Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
The SEB X-asset Waves framework links investment returns to macro cycles This note updates the historical analysis and expands it to cover alternative beta
13 JUNE 2013
X-asset themes
CONTENTS
Summary: Active allocation with alternatives ....................................................................................................................................... 3 The structural wave: return deviations lasting 10-20 years................................................................................................................. 4 The strategic wave: return deviations lasting 1-3 years ....................................................................................................................... 6 The tactical wave: return deviations lasting 1-2 quarters .................................................................................................................... 8 Active allocation based on all three investment cycles...................................................................................................................... 10
+46 8 50623246
X-asset themes
Tactical waves: inventory cycle, phase length 1-2 quarters Strategic waves: output gap cycle, phase length 1-3 years Structural waves: technology cycle, phase length 10-20 years The deep, calm sea: 100-year return trends
The conceptual idea of our framework is to find asset return patterns that are coincident with recurring patterns in macro indicators. This means we can replace forecasts with empirical patterns by assessing current macro environment and compare to deep analysis of similar historical episodes. Our cyclical framework is built around three global, well-known cycles: the technology cycle, the output gap cycle and the inventory cycle. Each cycle is independent of each other and divided into four phases. For each phase we find systematic patterns in risks, returns and correlations on which we optimise phase specific portfolios. As in the long-term studies we operate with seven risk premiums covering close to a century of data. The risk premiums are represented as a fixed index based on the long-term max Sharpe portfolio of the seven individual strategies with leverage included. The characteristics of the long-term risk premium portfolio with fixed weights are attractive for a long-term investor because it is generally uncorrelated to macro risk factors. On the other hand this quality is less helpful in an active analysis where investors might actually want correlation. Over shorter time horizons macro changes do correlate with returns, so uncorrelated assets will usually be inferior to the best asset in a given regime. While the fixed index is long-term uncorrelated to macro risks individual premiums are not necessarily, which cancel out in the static exposure. If investors can identify systematic biases in parameters they should target returns that are correlated over shorter horizons. There is a slight tendency for the more risky premiums to work best in bear markets. Equity related premiums tend to be negatively correlated with equity returns and outperform when cash equities underperform. The fixed index has a relatively high weight in equity premiums why an investor could change the composition of the static exposure to overcome the shortcomings of the fixed index. An equal weighted basket of the three individual overlays on top of the passive long-term portfolio has between 19702012 added 250 bps on an annual basis and at the same time avoided the largest losses. As the three cycles are independent of the underlying passive long-term portfolio, the addition of the combined overlay lowers the total portfolio risk. By relaxing the requirement of a static alternative beta exposure it is possible to add another 110 bps to the performance. This is a flexible system and investors can scale the weighting between the three overlays according to their own needs. The structural overlay could be seen as background noise and played down by giving it a somewhat lower weight in the combined overlay and the tactical overlay could be left out due to the high frequency that might not fit some investors.
1 2
For references please refer to X-asset Themes #7, 2012: The role of alternative betas in long-term portfolios and X-asset Themes #8, 2012: Expanding the universe 3 Hedge funds is throughout the report a fixed index consisting of equity market neutral, CTA and macro strategies, please refer to X-asset Themes #3, 2012: Hedge funds avoiding a simplistic approach
X-asset themes
Overcapacity crisis
Low Typical duration: 15-20 years Best asset class: bonds Risk premium: negative
According to this model, the structural cycle can be divided into four phases, two with falling inflation and bond yields and two with rising inflation and bond yields lasting 10-20 years. Due to the complex nature of the cycle it is difficult to point to one single indicator to capture turning points, triggers are qualitative with both political and economic changes as input. The start of a technology cycle in the New era boom-phase requires a technological Big Bang like the introduction of the PC in 1981, but is typically also accompanied by deregulation and other policies designed to benefit the supply side. A break in the IPO mania signals the end of the bull market and the start of an Overcapacity crisis, where demand falls short of supply. A reboot with reforms designed to support wages, regulate monopolies and inflate debt away is typically needed to propel the economy to the consumer-driven Golden age boom-phase, which ends when productivity growth falls and inflation accelerates as the technologys potential is exhausted.
