UBS Institutional Consulting

Transcription

1 Risk Management Strategies for Institutional Investors Prepared by John S. Adams, CFP, CIMA Senior Vice President -Investments Advisory & Brokerage Services The Arbor Group, Phone:

2 UBS: The Power of a Global Firm UBS shares are listed on the SWX Swiss Stock Exchange, the New York Stock Exchange (NYSE) and the Tokyo Stock Exchange (TSE) Present in all major financial centers over 50 countries/over 80,000 employees worldwide One of the world s premier investment banking and securities firms Market capitalization of over $40 billion (07/04/08) Strong credit ratings (07/04/08) Fitch AA- S&P AA- Moody s Aa2

3 Our Commitment to Excellence Numerous industry awards over the past few years demonstrate our continuing commitment to excellence. 1st Best Global Private Bank Euromoney, January 2007 Global Finance, 2006 World's Largest Wealth Manager Scorpio Partnership, June 2007 Best at Relationship Management Euromoney, January 2007 Best Provider of Equities Portfolio Management Euromoney, January 2007 Ranked #1 in Research Institutional Investor, 2006 #1 All-Europe Research Team #1 Latin American Research Team #1 All-Asia Research Team Best Provider of Hedge Fund Investments Euromoney, January 2007 Best Provider of Fixed Income Portfolio Management Euromoney, January 2007

4 is a specialized advisory consulting service program of UBS Financial Services Inc. is one of the largest investment consulting providers in the country*, consulting to over 500 institutional clients with approximately $45 billion in assets under advisement** has delivered specialized, comprehensive investment consulting services to institutional clients since 1984*** Clients include corporations, private and public retirement plans, Taft- Hartley plans, municipalities, foundations and endowments *Thomson Financial/Nelson Information s Annual Report of Pension Fund Consultants, ** As of 8/07 *** Prior to 1/1/08, was known as the PRIME Asset Consulting Program.

5 Organizational Structure - The Arbor Group at UBS UBS Financial Services Inc. As a member of the UBS AG family, UBS Financial Services Inc. is one of the leading US wealth managers. UBS Financial Services Inc. is a full service brokerage firm with a network of over 8,000 Financial Advisors. A select group of approximately 95 Financial Advisors have been authorized by UBS to provide institutional consulting services. These Institutional Consultants possess the knowledge, capabilities, and resources necessary to provide investment advisory services to institutional clients. Consultant- The Arbor Group The Arbor Group, lead by UBS Institutional Consultant, John S. Adams, CFP, CIMA, provides access to high quality institutional advice tailored to reflect the specific needs, philosophy, and mission of clients. We focus on serving the investment needs of endowments and foundations. UBS Wealth Management & Business Banking Investment Bank Global Asset Management Wealth Management US (UBS Financial Services Inc.) The Arbor Group

6 Our Mission Our commitment is to combine our experience, knowledge and energy with the global resources of UBS to provide proactive advice and customized solutions. The Arbor Group at UBS

7 Risk Management Strategies for Institutional Investors The Arbor Group Investment Consulting Service

8 Risk Management Strategies* 1. Strategic portfolio rebalancing 2. Tactical asset allocation 3. Use of low and negatively correlated asset classes 4. Identification and defensive use of equity manager capture ratios 5. Tactical adjustment of index vs. active equity managers 6. Mathematical market breaker risk reduction system 7. Optimal Curve allocation adjustment 8. Risk Budgeting 9. Use of Bear Exchange Traded Funds (ETFs) for hedging risk 10.Principal Protected Notes

9 Risk Management Strategies - Today's Discussion 1. Strategic portfolio rebalancing 2. Tactical asset allocation 3. Identification and defensive use of equity manager capture ratios 4. Mathematical market breaker risk reduction system 5. Principal Protected Notes

10 Importance of Asset Allocation A 1991 landmark study of large pension funds* concluded that if you compare two portfolios one that used an asset allocation strategy with one that did not 91% of the variation in portfolio performance could be attributed to asset allocation * Contribution of Asset Allocation Policy, Market Timing and Security Selection to Portfolio Performance. Source: Financial Analysts Journal, May June 1991.

