Risk Management for Fixed Income Portfolios Strategic Risk Management for Credit Suisse Private Banking & Wealth Management Products (SRM PB & WM) August 2014
1 SRM PB & WM Products Risk Management CRO SRM PB & WM Products Operational Risk Alternative Investments Americas Investment Strategy and Research Core Investments Counterparty PB Americas WMS Products Risk Analytics and Infrastructure Risk Capital Management STS Risk Oversight COO Hedging-Griffo Credit Suisse AM Brazil SRM Private Banking & Wealth Management Products Risk Management is part of the global Credit Suisse CRO organization and has an independent team of over 40 risk professionals globally. Main focus areas: Investment risk management (market, credit, liquidity) Counterparty/credit risk management Risk capital management and risk analytics infrastructure Operational risk management August 2014 2
2 Investment Risk Overview (Focus Areas) Our risk and quantitative analysis program is designed to focus on: Exposure and risk analysis (tracking error and value at risk) Stress testing, scenario and sensitivity analysis Concentration and liquidity analysis Performance analysis Risk and performance attribution and contribution analysis Various third-party and proprietary risk systems independent from portfolio management used in support of our risk program (e.g. RiskMetrics, BarraOne) Transparency: Top-down formal reviews conducted with executives through line management Rigorous analysis: Bottom-up portfolio risks independently quantified and formally reviewed with each portfolio team on an ongoing basis Credit Suisse s robust, established risk platform can accommodate and effectively administer the risk management needs, parameters and requirements of all our clients. August 2014 3
3 Exposure and Risk Analysis The focus is on ensuring that risks inherent in the portfolios are transparent and communicated to portfolio managers and senior management. Tools used to analyze portfolio risks include: Tracking error analysis with decomposition Exposure analysis vis-à-vis benchmark exposures Sensitivity analysis to relevant risk factors Sector and strategy exposures August 2014 4
4 Stress Testing and Scenario Analysis As part of our philosophy, we do not rely solely on value at risk (VaR) analytics, but incorporate the use of stress testing on our portfolios. The focus is on identifying events that may adversely affect our portfolios and that are not captured by VaR measures. Regular monthly risk reporting incorporates two types of stress analytics: Scenario analysis Historical stress testing Scenario analysis involves the stressing of one or a group of core risk factors in the portfolio by specific stress amounts. The predictive nature of these types of stress tests means that correlations among all risk factors in the portfolio (not limited to the stressed risk factor) are taken into account in the analysis. Within the historical stress testing methodology, all risk factors in the portfolio are identified and any historical changes for each of those risk factors are applied in the revaluation of the portfolio. Historical correlations are taken into account as history is repeated. August 2014 5
5 Concentration and Liquidity Analysis Concentration analysis performed across: Instrument, asset class, issuer, sector, strategy, rating, country, etc. An important pillar of our risk analysis is related to liquidity analysis. Forecasting the liquidity profile of our portfolios is one of the tools in our risk management toolbox that is deployed on a monthly basis. Using a proprietary methodology developed inhouse, we attempt to model the liquidity profile of our portfolios using some directly observable attributes of traded instruments in the portfolio. The focus is on identifying the instruments within a portfolio as well as the percentage of a portfolio likely to be most affected by a liquidity event. The methodology recognizes concentration risks, and security concentrations are taken into account because the methodology penalizes elevated concentrations in a particular security. August 2014 6
6 Counterparty and Credit Risk Management Dedicated resources to monitor and mitigate counterparty risk. The focus is on cash deposits and over-the-counter (OTC) counterparty risk. Functions include: Development and maintenance of cash DVP trading and OTC counterparty risk policies Maintenance of preapproval list/ongoing credit monitoring Credit approvals on new counterparties; ISDA negotiations when required Brokers analyze liquidity, solvency and cash flows Periodic review of overall exposure, both counterparty and issuer August 2014 7