Chart 4. Real return & risk in structural phases, USD, 1927-2012
20% Overcapacity crisis
20% Golden age boom
15%
15%
Real return
Real return
10% Credit Gvt.bonds 0% T-bills Alternative betas Hedge funds Commodities Equities
10%
Equities
5%
0%
-5%
20%
25%
30%
0%
5%
10%
20%
25%
30%
20%
15%
Real return
Real return
10%
5%
T-bills
10% Commodities 5% T-bills Credit -5% Gvt.bonds Equities Alternative betas Hedge funds
0%
0%
20%
25%
30%
0%
5%
10%
20%
25%
30%
X-asset themes
In this section we examine systematic patterns in risks and returns for the different stages of the structural cycle. Basic patterns for bonds and equities extend almost 200 years back, but we only have the broader investment universe since 1927. Every cycle shows unique characteristics but share underlying common recurring features. In each structural phase there is a tendency for the winner asset class to become a loser asset in the following phase. At the end of the New era boom investors have had up to 20 years of strong equity returns combined with falling bond yields. All asset classes but commodities have positive risk premiums with above average returns and the normal risk/return pattern, where investors get compensated for taking on risk, works. In Overcapacity crisis, bonds and credit still do well while equity returns are close to zero at elevated risk. In the Golden age boom, equities rebound while government bonds, credit and alternative beta returns approach zero. Finally, in the Capacity shortage crisis, all traditional assets have negative returns with only commodities and alternative beta offering high returns. The fixed alternative beta index has a positive return in all phases, and is thus uncorrelated to structural risk. However, it is possible to improve alternative beta performance by relaxing the requirement of a static exposure.
Chart 5. Real return & risk individual Alternative beta strategies in structural phases, USD, 1927-2012
10% Overcapacity crisis 10% Golden age boom
5% Real return
Small cap premium Dividend premium Defensive sectors Value premium Real return Alternative betas Credit premium Gvt.bond curvature
FX carry
0%
0% Gvt.bond curvature
15%
20%
10% FX carry 5% Gvt.bond curvature Credit premium Alternative betas Value premium Defensive sectors 0% Small cap premium Dividend premium
10%
5% Real return
Real return
Value premium Alternative betas FX carry Defensive sectors Credit premium Gvt.bond curvature
Dividend premium
0%
15%
20%
There is a tendency for the riskier equity related premiums to be less attractive in equity bull markets the value premium stands out with positive return in both secular bulls and secular bears for equities. In the New era boomphase, three out of four equity related premiums either have negative or negligible return, while the fixed income and FX premiums have their best returns. The small cap premium posts a negative return which may be related to the IPOboom which typically takes place in this phase. In the subsequent Overcapacity crisis, the equity risk premiums rebound, again rewarding investors for accepting their higher risk, even as equities overall hardly pay any return at all and have elevated risk at the same time. Credit and FX carry offer modest, positive returns. Whereas in the New era boom non-equity related premiums worked well, the Golden age boom, starting after the low point for inflation and yields, is more problematic with four of the seven risk premiums actually recording losses. It is more difficult to find a clear-cut risk/return pattern and the most attractive premiums are found in the middle of the risk-range. Then, as the Capacity shortage crisis brings overall equity returns down, investors are in general rewarded for taking on risk in alternative premiums again. Cash equities underperform and all equity related premiums deliver above-zero returns. The value premium has a positive return in all phases - being truly unsystematic at the structural level. The defensive sectors premium, which is a version of the low volatility strategy including energy, healthcare and staples, consistently has a lower volatility than the three other equity related premiums.