11 Strategic Portfolio Rebalancing Rebalancing of portfolios can systematically reduce portfolio volatility and increase long-term returns. Modern Portfolio Theory assumes that market dynamics assure that a "risk premium" is assigned to higher volatility asset classes. The risk premium accords greater long-term returns to higher risk assets. Rebalancing of accounts on a periodic basis will transfer gains from appreciating asset classes to assets classes with lower appreciation and lower risk. This should be scheduled with regularity. Annual Quarterly Monthly Many institutional investors intentionally maintain only a long-term strategic allocation and allow individual asset managers to make all tactical adaptations. For these investors, periodic rebalancing moves the portfolio back to the long-term target allocation.

12 Tactical Portfolio Rebalancing Tactical Portfolio Rebalancing allows implementation of tactical asset allocation advice, potentially taking advantage of market conditions. The purpose of tactical asset allocation can be to enhance capital appreciation, to reduce risk or both. The movement of assets on a tactical basis should be based upon solid research, and informed by a change in the asset allocation model not merely a "hunch" guided by a Consultant or Board member. Tactical decisions are made on the asset class level. Individual asset managers or index funds are employed to manage the assets in the class. Strategic allocation is necessary to control risk. Tactical allocation is optional.

13 Defensive use of Manager Capture Ratios Good defensive managers can reduce overall portfolio risk by controlling losses in down markets and by exhibiting less portfolio volatility than their respective benchmark index. Asset managers can be described by the percentage capture of the performance of the relevant market index that is used as a performance benchmark for the manager. Index funds should have a capture ratio of 100% - expressed as 1.0 capture ratio of the market index.

14 Defensive use of Manager Capture Ratios Those asset managers that tend to outperform the market index in up markets have an upside capture ratio of over 1.0. Managers that lose less than the index in periods of market decline have a lower than 1.0 downside capture ratio. These values are quantified for every asset manager in the Investment Consultant s performance database. If the ratio of upside to downside performance is higher than 1.0, this indicates positive Alpha on the part of the manager. The manager will have added performance value in comparison to their benchmark index.

15 Defensive use of Manager Capture Ratios This up/down capture ratio does not just tell the Investment Consultant if the manager outperforms the benchmark index, but how much of that outperformance is created by playing good defense compared to playing good offence. The use of historical information regarding manager capture ratios is not completely reliable as a predictive tool due to three factors. 1. The managers that created the discipline in past markets may have experienced turnover in key positions. 2. Assuming the same managers and analysts are employed, every down market has different dynamics. 3. There is a long-documented tendency of managers towards mean reversion.

16 Mathematical "Market breaker" System A "Market breaker" system is intended to protect portfolios from very large and unpredictable market declines. The tactical advice on allocation adjustments is triggered by a mathematical system involving limits, referred to as breakers. When a limit is exceeded, the Investment Consultant informs the client of the event and gives advice providing the client the option of implementing the defensive strategy. No specific time frames are imposed to the discipline, as it is informed by declines or gains in market indices only. Asset classes are sold at successive market lows and purchased at successive highs. This results in progressively lower exposure to asset classes in the event of very large market declines. It also results in progressively higher exposures during periods of market recovery. The breakers are set at wide intervals so that they are not triggered by small market moves that would cause "whipsawing", or inappropriate short-term moves in and out of asset groups.

17 Steps to Implement a "Market breaker" System The steps taken in a breaker system are as follows: 1. An appropriate index benchmark is identified. For example, the U.S. market benchmark commonly used is the S&P 500. The trailing one-year market high point is used as the point from which breakers are measured. 2. Breakers are set at specified percentages of market index decline. 3. As each breaker (percentage of decline) is breached, the Investment Consultant advises about initiating the sale of an established percentage of the investments in the asset class. 4. As long as the market does not go above the prior market high, the recommended percentage is maintained. As long as the market stays above the next downward breaker point, the recommended percentage is maintained. This range is called a corridor of asset exposure. Thus there is normally a wide corridor between these set levels, to assure that breakers are rarely implemented. 5. If the next breaker (down percentage break point) is reached, the Consultant advises that the next established percentage of the investment in the asset class be sold. 6. This results in advice to have progressively lower exposure to asset classes in the event of very large market declines. 7. Assuming that the market and its relative index begin to increase, the percentage of equities sold at each breaker is re-purchased as the market attains successive established breakpoints. This then results in advice to hold progressively higher exposures during periods of market recovery.

