Managing Risk in an Uncertain World \\\\ \\ September 2017 This - PowerPoint PPT Presentation

Managing Risk in an Uncertain World \\\\ \\ September 2017 This presentation is for Professional Clients only and is not Matt Parlour for consumer use. Please do not redistribute. Investment Speaker

Learning outcomes Following this presentation, you will understand:  How clients perceive and define risk  Different methods of managing risk  How investment solutions have evolved to deliver greater precision in risk management All images sourced from iStock Getty. 2

How clients perceive and define risk 3

How clients perceive and define risk Definition 35% 20% 16% 15% 8% 6% Permanent loss of capital Underperforming the market Failing to meet financial goals Exposing assets to market volatility Missing out on potential investment returns Other Source: Natixis Individual Investor Survey 2016, Key findings. 4

How clients perceive and define risk Perception vs reality Thoughtful 13% 87% Emotional Cautious 82% 18% Aggressive Research-driven 75% 25% Instinctual Self-sufficient 57% 43% Advice-seeking Trend follower 43% 57% Contrarian Fearful 20% 80% Confident Source: Coredata Research 2016. 5

How clients perceive and define risk Many HNWs are struggling with market volatility “While I worry about market shocks, “I struggle to avoid making emotional I feel helpless when trying to protect decisions when market shocks occur” my portfolio from them” 69% 48% Source: Coredata Research 2016. HNW= High Net Worth investors. 6

How clients perceive and define risk What were the perceived investment risks – end 2016 45% 38% 37% 19% 16% 9% Global Economic Rising Geopolitical Oil price rise Terrorism economic slowdown in interest rates event slowdown China Source: Coredata Research 2016. UK HNW investors. 7

How clients perceive and define risk Confusion about passive investing Investor perception Investment reality Approximately 60% of investors believe that index funds are: Lack any risk Less risky management Experience full market Can help minimise losses loss (plus charges) Offer better Many indices are heavily weighted by a diversification handful of sectors Source: Natixis Individual Investor Survey 2016, key findings. 8

What do investors want? A majority of investors want new portfolio strategies that:  Better manage risk  Offer a balance of risk and return  Better insulate their portfolios in volatile markets  Help them better diversify their portfolios Source: Natixis Individual Investor Survey 2016, key findings. 9

Managing risk

Managing risk  Diversification & correlation  Investment specific risk vs market risk  Managing risk with derivatives  Derivatives in practice 11

Managing risk  Diversification & correlation 12

Diversification & correlation Theory Return Umbrella manufacturer Combined return Ice cream company Dry Wet Dry Time Source: Invesco Perpetual. For illustration purposes only 13

Diversification & correlation Diversification in practice Combining UK gilts and equities - Return and Risk (%)* 10.0 Annual total return CAGR (%) 100% Equities Same risk as 100% Gilts: 71% Gilts 9.5 29% Equities 9.0 "Balanced Fund" 60% Equities Minimum Risk 40% Gilts 8.5 86% Gilts 14% Equities 100% Gilts 8.0 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Risk, standard deviation of returns (% pa) Source: Invesco, Datastream and Bloomberg as at 20 March 2017. Gilts - BofA ML Gilt Index , Equities - FTSE All Share. *Based on 31 year monthly returns Dec 1985 – Dec 2016. 14

Diversification & correlation Correlations in practice Correlation between FTSE All Share and Gilts indices (weekly one year rolling)* 1.0 0.8 0.6 0.4 0.2 0.0 -0.2 -0.4 -0.6 -0.8 -1.0 90 92 94 96 98 00 02 04 06 08 10 12 14 16 Source: Datastream and Bloomberg as at 20 March 2017. *Gilts - BofA ML Gilt. 15

Diversification & correlation Impact of changing correlations Effects of varying correlations on risk/return trade-off UK gilts and equities* 10.0 Annual total return CAGR (%) 1.00 0.50 0.00 -0.50 -1.00 9.5 9.0 8.5 8.0 0 2 4 6 8 10 12 14 16 18 Risk, standard deviation of returns (% pa) Source: Invesco, Datastream and Bloomberg as at 20 March 2017. Based on BofA ML Gilt Index and FTSE All Share. *Based on 30 year monthly returns Dec 1985 – Dec 2015. 16