X-asset themes
Late expansion
Average duration: 37 months Best asset class: commodities Risk premium: above average
Early recession
Average duration: 13 months Best asset class: cash/gvt bonds Risk premium: negative
Credit cycle
Early expansion
Easing Average duration: 33 months Best asset class: equities Risk premium: very high
Late recession
Average duration: 22 months Best asset class: credit Risk premium: low, but positive
The strategic cycle in our version is divided into four phases lasting on average around 1-3 years, using two separate macro cycles, a GDP growth and a credit cycle. The primary cycle is the growth cycle: GDP growth below trend signals the economy is in recession while GDP growth above trend means expansion. This generally anchors the risk premium pattern: high risk is generally only rewarded in expansions. In practice, unemployment is used as a proxy for the output gap since it is robust and observable on a monthly basis. The secondary cycle, the credit cycle, provides additional signals to decide secondary turning points and leads the GDP growth cycle with turning points always being a couple of years ahead. The credit cycle is about credit quality so true turning points are peaks and troughs for corporate debt/profit ratios. In practice these are closely correlated with the yield curve, which we use as a proxy in real-time analysis. Systematic strategic patterns exist independent of the structural cycle. Passive strategies work well when the underlying structural trend is upward sloping, but recessions still occur even if not as damaging as when the structural trend is downward sloping. Losses in the first part of a recession are significantly larger in a structural crisis and volatility is generally higher.
Chart 8. Real return & risk in strategic phases, USD, 1970-2012
15% 10% Hedge funds 5% Real return Real return Credit T-bills 0% -5% -10% -15% 0% 5% 10% 15% 20% 25% Standard deviation
Source: GFD, Ecowin, Fama & French and SEB X-asset
15% 10% Alternative betas 5% Gvt.bonds Credit Hedge funds -5% -10%
Early recession
0%
T-bills
Commodities
15% 10% 5% Real return 0% -5% -10% -15% 0% 5% 10% 15% 20% Credit T-bills Alternative betas Hedge funds Gvt.bonds Equities Commodities
Early expansion
15% 10% 5% Real return 0% -5% -10% -15% Alternative betas T-bills Commodities Credit Equities Gvt.bonds Hedge funds
Late recession
25%
0%
5%
10%
15%
20%
25%
Standard deviation
Source: GFD, Ecowin, Fama & French and SEB X-asset
Standard deviation
Source: GFD, Ecowin, Fama & French and SEB X-asset
X-asset themes
In the strategic cycle there is only one phase where investors do not get rewarded for moving out on the risk scale. In early recession returns systematically go down as risk goes up for the broad asset classes. Both equities and commodities show negative returns at elevated risk. Hedge funds, which are expected to provide positive return in periods where losses are clustered, post a negative return. Alternative beta stands out together with government bonds. In the late recession phase, as the credit cycle eases, credit provides very attractive risk-adjusted return. Commodities deliver flat return and equities break well into positive territory, showing a massive return difference between the first and last part of recessions, albeit volatility stays high until GDP growth is above trend. Some claim the market is forward-looking as it rebounds before GDP growth is above trend. In fact, equities respond to easing credit conditions and there is nothing forward-looking about it. Even though equity returns have historically recovered in late recession they still fall short of credit returns. In expansions, as growth above trend has materialized, all assets offer positive risk premiums and the relation between risk and return is normal.
