Asset Allocation for Institutional Investors Palace of the Grand Dukes of Lithuania, September 2015, Vilnius
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1 Not For Use with Retail Investors Asset Allocation for Institutional Investors Palace of the Grand Dukes of Lithuania, September 2015, Vilnius Alessio de Longis VP Portfolio Manager and Macro Strategist Global Multi Asset Group (GMAG) The U.S. dollar Safe Haven Myth and the United States Hedge Fund JM OFI Global Asset Management 225 Liberty Street, New York, NY OppenheimerFunds Distributor, Inc. All rights reserved.
2 Outline The US dollar Safe Haven Theory Empirical analysis of US capital flows The United States Hedge Fund Theory Implications for FX Investment Strategies 2
3 The US dollar Safe Haven Theory 1. Rising Global Risk Aversion 5. CONCLUSION: the US dollar is a safe haven currency 2. Risky Assets Sell-off 4. Capital flows into the US lead to UST and USD outperformance 3. Foreign Investors Seek Safety/Liquidity in US Treasuries 3
4 Selecting Major Risk Aversion Events Looking for three criteria: 1. Equity sell-off 2. US Treasury rally 3. US dollar rally PERIOD RETURNS Risk Aversion Event Start Date End Date # Months MSCI ACWI UST 10Y USD TWI Euro debt crisis/emergency summit Mar-12 May % 6.42% 1.33% Euro debt crisis & US downgrade Apr-11 Sep % 14.36% 2.39% Euro debt crisis / first Greece bailout Apr-10 Jun % 6.50% 4.83% Global Financial Crisis (Lehman, etc) Aug-08 Feb % 8.48% 12.72% Tech bubble unwind Mar-00 Feb % 16.74% 13.53% Russian default / LTCM Jun-98 Aug % 3.94% 2.17% Asian Financial Crisis Jun-97 Dec % 8.55% 5.18% Are foreign capital inflows into US Treasuries driving this positive correlation with the US dollar? Data Source: Bloomberg, MSCI, Citigroup. Author s calculations. 4
5 Measuring the Change in Capital Flows: Foreign Investors, 12 sum of monthly flows during risk aversion episode annualization factor previous 12-month cumulative flows CHANGE IN FOREIGN INVESTORS' INFLOWS (% GDP) Risk Aversion Event Start Date End Date # Months UST bonds UST bonds US Corporate bonds + (private + official) (private) Agency bonds + Stocks Euro debt crisis/emergency summit Mar-12 May % 1.65% -0.20% Euro debt crisis & US downgrade Apr-11 Sep % 0.14% -1.74% Euro debt crisis / first Greece bailout Apr-10 Jun % -2.49% -1.26% Global Financial Crisis (Lehman, etc) Aug-08 Feb % -0.34% -2.58% Tech bubble unwind Mar-00 Feb % -0.08% 0.42% Russian default / LTCM Jun-98 Aug % -1.23% -1.30% Asian Financial Crisis Jun-97 Dec % -0.45% 0.36% POSITIVE NEGATIVE Foreign Investor Inflows => USD positive Foreign Investor Repatriation => USD negative Data Source: Bloomberg, US Treasury. Author s calculations. 5
6 Measuring the Change in Capital Flows: US Investors, 12 sum of monthly flows during risk aversion episode annualization factor previous 12-month cumulative flows Risk Aversion Event CHANGE IN US INVESTORS' OUTFLOWS (% GDP) Start date End date # months Foreign Bonds Foreign Stocks Foreign Bonds + Foreign Stocks Euro debt crisis/emergency summit Mar-12 May % -0.24% 0.45% Euro debt crisis & US downgrade Apr-11 Sep % 0.29% 0.12% Euro debt crisis / first Greece bailout Apr-10 Jun % 0.29% 2.14% Global Financial Crisis (Lehman, etc) Aug-08 Feb % 0.80% 1.60% Tech bubble unwind Mar-00 Feb % -0.16% 0.15% Russian default / LTCM Jun-98 Aug % 0.29% 1.35% Asian Financial Crisis Jun-97 Dec % 0.20% 0.00% POSITIVE NEGATIVE US Investor Repatriation => USD positive US Investor Outflows => USD negative Data Source: Bloomberg, US Treasury. Author s calculations. 6
7 Risk Aversion Episodes: US versus Foreign Investor Flows Foreign Investors No evidence of foreign inflows into US Treasuries No Safe Haven demand Empirical evidence suggests capital outflows Repatriation (i.e. Home Bias) US Investors Sell foreign assets, sell foreign currency Repatriation (i.e. Home Bias) Questions Why aren t capital outflows from the US having a negative impact on the US dollar? What drives US dollar appreciation during risk aversion episodes? 7
8 US International Investment Position: A Global Hedge Fund US Net Fixed Income Position US Net Equity Position UK Turkey Taiwan Switzerland Sweden South Africa Singapore Russia Norway Mexico Malaysia South Korea Japan Indonesia India Eurozone China Hong Kong Cayman Islands Canada Brazil Australia -1, US$ bln Data Source: IMF CPIS Survey (2013), excluding reserve managers. Author s calculations. United States Net Foreign Asset Position (private investors only) Long Equities / Short Fixed Income against almost every country 8
