02 Jun-04 Jun-06 Jun-08 Jun-10 Jun-12 Jun-143.0

3.2

3.4

3.6

3.8

4.0

4.2

4.4

4.6

4.8

Modified duration of the AusBond Composite 0+ Year Index (years)

Source: Bloomberg

Capital impact of a 1% rise in yield for benchmark investor

-3.2%

-4.6%

27

Integrate risk management into return management

Charts are for illustrative purposes only

Trade design• Anticipate risk-return impacts of new trades

to the overall portfolio

• Help to avoid doubling risks with the inclusion of new trades

% in GAAC 3.6% 0.7% 12.3% 2.7%

ST \ LT AAT74 AAT66 AAT34 AAT53AAT74 1.0 -0.2 0.2 0.4AAT66 -0.2 1.0 -0.2 -0.7 AAT34 0.1 -0.3 1.0 0.4AAT53 0.2 -0.8 0.4 1.0

% in Fund

Trade 1Trade 1

Trade 2 Trade 3 Trade 4

Trade 2Trade 3Trade 4

ST \ LT

Portfolio Construction

• Optimize the risk-return profile of the total portfolio (efficient frontier)

• Identify sources of alpha in the portfolio (negative and positive)

Expected Return

100% Cash

Benefit of Risk Diversification and Efficient Portfolio Construction

Risk

Leverage

Tail-risk management

• Identify the tail-risks to protect the portfolio

• Sophisticated risk measures beyond simple volatility

% R

etur

nsTime

MaximumDrawdown

28

The end game - achieving an asymmetric portfolio

For illustrative purposes only

Stress test summaryScenario Total Return HorizonEQ down IR down spreads widen -5.64% 1 month

All markets down -5.34% 1 month

Flight to quality currency pegs hold

-5.18% 1 month

IR up spreads widen -3.03% 1 month

USD weakening (currency only) 0.29% 1 month

IR down spreads narrow 10.17% 1 month

EQ up IR up spreads narrow 10.17% 1 month

All markets up 11.04% 1 month

29

Risk parity – different way of thinking about risk

29

Source: UBS Global Asset ManagementFor illustration purposes only

Traditional Approach (example) Risk Parity Approach (example)

Asset Weights Risk Contributions Asset WeightsRisk Contributions

Allocating units of risk versus amounts of money

Traditional 60/40 versus risk parity allocation

Equity 60%

Fixed Income

40%

0%

20%

40%

60%

80%

100%

120%

Asset weight

Equity90%

Fixed Income10%

Asset weights drive risks

Equity 18%

Fixed Income

95%

Commodities 20%

0%

20%

40%

60%

80%

100%

120%

140%

Asset weight

Commodities33%

Fixed Income33%

Equity33%

Risk allocation drives asset weights

31

UBS Multi-Asset Fund evolutionBalanced Investment

FundDefensive Investment

Fund

Tactical Beta Funds Dynamic Alpha Strategy Fund A

Global Balanced w/ dynamic allocation

Global Balanced w/ Lower Cost Approachand Dynamic Allocation

Real Return Strategy

Total FUM (A$m) 1,082m 466m 1,511m

Managers Keiko Kondo/Tom Rivers

Keiko Kondo/Tom Rivers

Andreas Koester/Tom Rivers

Benchmark Custom SAA benchmark Custom SAA benchmark UBS Bank Bill

SAA TAA Currency exposure Active overlay Active overlay Active overlay

Building blocks Active Passive Mainly derivatives

Target alpha CPI + 6-8% / CPI + 4.5-6.5% CPI + 4.5-6% 3.5-5.5%

Average risk budget 9-10% / 5-6% 8-9% for Balanced 7-10%

Inception Nov/June 1992 May/Oct 2012 June 2007Source: UBS Global Asset Management. As at 29 February 2016

32

DisclaimerThis presentation and accompanying documents is intended to provide general information only and has been prepared by UBS Asset Management (Australia) Ltd (ABN 31 003 146 290) (AFS Licence No. 222605) without taking into account any particular person’s objectives, financial situation or needs. Investors should before acting on the information provided in this presentation, consider the appropriateness of the information having regard to their personal objectives, financial situation or needs.

Any opinions expressed in this material are those of UBS Asset Management (Australia) Ltd, a member of the Asset Management division of UBS AG, and are subject to change without notice. Although all information in this presentation and documents is obtained in good faith from sources believed to be reliable no representation of warranty, express or implied is made as to its accuracy or completeness. Neither UBS AG nor any of its affiliates, directors, employees or agents accepts any liability for any loss or damage arising out of the use of all or any part of this material.

The information provided during this presentation must not be relied on to make an investment decision. It is not an offer or recommendation to acquire an interest in the UBS Managed Investment Funds (UBS Funds) or recommendation to purchase or sell any particular security. Offers of interests in the UBS Funds are contained in the relevant current Product Disclosure Statement (PDS). An investment in any of the UBS Funds does not represent deposits or other liabilities of UBS AG or any other member company of the UBS Group. Your investment is subject to investment risk, including possible delays in repayment and loss of income and capital invested. The repayment of capital or income is not guaranteed by any company in the UBS Group.

Performance can be volatile and future returns can vary from past returns. Up-to-date performance information can be obtained by contacting UBS Asset Management (Australia) Ltd. A copy of the PDS is available from UBS Asset Management (Australia) Ltd, the issuer of the UBS Funds, on (02) 9324 3222 or freecall on 1800 023 043. You should consider that PDS and obtain professional advice before making any decision about whether to acquire or continue to hold an investment in the Fund(s).

This document may not be reproduced or copies circulated without prior authority from UBS Asset Management (Australia) Ltd.

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netwealth educational webinar - the evolution of asset allocation

Economy & Finance