Chart 9. Real return & risk individual Alternative beta strategies in strategic phases, USD, 1927-2012
15% Late expansion 15% Early recession
Dividend premium 10% FX carry Real return Real return Alternative betas 5% Gvt.bond curvature 0% Credit premium FX carry Defensive sectors Small cap premium 5% Gvt.bond curvature 0% Credit premium Defensive sectors Alternative betas Value premium Dividend premium Small cap premium -5% 0% 5% 10% Standard deviation
Source: GFD, Ecowin, Fama & French and SEB X-asset
15%
20%
15%
Early expansion
15%
Late recession
10% FX carry Credit premium Alternative betas Gvt.bond curvature 0% Dividend premium Defensive sectors
5%
Dividend premium
5%
0%
FX carry Credit premium Small cap premium Defensive sectors Gvt.bond curvature
15%
20%
There are some strategic similarities for the individual alternative strategies to what we found in the structural cycle. As a general rule it does not always seem profitable to go to the highest part of the risk spectrum as the most risky premiums do not consistently pay off. The only phase where investors get rewarded for going for the most risky assets is in early recession, where investors need it most. There is thus a tendency for equity related premiums to do best when the equity market has its lowest return. In early recession returns are in general very high but risks are elevated, especially for the equity related strategies. Defensive sectors are normally counter cyclical with its premium concentrated to periods of slowing GDP growth. High dividend stocks are yield supported meaning losses during market declines will be reduced. The value premium is related to exaggerated earnings expectations for growth stocks which tend to adjust to more realistic levels in market declines. As the credit cycle starts easing in late recession the credit premium and FX carry outperform together with the value premium and the small cap premium. Cash equities rebound in this part of the cycle why defensive sectors are reversed in a cyclical rotation. The first part of expansions offers a positive sloping risk/return pattern as we found for broad asset classes with positive returns at moderate volatility. In the last part of expansions the positive relation between risk and return breaks down. The high cash equity return is not reflected in the equity-related premiums, three out of four underperform at elevated risk. FX carry is a slow mover and peaks in the last part of expansions as risk appetite in general is high. Defensive sectors pick up from low levels when credit conditions start tightening and GDP growth starts falling. The value premium and the small cap premium are persistent and manage to deliver above-zero-returns in the most critical phases of the strategic cycle where losses tend to cluster for broad asset classes. FX carry and defensive sectors are also persistent and work well as we approach a recession.
X-asset themes
Late upswing
Average duration: 4 months Best asset class: commodities Risk premium: average Rising
Early downturn
Average duration: 5 months Best asset class: gvt bonds Risk premium: negative
Inventories
Early upswing
Average duration: 4 months Best asset class equities Risk premium: very high Falling
Late downturn
Average duration: 3 months Best asset class: credit Risk premium: low, but positive
The tactical cycle is divided into four phases, lasting on average around three to six months, using a traditional phase diagram based on only one cycle. Primary turning points are based on the direction of OECD leading indicators, if they are falling or rising, and secondary turning points depend on the second derivative of these indicators. In practice we use the global PMI, which is released on a monthly basis with far less delay and basically follows the same pattern as OECD leading indicators, as a proxy for the OECD measure. The tactical cycle is present in both recessions and expansions, and just like recessions are deeper in a structural crisis market tactical corrections are also significantly deeper in a strategic recession. Shorter cycles dominate longer cycles within their timeframe, so a tactical upswing can still lift markets during a recession, but in general they do not change the direction of the longer cycles. On the other hand, a turning point in a longer cycle is likely to coincide with a turning point in a shorter cycle. So, while most corrections in the PMI cycle do not herald a longer-lasting recession, the start of every recession is likely to be associated with a tactical downswing.
Chart 12. Real return & risk in tactical phases, USD, 1970-2012
25% 20% 15% 10% Real return Real return 5% 0% -5% -10% -15% -20% 0% 5% 10% 15% 20% 25% Standard deviation
Source: GFD, Ecowin, Fama & French and SEB X-asset
Late upswing
Early downturn
Credit T-bills
Commodities
Equities
5%
10%
15%
20%
25%
Standard deviation
Source: GFD, Ecowin, Fama & French and SEB X-asset
25% 20% 15% 10% Real return 5% 0% -5% -10% -15% -20% 0% 5% 10% 15% 20% Alternative betas T-bills Hedge funds Gvt.bonds Credit Equities Commodities
Early upswing
25% 20% 15% 10% Real return 5% 0% -5% -10% -15% -20% T-bills Credit Gvt.bonds Alternative betas Hedge funds Commodities Equities
Late downturn
25%
0%
5%
10%
15%
20%
25%
Standard deviation
Source: GFD, Ecowin, Fama & French and SEB X-asset
Standard deviation
Source: GFD, Ecowin, Fama & French and SEB X-asset
X-asset themes
Even though the strategic and tactical cycles are driven by different macro cycles phase specific risks and returns in the tactical cycle are comparable to strategic results, almost like a fractal image. There is only one phase where higher risk is not rewarded. Early downturns penalize investors at higher risk levels, however commodities show a small positive return in this part of the tactical cycle. In late downturn fixed income related assets, alternative beta and hedge funds have the same risk level but returns vary from flat to +15% with credit being most attractive. Equities post a positive return, before OECD leading indicators stop falling, the fall just has to decelerate. During upswings, risk premiums are positive for all assets but government bonds and apart from bonds investors are compensated for taking on risk. Equities and commodities peak the first months after OECD leading indicators have bottomed out and continue to deliver high returns until OECD leading indicators peak, with volatility well below trend. As tactical patterns are very similar to strategic it is challenging for investors to distinguish between initial tactical and strategic changes since the market will not tell which kind of movement investors experience and as a consequence uncertainty will be elevated a quarter every year.
