Investment Management: Luxury or Commodity?

Dr Drago Indjic Sunningdale Capital Partners LLP

UWL, 25 November 2012

Contents

• UK plc: Jurisdiction, domicile = law, GBP, tax …

• Master of Science – Finance iff certified

• An example of asset class and related investment strategies

• Packaging, features, costs and value of (commoditised) investments

W5 5RF (c 2013)

• UK Financial Conduct Authority

– http://www.bankofengland.co.uk/

• “Square Mile”

– Law, insurance

– Silicon Roundabout: technology

Structure of Investments

• Investment business • “Authorised and regulated” for clients; CIIA

• Fundamentals • Rights and cash flows of an (financial) instrument and

(today’s) universe;

• Redundant, hence priced and arbitraged

• Investment strategy • Stock pick, passive (index), traditional active (mutual

fund), hyper-active (long/short, hedged, leveraged), replicated (exchange traded products)

What is this?

• 007

– Q0: Where is the market? Demand? Supply? Price? Lending? Financing? Advisors? Products?

– Q1: What are its characteristics? Risk sensitivities?

– Q2: How do you calculate all this? In “bulk” and on time?

Bond, Convertible Bond (“CB”)

Supply: Why issue CB?

•

– Discuss: IPO discount; liquidation and recovery

Market: Price vs Value

•

• Happy to leave pricing to PhDs and geeks!

Qualitative Strategy Analysis

•

– Time-varying credit and optionality

Good Old Times Always Exist

From ‘Good’ to ‘New Normal’ Time

•

– Note: balance sheet bank and sovereign (credit)

Time to Take Risk

• “Trade” - what is it about?

– Your role? Beneficiary? Preferences? Horizon? Capital? Counterparty? Credit? Leverage? Spread?

• Investment View

– Leave “risk free”: inflation? Opportunity? Value?

– Asset class location, instrument, strategy, timing

– Risk (act) confidently only if it is rare or unique

Investment Strategies

• Informed trading: “Prices, probabilities and preferences” (Andrew Lo)

– Timing - when? Cash - Buy – hold – sell

• Investment and Trading Objectives

– Legal claims and contracts: control rights (activist, insolvency); market making; income – growth - multiple – hedge – bet?

– Explanation: performance and risk attribution

Business Decisions

• Why investing or trading?

– Legal: Private, advisory, professional (FCA)

– Your hobby? Job? Business? Is it only about your wealth (or time)?

• Principal/Agent; Cost/Benefit

– Market efficiency (public benefit) and innovations (private)

– “Trust” and “reputation” (brand recognition)

– Outsourcing; total costs ( 0%);

“Long Term” Starting Position

• Why buy CB now? Who is selling it to us?

Active or Passive

• Buy fund or index? Or managing your fund?

– “Beta diet”: DIY cooking, take-away or Michelin?

Experimenting with Your “Beta”

• UWL Class 2012/13 “Endowment”

– Today’s class as active investment manager & “market”: make “index” (est. NAV, Betas …)

• Q. Can we create some reports and charts?

• Q. Fundamentals and risks: events, corporate actions, capital structure

• Risk manage

– Role playing: control and rebalance individuals or groups? Strategy? Protect or enhance, hedge …

Xmas – White or Black?

Q. Mr Smart, what is the best strategy in 2012?

A. Credit Arbitrage: ABS - Mortgage-Backed

– Almost exclusive US, large size trade, macro backdrop, complex derivatives (“not available in shops”)

Real Markets

• “Freedom” of trading vs reality

– asset class, brokerage costs, “best execution”

Real-time: is market open? Trade size, spreads ..

Market Re-Regulation

• Market micro structure: CDA, “dark pool”, OTC

– High frequency trading: “special” orders for order book queue jumpers, exchange rebate rentiers

• Sunday Times, 25 Nov 12: self-made, but • Salary? Annual management fee? Performance-related

fee? Is it worth?

Hedge Manager’s Wealth

What is Risk Then?

• Capital: not “variance” and “mean”

– Ruin; impairment (“return of capital”); liquidity

• Statistical bells and whistles

– Correlation; Beta; fashionable: risk “parity”, risk “off/on”

• Macro risks

Modern Performance Charts

Managing Portfolios

• Investment manager • Life beyond a single trade: idea flow, edge …

• Launch and market as business: teamwork

• Hedge, arbitrage, speculation

• Core (“Beta”) • Capital preservation, income, liquidity ...

• Satellite • Theme: trend; opportunity/event: macro, dislocation,

corporate action

Crisis: Macro, Regs, Retail

What now?

• Macro context: “Perma-QE” • “Anti-fragility”; Resources, demographics

• Syria, Iran, Gaza; North Korea …

• Policy agility divergence • Growth vs solvency; global vs national level

• FX vol, trade, debt, IMF/OECD, Fed/ECB

• Fairness vs fraud • LIBOR, HFT; Pension systems; DC risk transfer, SIPP

• Anglo-Saxon export: financial trading and technology

Your Future Portfolio

• Decisions

– Confidence, evidence, behavioural, utility (wrt boss, partner, peers, client, child ..)

– Your benefit: aligned interest? Horizon?

• From single stock pitch to portfolio

– Value catalyst? Short? Including an index? Money management? Performance attribution

– Emergence of Beta; control of max drawdown or Beta; implied views (reverse optimisation)

Awarding Traders

• Minimal

– drawdown

– variance (max Sharpe)

– correlation (Beta)

– Minimal #trades (costs)

• Best

– Business development proposal (seeding offer)

– Research and analytics

Conclusions and Q & A

• Pricing and marketing “performance”

• Absolute or relative; “” as “undiscovered”

• Value for money (or time)

– Hedged, more agile strategies outperform (smaller losses, lower variance); long-only risks capital

• Alpha by design

– “Non replicable” only: activist, event driven; macro relative value

Christmas Time post-2007

• “While tough regulations have spiked demand for compliance, risk and legal officers, creating a bright spot in an otherwise depressing job market for the financial industry (…) If all of this is a little too dark and gloomy for you, you can always take a sip of Cognito’s latest set of financial services drinks, specially designed to bring back some pre-2007 holiday cheer.

– 2 Dec 2012, WS&T Daily