9 US International Investment Position: A Global Hedge Fund Reserve Managers UK Turkey Taiwan Switzerland Sweden South Africa Singapore Russia Norway Mexico Malaysia South Korea Japan Indonesia India Eurozone China Hong Kong Cayman Islands Canada Brazil Australia US Net Fixed Income Position US Net Equity Position -6,000-5,000-4,000-3,000-2,000-1, ,000 2,000 US$ bln United States Net Foreign Asset Position (including reserve managers) Long Equities / Short Fixed Income against almost every country Data Source: IMF CPIS Survey (2013), including reserve managers, which include proxy allocation from China and Taiwan, countries not participating in CPIS survey. Author s calculations. 9
10 United States Dominates in Foreign Equity Markets 80% Equity Market: Foreign Ownership by Source (as % of total foreign ownership) 70% 60% 50% 40% 30% 20% 10% United States Eurozone United Kingdom Japan 0% Data Source: IMF CPIS Survey (2013), excluding reserve managers. 10
11 But Not In Foreign Fixed Income Markets 70% Fixed Income Market: Foreign Ownership by Source (as % of total foreign ownership) 60% 50% 40% 30% 20% 10% United States Eurozone United Kingdom Japan 0% Data Source: IMF CPIS Survey (2013), excluding reserve managers. 11
12 A Global Comparison: Who is Long Risk? 100% 80% 60% 40% 20% 0% -20% -40% -60% 19% net foreign equity position (%GDP) net foreign fixed income position (%GDP) -41% -8% 42% 2% -4% -16% 20% -30% 92% 0% 15% US Japan Eurozone UK Switzerland Reserve Managers * The United States Hedge Fund : Long Equity / Short Fixed Income. The US dollar as the funding currency of global growth (i.e. global equity markets) Negative Relationship between Foreign Growth and the US dollar Data Source: IMF CPIS Survey (2013). Reserve managers include proxy allocation from China and Taiwan, countries not participating in CPIS survey. Note: * as % of World GDP. Author s calculations. 12
13 Economic Surprise Indices ( ESI ) Measuring International Growth Sentiment with Economic Surprise Indices Index 200 Citigroup Eurozone ESI Index 100 Citigroup Emerging Markets ESI Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Source: Bloomberg, CitiFX QIS, Citigroup. Notes: for more details on index construction methodology see Kasikov, K., A. Ermogenous, and S. Kumar, 2009, QIS Focus: Economic Surprise Indices for Emerging Markets, April, CitiFX Quantitative Investment Solutions, Citigroup Inc. Indices are unmanaged and cannot be purchased directly by investors. The Citigroup Economic Surprise Indices are objective and quantitative measures of economic news. They are defined as weighted historical standard deviations of data surprises. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any investment. Past performance does not guarantee future results. 13
14 USD Trade Weighted Index Strategy based on ESIs ESI Strategy* Eurozone & EM ESI >0 Eurozone & EM ESI <0 Average annualized return 7.54% 6.11% 9.77% % 4.52% 14.32% / % 7.65% 9.23% Standard Deviation 6.01% 5.29% 6.98% % 4.47% 4.97% / % 5.97% 7.18% Information Ratio / % Profitable days 54% 53% 57% % 51% 59% / % 54% 57% Largest daily loss -2.09% -1.18% -2.09% % -0.81% -0.77% / % -1.18% -2.09% Risk Differential / Skewness / Kurtosis / Downside Vol (left tail) 6.02% 5.17% 7.26% % 4.26% 4.92% / % 5.98% 7.48% Sortino Ratio / Maximum drawdown -9.63% -6.88% % Return/Drawdown Time Invested 65.96% 40.16% 25.80% Total Return Index Jan-03 Jan-04 _ 1 >0 _ 1 >0 / _ 1 <0 _ 1 <0 h / ESI strategy h / Eurozone & EM ESI >0 Eurozone & EM ESI <0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Source: Bloomberg, CitiFX QIS, Citigroup, authors' calculations. Note: transaction costs and carry included; daily data from January 2003 to August *The ESI strategy is a combination of the Eurozone and Emerging Markets economic surprise indices based on statistical analysis of currency returns during regimes of positive and negative surprises. Returns and statistics calculated for when the strategy is invested. When strategy is neutral, observations are not included as zero values. Indices are unmanaged and cannot be purchased directly by investors. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any investment. Past performance does not guarantee future results. 14
15 The Role of Currency in Institutional Portfolios Edited by Momtchil Pojarliev and Richard Levich, Riskbooks Incisive Media, 2014 Update to Chapter 7: de Longis, A., and Tufekci, E., 2014, Economic Data Surprises and Currency Alpha, 15