Chart 13. Real return & risk individual Alternative beta strategies in tactical phases, USD, 1927-2012
15% Late upswing 15% Early downturn Dividend premium Defensive sectors Value premium Alternative betas Gvt.bond curvature 0% Credit premium FX carry
10%
10%
Real return
5% Credit premium 0%
Real return
5%
Gvt.bond curvature
-5%
-5%
10%
15%
15%
Early upswing
15%
Late downturn
10% FX carry Real return 5% Credit premium Gvt.bond curvature Defensive sectors -5%
5%
Dividend premium
0%
0%
Dividend premium
-5%
10%
15%
Whereas broad asset class patterns look similar to the patterns in the strategic cycle, there are larger differences for the individual premiums. The main difference is that the cyclical rotation and reversal of equity premiums is after rather than before the trough in OECD leading indicators, while these changes led the move to above-trend growth in the strategic cycle. Also, while equity-related premiums in general do best in the first part of a tactical downswing, the small cap premium is not defensive as in the strategic cycle, showing a negative return at elevated risk level. Small cap beta is generally more risky over shorter time horizons compared to longer horizons, most likely because they are less liquid and therefore more sensitive to short-term flows than other equity premiums. The other three equity related premiums show opposite results with double digit returns at only somewhat higher than average risk. In the last part of a downswing all premiums except the defensive sectors premium have positive returns. However, only when the upswing has started do we see the full cyclical rotation, and poor performance for some equity premiums, that characterize the last part of a strategic recession. Both defensive sectors and the dividend premium thus show negative returns. Again, the small cap premium stands out and continues to deliver well above average return as OECD leading indicators rise and registers the highest return of all risk premiums. FX carry also excels in this phase, which otherwise favors the low-risk fixed income premiums. In the late upswing phase, the small cap premium comes back to earth, and the other three equity premiums have low, but positive, risk-adjusted returns. FX carry continues to deliver high returns all the way through the upswing, but apart from FX carry, returns are muted in late upswing: the small cap premium is negative and the fixed incomerelated premiums close to zero. Value again stands out as the most robust and consistent equity premium.
X-asset themes
12%
21%
T-bills Gvt.bonds Credit Equities Commodities Hedge funds Alternative beta
20% Gvt.bonds curvature Credit premium Value premium Defensive sectors Dividend premium Small cap premium FX carry
37%
12%
6% 3% 15%
5% 4%
Note: Consturcted using 98% confidence level and 12 months time horizon
29%
16% 19%
Source: GFD, Ecowin, Fama & French and SEB X-asset
Note: Consturcted using 98% confidence level and 12 months time horizon
T-bills
Commodities
In the strategic cycle, the optimal portfolio for the early recession phase has a significantly higher bond allocation. As the credit cycles eases in late recession the bond overweight is shifted into an equally large credit allocation. In both parts of expansions commodities dominate. Equities are not the clearly preferred asset class at this risk level, neither is alternative beta. Two risk premium strategies dominate strategic results. The government bonds curvature premium is preferred in early recession, shifting into the credit premium in late recession. During early expansion both the credit premium and the small cap premium are preferred, and in the last part of expansions the bond curvature premium dominates once again, closely followed by FX carry. Four of the seven premiums are never the winner, but the value premium is the only of the four showing an underweight in a majority of the phases.