18 Steps to Implement a "Market breaker" System

19 Steps to Implement a "Market breaker" System In using any risk management system that deviates from maintaining the long-term strategic allocation for an institution, the Consultant's role is to provide advice and council, but only the client may authorize a change in asset allocation. In the case of the "market breaker", the tactical advice on adjustments is triggered by a mathematical system involving limits, referred to as breakers. When a limit is exceeded, the Investment Consultant informs the client of the event and gives advice providing the client the option of implementing the defensive strategy Modeling of the use of mathematic breakers shows that it has limited but certain opportunity costs in advancing markets. This opportunity cost is the insurance premium for implementing the market breaker defensive strategy. A note of caution: During periods of market volatility, the Investment Consultant will often pause to add a subjective evaluation. This can impede implementation. It should not provide an opportunity to dither and second guess whether to implement the breaker, either when reducing or increasing. Unless adhered to, this system will not function properly.

20 Inclusion of Principal Protected Notes Principal Protected Notes (PPNs) are a type of structured product offered by many large investment banks. Banks normally do not participate in any of the risk in the underlying options, but make their profits from fees for origination of structured notes. PPNs are not insured by Federal or State government programs in the United States. These structured products are categorized as senior, unsecured debt of the issuing bank. Therefore, the principal protection is only as secure as the issuing bank.

21 Inclusion of Principal Protected Notes There are several variations in structure. Returns can be equity linked and provide a guarantee of principal protection if held until term. The simplest form of PPN is an equity-linked note with a specific maturity (12, 18, 24, 36 or 48 months) and a structure providing a multiple of the return of an underlying index. A second common type of PPN is the Barrier Note. The barrier note typically provides a positive return linked to either or both the negative or positive return of the underlying equity or index. PPNs can be substituted for index holdings. When this is done, as long as the client holds the PPN until term, there is an assurance of participation in the market index with protection of principal (subject to credit risk of the issuing bank) should markets turn negative.

22 Inclusion of Principal Protected Notes Implementation Challenges: 1. The Investment Policy Statement of the client may not have language that includes or excludes structured products, of which Principal Protected Notes are a subclass. 2. Principal Protected Notes are a financial product that lies outside of the fee-based investment management normally used by Investment Consultants. The products are sold by banks and are registered as private placement new issues. 3. Because PPNs are not insured by Federal or State government programs in the United States, the principal guarantee resides with the issuing bank. This in turn puts the Investment Consultant in the unusual position of having to perform due diligence related to the solvency of the bank during the period of the guarantee. 4. PPNs have complex terms that must be communicated to the client with a formal disclosure process including documentation of consent to provide a prospectus, provision of the prospectus and discussion of the strategy for inclusion in the asset allocation of the client.

23 Risk Management Strategies *This presentation is provided for educational purposes only and does not represent a comprehensive list of questions or considerations necessary for making effective investment decisions. Consult with your investment and legal advisors for a more through discussion of your unique needs, risks, expenses and other investmentrelated matters. This presentation is not intended to be a recommendation to you regarding any particular investment strategy or investment approach and is not intended to be a recommendation or solicitation for the purchase or sale of any securities or index. Indexes are cited for example purposes only and are not intended to be used as benchmarks or other references. Neither UBS Financial Services Inc. nor its employees offer legal or tax advice. You must consult your attorney and or tax advisor regarding your particular situation.

