Managing risk with currency. Michael DuCharme, CFA Head of Currency Strategy, Russell Investments

Transcription

1 Managing risk with currency Michael DuCharme, CFA Head of Currency Strategy, Russell Investments 10 DECEMBER 2014

2 Important information Nothing in this publication is intended to constitute legal, tax securities or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. This information is made available on an "as is" basis. Russell Investments Canada Limited does not make any warranty or representation regarding the information. Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns. Diversification does not assure a profit and does not protect against loss in declining markets Unless otherwise noted, source for the data in this presentation is Russell Investments. All information contained in this material is current at the time of issue and, to the best of our knowledge, accurate. Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and, unless it relates to a specified investment, does not constitute the regulated activity of 'advising on investments' for the purposes of the Financial Services and Markets Act The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested. Any forecast, projection or target is indicative only and not guaranteed in any way. Any past performance figures are not necessarily a guide to future performance. Any reference to returns linked to currencies may increase or decrease as a result of currency fluctuations. Any references to tax treatments depend on the circumstances of the individual client and may be subject to change in the future. Conscious Currency is a trademark of Russell Investments. The Russell Conscious Currency Index Series is designed to reflect the performance of common foreign currency market factors (Carry, Value, and Trend). Carry Index Carry aims to capture exposure to high-yielding currencies, offset by short positions in low-yielding currencies. Value Index Value aims to capture exposure to undervalued currencies, offset by short positions in overvalued currencies. Trend Index Trend aims to capture exposure to currencies trending positive by short positions in currencies trending negatively. Copyright Russell Investments Canada Limited All rights reserved. Russell Investments Canada Limited is a wholly owned subsidiary of Frank Russell Company and was established in Russell Investments Canada Limited and its affiliates, including Frank Russell Company, are collectively known as "Russell Investments. Russell Investments, Russell Indexes and Russell Investments logo are either trademarks or registered trademarks of Frank Russell Company, used under a license by Russell Investments Canada Limited. Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance and are not indicative of any specific investment. First used: December 2014 INST (EXP ) p.2 THIS CONFERENCE MATERIAL WAS CREATED BY RUSSELL AS AN EDUCATIONAL TOOL AND IS NOT FOR FURTHER DISTRIBUTION.

3 Source: MBC Strategic. p.3

4 Historical US 10 year Treasury yield 16% 14% 12% 10% Historically nowhere to go but up! 8% 6% 4% 2% 0% Source: Bloomberg Russell also recognizes the possible outcomes of flat to a (continued) downward trend. Past performance is not a guarantee of future results. Indexes and/or benchmarks are unmanaged and cannot be invested in directly. p.4

5 Barclays US Aggregate Bond Index (Agg) Sector weights 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 40% 40% 45% 40% 34% 32% 20% 22% 22% 20% 19% 20% 11% 10% 16% 15% 13% 13% 22% 25% 22% 28% 35% 36% Securitized Corporate Government -related Treasury Increased by 63% in past 10 years High treasury issuance decreased the effectiveness of sector spreads to act as a cushion in a rising rate environment Source: Barclays; Russell Investments (Prasetyo and Lo, Currency Strategies and bond portfolios, February 2014). Past performance is not a guarantee of future results. Indexes and/or benchmarks are unmanaged and cannot be invested in directly. p.5

6 Forecasted returns and correlations Forecasted Return Correlation to Barclays Agg Barclays Agg 1.0% 1 Investment grade credit 0.5% 0.8 US high yield 3.0% 0.2 Bank loan 4.0% (0.07) Emerging markets debt hard currency 4.0% 0.63 Emerging markets debt hard local currency 1.0% 0.62 The addition of currencies to a fixed income portfolio also presented an intriguing possibility Sources: Forecasts 12 month outlooks from Russell Investments as of March Correlations: Bloomberg and Russell Investments. Past performance is not a guarantee of future results. Indexes and/or benchmarks are unmanaged and cannot be invested in directly. p.6

7 Currency solution to a low interest rate environment Currency overlay In a portfolio with various assets currencies would : Diversify existing interest rate exposure Not materially add to portfolio risk Unlike preferred securities, bank loans, and corporate floating notes Currencies exhibit good returns with moderate risk p.7

8 THE CHALLENGE Balancing risks Source: shutterstock p.8

9 Sources of return in currency markets $ Carry Tendency of higher interest rate currencies to appreciate relative to lower interest rate currencies. Value Compare currency to some equilibrium or fair value. Sell if currency is over-valued and buy if undervalued. Trend Buying (selling) currencies which have recently shown positive (negative) performance. p. 9