10
X-asset themes
Tactical portfolios have a similar pattern as in the strategic cycle, albeit with some differences. Equities dominate in the early upswing phase, and all asset classes but alternative beta have a phase where they are preferred. The government bonds curvature premium, together with defensive sectors and the dividend premium dominate early downturns. The small cap premium is preferred in early upswing and in late upswing FX carry is the winner premium. The value premium is never the winner premium, instead it posts a sizeable underweight in all phases.
Chart 20. Tactical weights broad asset classes
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Early downturn T-bills Gvt.bonds Credit Late downturn Equities Early upswing Hedge funds Late upswing Alternative betas Commodities
Further more, the combined overlay on top of the passive benchmark demonstrates smaller maximum drawdown, reduced to around 40% of the passive long-term level. The tactical overlay has the most powerful return impact, but also the largest downside potential as timing is very important. Trading costs are not included which will impact results. On a combined overlay level annual two-sided turnover is around 80%, for both the broad asset classes and the individual risk premiums. This translates into a break even cost per transaction of roughly 320 bps for the broad asset classes and 140 bps for the individual alternative beta strategies.
11
STOCKHOLM
Kungstrdgrdsgatan 8 Merchant Banking Division SE-106 40 Stockholm Telephone: +46 8 763 80 00
LONDON
2 Cannon Street GB-London EC4M 6XX Telephone: +44 20 7246 4000 Registered in England under NFC014326 BR000979
COPENHAGEN
Bernstorffsgade 50 DK-1577 Copenhagen V Telephone: +45 3328 1400
FRANKFURT
Merchant Banking Division Ulmenstrasse 30 DE-60283 Frankfurt Telephone: +49 69 258-0
FX SALES
Telephone: +46 8 506 23 140
LUXEMBOURG
6 A, Circuit de la Foire Internationale L-2014 Luxembourg Telephone: +352 26 23 1
HELSINKI
Unioninkatu 30 P.O Box 630 FI-00100 Helsinki Telephone: +358 9 616 280 00
DISCLAIMER
Important: This statement affects your rights The information in this document has been compiled by Skandinaviska Enskilda Banken AB (publ) (SEB AB) and SEB A/S, a subsidiary to SEB AB. It is produced for private information of recipients and SEB is not soliciting any action based upon it. All information has been compiled in good faith from sources believed to be reliable. However, no representation or warranty, expressed or implied, is made with respect to the completeness or accuracy of its contents and the information is not to be relied upon as authoritative. Recipients are urged to base any investment decisions upon such investigations as they deem necessary. To the extent permitted by applicable law, no liability whatsoever is accepted for any direct or consequential loss arising from use of this document or its contents. Any presented performance data is un-audited. Information relating to taxes may become outdated and may not fit your individual circumstances. Investment products produce a return linked to risk. Their value may fall as well as rise, and historic returns are no guarantee of future returns; in some cases, losses can exceed the initial amount invested. Where either funds or you invest in securities denominated in a foreign currency, changes in exchange rates can impact the return. Your attention is drawn to the fact that SEB, a member of, or any entity associated with, SEB or its affiliates, officers, directors, employees or shareholders of such members may from time to time have holdings in the securities mentioned herein. THIS INFORMATION IS NOT INTENDED TO BE PUBLISHED OR DISTRIBUTED IN THE UNITED STATES. SEB AB is incorporated in Stockholm, Sweden, with limited liability. SEB AB is regulated by Finansinspektionen (the Swedish Financial Supervisory Authority). SEB A/S is incorporated in Copenhagen, Denmark, with limited liability SEB A/S is regulated by Finanstillsynet (the Danish Financial Supervisory Authority) Confidentiality Notice This information is confidential and may not be reproduced or redistributed to any person.
www.seb.se/mb