Managing risk  Diversification & correlation  Investment specific risk vs market risk 17

Investment specific risk vs market risk Risk in portfolio Total risk Investment-specific risk Market risk 10 20 Number of different investments in portfolio Source: Invesco Perpetual. For illustration purposes only 18

Managing risk  Diversification & correlation  Investment specific risk vs market risk  Managing risk with derivatives - Potential uses 19

Managing risk with derivatives Potential uses  Gain exposure  Increase opportunities  Tailor positions  Manage downside risk  Provide flexibility  Provide additional income stream Source: Invesco Perpetual for illustrative purposes. 20

Managing risk  Diversification & correlation  Investment specific risk vs market risk  Managing risk with derivatives  Derivatives in practice 21

Derivatives in practice Selling an equities index future as a hedge Example Asian Fund (unhedged), components and Asian Fund (hedged) Index / market values 2,500 2,400 2,300 (rebased) 2,200 2,100 2,000 1,900 1,800 0 5 10 15 20 25 30 35 40 45 50 Time Japan Hong Kong New Zealand Singapore Australia Fund (unhedged) Fund (hedged) Hedge 40 Profit / loss 20 0 -20 0 5 10 15 20 25 30 35 40 45 50 Time Hedge Source: Fitch Learning/Invesco Perpetual. For illustration purposes only. 22

Derivatives in practice Using a put option as crash mitigation Put Fund: strike long equity exposure Long put option Overall: Profit long equity exposure + Market long put option now Underlying at expiry Loss Source: Fitch Learning/Invesco Perpetual. For illustration purposes only. 23

Derivatives in practice Greater precision in risk management EUR Adidas 1.25% EUR Adidas Interest = + + Currency credit 2025 rate risk risk risk EUR Interest forward rate swap Source: Fitch Learning/Invesco Perpetual. For illustration purposes only. 24

How investment solutions have evolved to deliver greater precision in risk management

The evolution of investment solutions Single asset “Traditional” “Modern” Multi Risk Multi Equities Bonds Balanced Asset Targeted Strategy Limited flexibility Highly flexible Limited diversification Highly diversified Return focus Risk/return focus Asset allocation “Strategy / Idea” allocation Simple Complex Source: Invesco Perpetual. For illustrative purposes only. 26

The benefit of diversification Change in volatility by adding a multi-asset fund Annualised standard deviation of portfolio 6% 5% 4% 3% 2% Portfolio Risk Profile 3 1% Portfolio Risk Profile 4 0% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Weighting of multi-asset fund as a % of portfolio Source: Invesco Perpetual/Bloomberg. For illustration purposes only. Based upon example model portfolios. Volatility data is annualised, 3 years to 31/3/2017. Multi-asset fund used is Invesco Perpetual Global Targeted Returns, gross performance. 29

The benefit of diversification Change in potential returns by adding a multi-asset fund Annualised return of portfolio 10% 8% 6% 4% Portfolio Risk Profile 3 2% Portfolio Risk Profile 4 0% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Weighting of multi-asset fund as a % of portfolio Source: Invesco Perpetual/Bloomberg. For illustration purposes only. Based upon example model portfolios. Performance data is gross, annualised 3 years to 31/3/2017. Multi-asset fund used is Invesco Perpetual Global Targeted Returns. 30

Managing risk in an uncertain world Summary  A majority of investors would like to better insulate their portfolios in volatile markets  Portfolio volatility is only reduced if asset classes have a low correlation to one another  Derivatives allow fund managers to manage exposure & focus risk precision  Traditional multi-asset funds continue to play a role in client portfolios  Modern investment solutions potentially deliver greater precision in risk management 31

Learning outcomes Following this presentation, you will understand:  How clients perceive and define risk  Different methods of managing risk  How investment solutions have evolved to deliver greater precision in risk management All images sourced from iStock Getty. 32