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25 The Arbor Group at UBS Business Associates Professional Associates John S. Adams, CFP CIMA Senior Vice President - Investments Carlos Obando Senior Vice President - Investments..\Small Photos\Patrick Drum CFA.JPG Patrick Drum, CFA Financial Advisor Jon Highum Senior Vice President - investments

26 The Arbor Group at UBS Strategy & Service Allison Nathe Senior Registered Client Service Associate Dina Carkonen Branch Consulting Analyst Operations & Analysis Deena Fuller Senior Registered Client Service Associate Yuta Taketani College Intern

27 The Management Team at UBS Senior Branch Management Brandt Westover Executive Director Branch Manager Robert Meston Executive Director Manager of Sales Branch Administration Janet Leahy Director, Administrative Manager Whitney Shelton Branch Office Administrator

28 The Operations Team at UBS Operations Associates Judy Guzek Front Desk Carisa Helm Control Officer Operations & Analysis Brady Flynn, Bryn Larsen, Jib Pongprasert The Operations Team

29 The UBS Institutional Investment Consulting Process The Arbor Group Investment Consulting Service

30 Process Assess Current Situation Risk/Reward Profile Assistance with Development and Review Investment Policy Planning Assistance Asset Allocation Modeling Asset Allocation Analysis Overall Portfolio Design Institutions Clients Portfolio and Manager Reviews Portfolio Rebalancing Develop Further Action Plans Trustee Education Ongoing Consulting and Performance Manager and Fund Search Investment Manager Search, Evaluation and Recommendation Strategy Integration Cost Analysis

31 Our Consulting Services Assistance in developing Investment Policy statements Asset allocation analysis Spending Policy assistance Investment manager research/evaluation and search capabilities Investment manager performance evaluation Foundation and Endowment services: Board education and communication Investment Policy performance monitoring Ongoing communication Cash management services For more information about services, please request a copy of the UBS Institutional Consulting ADV Disclosure Document.

32 Investment Policy The Arbor Group Investment Consulting Service

33 Investment Policy Statement Components Investment Goals & Objectives Appropriate Time Horizon Risk Tolerance and Risk Management Asset Allocation Development* Responsibilities of Interested Parties Acceptable Investment Vehicles Securities Guidelines Performance Review Standards Rebalancing Strategies Spending Policy * For Illustrative Purposes Only Other Considerations

34 Asset Allocation Methodology Assessment of your investment objectives and tolerance for risk Sophisticated proprietary methodologies utilizing our capital market assumptions An estimated covariance matrix for a set of primary factors that estimates expected relative reactions during all market conditions Identification of underlying economic and fundamental influences of each asset class to be considered for inclusion Our research on the future risk and return potential of each asset category under consideration Equity and fixed income allocations that are further segmented into subclasses and investment styles Final correlations among asset classes as well as market-related risks We recommend combinations of managers for your asset allocation model which complement each other within and across asset classes

35 Investment Manager Research and Recommendation The Arbor Group Investment Consulting Service

36 Our Manager Research Model Process is both quantitative and qualitative Identify Candidates Ongoing Due Diligence Collect and Analyze Information Discussion and Decision by Committee Understand Their Investment Philosophy & Process Verify and Build Conviction * For managers included in searches, we currently provide IS Researched and IS Eligible categories of investment manager analysis by the Investment Solutions Manager Research Group. We cannot assure you that we will continue to provide ongoing analysis for any of these managers. Please see the ADV Disclosure Document for a general description of the parameters and criteria reviewed for each manager category.

37 Manager Research Process Manager research and due diligence is a collaborative effort between UBS research professionals and your Institutional Consultant UBS proprietary database generated by the Manager Research Group of Investment Solutions Managers must satisfy certain due diligence requirements Ongoing due diligence review Your Institutional Consultant has access to independent manager databases for information on thousands of investment products Plan Sponsor Network (PSN) separate account database Covers more than 2,000 investment managers representing more than 10,000 domestic, global and international investment programs Basic firm-level information to detailed product specific information and tracks dozens of manager characteristics