7 Operational Risk Supervisory Framework Ensure that a consistent control framework for supervision is implemented across the division; monitor issues/status through various tools and governance committees Error Monitoring and Reporting Use of a dedicated system to record, escalate errors and/or control incidents; work with the business and support factions on lessons learned Risk Control Self-Assessments Support for and verification of management self-assessments of the control environment Key Risk Indicators Define KRIs for each business and review trends; periodically report to management Issue Tracking and Verification Ensure that issues raised by regulators, internal audits or other reviews are tracked, presented to management and verified before closing August 2014 8
8 How Can We Compute Risk? Ex-Post Risk Analysis The realized VaR, i.e. based on changes in the NAV of the portfolio Backward-looking An important change in the investment strategy will only progressively be reflected in the risk figures No risk assessment can be made for a portfolio that was recently launched Ex-Ante Risk Analysis When a model is used to predict the risk figures (see next slide for an illustration) Forward-looking An important change in the portfolio investment style will be reflected immediately Tracking Error (TE) The volatility of the relative returns (portfolio returns benchmark returns) Measures how closely a portfolio follows its benchmark Typical annualized TE figures are: 1 20 basis points for index products (with some exceptions, like for small-cap or emerging-market funds) 20 100 basis points for actively managed fixed-income products 0.5% 5.0% for active equity portfolios August 2014 9
9 Putting Current Level of Risk into Perspective In % VIX Index In % 80 JPM Global FX Volatility Index Move Index (r.h.s.) 4.0 70 3.5 60 50 40 30 20 10 0 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 3.0 2.5 2.0 1.5 1.0 0.5 0.0 VIX index: Implied volatility of S&P 500 index options (by CBOE) Move index: Implied volatility index for the US Treasury market (by Merrill Lynch) Source: Bloomberg As of July 2014 August 2014 10
10 Absolute VaR and TE Have Been Decreasing Aggregate statistics across all FI funds, excluding funds without a benchmark 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% VaR 14% 12% 10% 8% 6% 4% -1.0% 2% Jan 12 Apr 12 Jul 12 Okt 12 Jan 13 Apr 13 Jul 13 Okt 13 Jan 14 Apr 14 TE, excludes funds without bmk CS100 DV100 VaR 99% (r.h.s.) Sources: RiskMetrics, Core and ISR Risk August 2014 11
11 Risk Results from Yesterday s Workshop Risk figures are computed with RiskMetrics. Defining the risk settings is at the discretion of the risk manager. Here, weekly returns over a one-year time horizon are used to compute the ex-ante risk figures. No decay factor is applied. Parametric estimation of risk (Monte Carlo is a possible alternative, which is particularly suitable for instruments having a fat tail). August 2014 12
12 Risk Reports Explanation of Selected Risk Statistics (1/3) Value at Risk (VaR) is a summary measure of downside risk. It is the maximum loss over a target horizon in that there is a low, pre-specified probability that the actual loss will be larger. A VaR figure comes with a confidence level and a time horizon: A one-week 95% VaR of 6% means that there is a 5% probability that the portfolio will decrease in value by more than 6% over the next five days. 25 20 Histogram Returns distribution based on the last 100 daily returns on the DAX Index 15 10 95% CVaR: Average loss if 95% VaR is exceeded: 2.2% 95% VaR: 5th worst loss: 1.74% 5 0-3.5% -2.5% -1.5% -0.5% 0.5% 1.5% 2.5% August 2014 13