10 Currency indexes Rules-based construction 1 Equal weighting of 3 factors: carry, value & trend 2 3 Eligible currencies: AUD, CAD, CHF, EUR, GPB, JPY, NOK, NZD, SEK, USD Each factor index: 3 long / 3 short currencies, equally weighted 4 Rebalancing: performed monthly Indexes and/or benchmarks are unmanaged and cannot be invested in directly. p.10

11 Cumulative performance for an index series 140% 120% 100% 2008 was very volatile, but value and trend compensated for the severe decline in carry, resulting in only a slight drop for the Composite Carry 80% 60% 40% 20% Composite Value Trend 0% -20% Source: Russell Investments. December 1999 through September The inception date of the Russell Conscious Currency Index series is April 18, The returns provided for each Russell Index may include data for periods prior to when the index was in live production. Historical returns for these Russell Indexes prior to the live production date are calculated using the same Russell methodology; however, application to the performance calculation may vary due to data sources and the availability of historical data. Please contact the Russell Index Client Service Team for further detail. Past performance is not a guarantee of future results. Indexes and/or benchmarks are unmanaged and cannot be invested in directly p.11

12 Currency index correlations Composite Value Trend Carry Composite index 1 Value index Trend index 0.52 (0.14) 1 Carry index 0.53 (0.14) (0.16) 1 Barclays US Agg index (0.11) (0.07) (0.18) (0.07) Investment grade credit (0.04) (0.27) (0.16) 0.32 US high yield (0.00) (0.37) (0.23) 0.53 Bank loan 0.01 (0.27) (0.25) 0.49 Emerging markets debt hard currency 0.02 (0.35) (0.25) 0.55 Emerging markets debt local currency 0.07 (0.20) (0.10) 0.35 Emerging markets currencies 0.10 (0.42) (0.18) 0.65 Russell 1000 index 0.16 (0.28) (0.19) 0.64 Russell emerging markets equity index 0.20 (0.32) (0.17) 0.71 Source: Russell Investments (Prasetyo and Lo, Currency Strategies and bond portfolios, February 2014). Past performance is not a guarantee of future results. Indexes and/or benchmarks are unmanaged and cannot be invested in directly.. p.12

13 THE SOLUTION Why currency works Source: shutterstock p.13

14 Returns during rising Fed funds rate environment Example: June 2004 to June % 6% 5% 4% 3% 2% 1% 5,25% 1,00% Return during period Composite index 7.0% Carry index 9.3% Trend index -1.04% Value index 12.6% 0% Source: Bloomberg, Federal Reserve Bank and Russell Investments (Prasetyo and Lo, Currency Strategies and bond portfolios, February 2014). Past performance is not a guarantee of future results. Indexes and/or benchmarks are unmanaged and cannot be invested in directly. p.14

15 Custom currency exposure in FI portfolio Allocation process and outcome Process Issues Outcome Returns-based optimization emphasizing drawdowns and downside deviation Holdings-based risk check to see immediate portfolio impact Source: Russell Investments Reliance on credit when spreads are tight Limited number of skilled managers Need to continue to generate net-of-fee performance 7.5% allocation composite custom blend 15% Carry 50% Value 35% Trend Carry is underweight because of its high correlation with higher yielding securities p.15

16 Custom currency exposure in total portfolio Analysis results 7,0% 6,8% 6,6% Risk Reward Comparison for a 60/40 Portfolio Unhedged with composite index Annualized Return 6,4% 6,2% 6,0% 5,8% 5,6% 5,4% Hedged with composite index Unhedged 5,2% Hedged 5,0% 9,0% 9,5% 10,0% 10,5% 11,0% Standard Deviation *See slide 19 for information about this chart. Past performance is not a guarantee of future results. Indexes and/or benchmarks are unmanaged and cannot be invested in directly. For illustrative purposes only. p.16

17 Acting on our currency convictions Most currency portfolios began March 18, 2014 One fund began March 28, 2014 $720 million Exposure value Information is for Frank Russell Company As of March 28, 2014 Currency exposures added + p.17

18 Using currency for managing risk Currency is often thought of as a risk to manage Currency can be diversifying Intentional currency exposure can be beneficial Consider indexes for gaining currency exposure p.18

19 Notes Slide 16: Sources: Bloomberg, Russell Investments and Barclays. Data are from12/31/1999 to 12/31/ /40 allocations assume 35% in US equity, 20% in international equity, 5% in EM equity, and 40% in US bonds. International equity and the FX return are represented by the Russell Global Developed ex-us Index (USDhedged) and its return from currency off a USD base, respectively. US equity is represented by the Russell 3000 Index. EM equity is represented by the Russell Global Emerging Markets Index. US bonds are represented by the Barclays US Aggregate Index. Portfolio with Russell Conscious Currency index and Custom Russell Conscious Currency index assume 20% exposure to FX factors. p.19

20 Thank you