38 Evaluating Investment Managers Researched and Institutional reviewed strategies* are evaluated on the following criteria: Organization Financially and structurally sound Incentive arrangements and retention Proper resources Disaster recovery plan Quality of Personnel Experienced and skilled investment professionals that work well as a team Quality of Research Proper resources to track full universe Knowledgeable and skilled research team Objectivity and creativity Risk Management Appropriate system of risk controls Managed in accordance to their philosophy and process Philosophy Clearly defined investment philosophy Process Methods and procedures must be sound and consistent Effectiveness of decision-making Buy and sell disciplines Performed well in the past and structured to perform well in the future Style Consistency and Implementation Adherence to style Appropriate trading capabilities System of checks and balances Performance Competitive past absolute and risk-adjusted performance results Consistent with investment philosophy Track record by current team * For managers included in searches, we currently provide IS Researched and IS Eligible categories of investment manager analysis by the Investment Solutions Manager Research Group. We cannot assure you that we will continue to provide ongoing analysis for any of these managers. Please see the ADV Disclosure Document for a general description of the parameters and criteria reviewed for each manager category.

39 Portfolio Review & Communication The Arbor Group Investment Consulting Service

40 Portfolio Reviews Basic Performance Report Components Summary of assets at the beginning and end of the period (including additions and withdrawals) Industry standard time-weighted rates of return Graphic and tabular representations of performance Comparisons to a universe of similar managers Market cycle comparisons Performance attribution Risk and return analysis

41 Portfolio Reviews Our objective is to provide a comprehensive format to help you determine the extent to which your goals are being met Performance monitoring reports are provided quarterly for each manager and the total fund composite versus objectives, indexes and peer groups Benchmarks and comparative universes are customized based upon your objectives and the manager s investment approach You will have a structured process to reaffirm your decisions

42 Performance Evaluation In-depth The Investment Policy Statement provides standards and the frequency for portfolio review Quarterly evaluation of performance, execution of style of each manager relative to selection criteria and any material changes within the manager's organization are reviewed Formal annual review of the investment plan and each individual investment manager Replacement of managers if warranted after formal evaluation

43 The Results of the Process Clearly articulated goals and objectives and a methodology to pursue them Attention is focused on implementation of the Investment Policy A formal and customized asset allocation Appropriate investment managers to fulfill the foundation's asset allocation A method to objectively evaluate investment performance Customized fee structures Comfort of knowing that you are addressing your obligations Senior Consultants personally meet with the Board A proactive team responsive to the changing needs of your organization

44 The Arbor Group A Commitment to Conservation Funds Proven experience and dedicated business structure from The Arbor Group at UBS The group specializing in service for Conservation Trust Funds The Arbor Group are members and consistent donors to International environmental conservation. This includes The World Wildlife Fund, Conservation International, The Wildlife Conservation Society, The Ocean Conservancy, Methow Conservancy, Sierra Club and World Wildlife Fund Global Investment Research of UBS, including the largest social and environmental investment research department in the major banks Speakers at conferences and workshops about best practices for investment management and risk control for foundations and endowments Commitment to the success of our non-profit clients demonstrated through The Arbor Group Foundation Board education series and white papers about investment risk management and grant administration

45 Disclaimer It is important that you understand the ways in which we conduct business and the applicable laws and regulations that govern us. As a firm providing wealth management services to clients, we are registered with the U.S. Securities and Exchange Commission (SEC) as an investment adviser and a broker-dealer, offering both investment advisory and brokerage services. Though there are similarities among these services, the investment advisory programs and brokerage accounts we offer are separate and distinct, differ in material ways and are governed by different laws and separate contracts. It is important that you carefully read the agreements and disclosures that we provide to you about the products or services we offer. While we strive to ensure the nature of our services is clear in the materials we publish, if at any time you seek clarification the nature of your accounts or the services you receive, please speak with your Financial Advisor. For more information, please visit our website at Services are advisory services and clients should read the ADV Disclosure Document applicable to carefully before entering into a Consulting Services Agreement with. This presentation is provided for educational purposes only and does not represent a comprehensive list of questions or considerations necessary for making effective investment decisions. Consult with your investment and legal advisors for a more through discussion of your unique needs, risks, expenses and other investment-related matters.