16 Conclusion: The US dollar is a Hedge Fund Repatriation Currency, Not a Safe Haven 1. Rising Global Risk Aversion 5. CONCLUSION: the US dollar is Repatriation currency 2. Risky Assets Sell-off 4. Capital Repatriation leads to USD outperformance 3. US Investors Sell Foreign Equity and FX positions Attractive USD directional strategies based on foreign growth. 16
17 Conclusions The US dollar is a Repatriation currency, not a Safe Haven. No evidence of foreign investors Flight to Quality into US Treasuries and US dollar. Price action driven by US Investors Run for the Exit, i.e. Repatriation. United States long risk exposure reveals link between US dollar and foreign growth. Attractive USD directional strategies based on foreign growth. 17
18 APPENDIX
19 US Dollar vs. Flows: Equilibrium Relationship, excluding US Treasuries US Capital and Trade Flows: 12month rolling sum as % of GDP Correlation = 86% Co-integrated, no causality Fed USD TWI (left) ex-ust Basic Balance (% GDP) 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% -4.0% -5.0% -6.0% 60 Dec-92 Aug-93 Apr-94 Dec-94 Aug-95 Apr-96 Dec-96 Aug-97 Apr-98 Dec-98 Aug-99 Apr-00 Dec-00 Aug-01 Apr-02 Dec-02 Aug-03 Apr-04 Dec-04 Aug-05 Apr-06 Dec-06 Aug-07 Apr-08 Dec-08 Aug-09 Apr-10 Dec-10 Aug-11 Apr-12 Dec-12 Aug-13 Apr-14 Dec-14 Aug % ex-ust Basic Balance = Trade balance + net FDI + net Equity + US corporate and agency bonds + Foreign bonds Data Source: Bloomberg, US Treasury, Federal Reserve. Author s calculations 19
20 Explaining the Recent US dollar Rally No evidence of foreign inflows into UST Treasuries due to attractive spreads over rest of QE/ZIRP bond markets 1.5% 1.0% Change in Flows between June March 2015 (% GDP) foreign inflows or US repatriation 0.5% 0.0% -0.5% -1.0% US outflows or foreigner repatriation -1.5% Foreign Bonds Net FDI Foreign Stocks, US Corporate Bonds US Agency Bonds Source: Bloomberg. U.S. Department of the Treasury, Treasury International Capital System, Federal Reserve. The items above do not represent specific indices. US Stocks 12 US Trade Balance UST Bonds Private UST Bonds Total 20
21 Disclosures OFI Global Asset Management ( OFI Global ) consists of OppenheimerFunds,Inc. and certain of its advisory subsidaries, including OFI Global Asset Management, Inc., OFI Global Institutional Inc., OFI SteelPath Inc. and OFI Global Trust Company. The firm offers a full range of investment solutions across equity, fixed income and alternative asset classes. The views presented herein represent the opinions of OFI Global Asset Management ( OFI Global ) and are not intended as recommendations, as investment advice or to predict or depict the performance of any investment. These views are based on the information available as of the date noted and are subject to change at any time based on subsequent developments. OFI Global disclaims any responsibility to update such views. No forecasts can be guaranteed. These views may not be relied upon as investment advice or as an indication of trading intent or holdings on behalf of any OFI Global strategy. The information contained herein is deemed to be from reliable sources; however, OFI Global does not warrant its completeness or accuracy. Performance data shown represents past performance and is no guarantee of future results. DISCLAIMER FOR NON-U.S. CLIENTS: Prospective clients should inform themselves as to the legal requirements and tax consequences within the countries of their citizenship, residence, domicile and place of business with respect to the purchase and ongoing provision of advisory services. OFI Global is not registered in any jurisdiction outside the United States, and no regulator or government authority has reviewed this document or the merits of the products and services referenced herein. This document is directed at and intended for institutional investors (as such term is defined in various jurisdictions). This document is provided on a confidential basis and, where required by local law, at the request of the recipient. This document may not be reproduced in any form or transmitted to any person without authorization from OFI Global. By accepting a copy of this document, you agree (a) to keep the information contained herein (the Information ) confidential, (b) not to use the Information for any purpose other than to evaluate a potential investment in any product described herein, and (c) not to distribute the Information to any person other than persons within your organization or to your client that has engaged you to evaluate an investment in such product. OFI Global Asset Management, 225 Liberty Street, New York, NY OppenheimerFunds, Inc. All rights reserved. 21
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