13 Risk Reports Explanation of Selected Risk Statistics (2/3) CVaR: Conditional Value at Risk/expected shortfall: The tail end of the distribution of loss is not taken into account with the VaR. CVaR gives the average of the worst-case loss scenarios once the VaR is exceeded for a given confidence interval. Duration: Macaulay Duration is the weighted average time until cash flows are received (in years), whereas modified duration measures the price sensitivity to yield. Effective Duration takes into account that future cash flows can change due to interest-rate movements. This is not the case for Modified Duration or Macaulay Duration; these duration determinants usually work fine for option-free bonds, but are less adequate for option-embedded bonds, for which Effective Duration is better suited. DV100: Change in the instrument/portfolio value in the event of a 100-basis-point parallel upward shift in the discount curve. CS100: Change in the instrument/portfolio value in the event of a 100-basis-point parallel upward shift in the spread curve. Similar to DV100 for a corporate bond, though typically larger because the credit curve is steeper compared to a government curve. For a government bond the CS100 will be zero. Incremental VaR: Effect on risk in the event of a small change in position weighting. August 2014 14
14 Risk Reports Explanation of Selected Risk Statistics (3/3) Credit Suisse s 3-Month/12-Month View: Interest-rate forecast stress tests, which are based on the interest-rate views of Credit Suisse s investment strategy department Credit Suisse s Strategy Interest-Rate Forecast Spot Horizon Spot Horizon 19.08. 3M 12M 19.08. 3M 12M CHF 3M 0.01% 0.10% 0.10% GBP 3M 0.55% 0.60% 0.90% 2Y 0.01% 0.05% 0.10% 2Y 0.84% 1.00% 1.70% 5Y 0.11% 0.30% 0.60% 5Y 1.99% 2.20% 2.80% 10Y 0.61% 0.90% 1.20% 10Y 2.60% 3.00% 3.50% EUR 3M 0.20% 0.20% 0.20% USD 3M 0.23% 0.30% 0.60% 2Y 0.02% 0.20% 0.40% 2Y 0.45% 0.70% 1.30% 5Y 0.31% 0.70% 1.10% 5Y 1.64% 1.80% 2.40% 10Y 1.20% 1.50% 1.80% 10Y 2.52% 2.90% 3.30% Spot rates as of 14.07.2014, rate forecast from July 2014. As mentioned before, we usually use a look period of one year for computing the different risk figures. In the risk reports we also include a VaR with a look-back period of six years (hence including the market turmoil of 2008 2009). August 2014 15
15 Risk Reports For each portfolio we show: Key risk figures on the first page The largest contributors to the tracking error by issuer on the second page The largest contributors to the tracking error by security on the third page August 2014 16
Contacts Charles Traband Investment Risk Manager Credit Suisse Zurich: +41 44 332 10 74 charles.traband@credit-suisse.com August 2014 17
Disclaimer This document was produced by Credit Suisse AG and/or its affiliates (hereafter "CS") with the greatest of care and to the best of its knowledge and belief. However, CS provides no guarantee with regard to its content and completeness and does not accept any liability for losses which might arise from making use of this information. The opinions expressed in this document are those of CS at the time of writing and are subject to change at any time without notice. If nothing is indicated to the contrary, all figures are unaudited. This document is provided for information purposes only and is for the exclusive use of the recipient. It does not constitute an offer or a recommendation to buy or sell financial instruments or banking services and does not release the recipient from exercising his/her own judgment. The recipient is in particular recommended to check that the information provided is in line with his/her own circumstances with regard to any legal, regulatory, tax or other consequences, if necessary with the help of a professional advisor. This document may not be reproduced either in part or in full without the written permission of CS. It is expressly not intended for persons who, due to their nationality or place of residence, are not permitted access to such information under local law. Neither this document nor any copy thereof may be sent, taken into or distributed in the United States or to any U. S. person (within the meaning of Regulation S under the US Securities Act of 1933, as amended). Every investment involves risk, especially with regard to fluctuations in value and return. Investments in foreign currencies involve the additional risk that the foreign currency might lose value against the investor's reference currency. Historical performance indications and financial market scenarios are not reliable indicators of current or future performance. Performance indications do not consider commissions levied at subscription and/or redemption. Furthermore, no guarantee can be given that the performance of the benchmark will be reached or outperformed. Copyright 2014 Credit Suisse Group AG and/or its affiliates. All rights reserved. August 2014 18