Koris international - 2014 European Institutional Risk-Based Investing Survey

Koris International

2014 EuropEan InstItutIonal rIsK-BasED InVEstInG surVEy

For InstItutIonal anD proFEssIonal InVEstors only

In partnership with

1

3

5

10

20

24

26

Summary

Koris International | 2014 European Institutional Risk-Based Investing Survey | December 2014

IntroductIon

key FIndIngS

the reSpondentS

uSe and perceptIon oF rISk-BaSed InveStIng approacheS

the SpecIFIc caSe oF SyStematIc LoSS controL StrategIeS

reFerenceS

aBout korIS InternatIonaL

IntroDuCtIon


2

Koris International would like to thank all institutional investors that participated in the first

Koris International 2014 European Institutional Risk-Based Investing Survey.

Over 70 CFOs, CIOs, CROs and other senior decision makers across 12 European countries

took part in this online and telephone survey, representing pension funds, insurance firms,

family offices, corporates, endowments and other institutional investors.

We recognise that this year investors have received numerous requests to complete surveys.

Bearing this in mind, we kindly thank these institutions for taking the time to share with us

some invaluable insights regarding how they comprehend and manage the investment risk.

Finally, we would like to thank our partners, who helped us in reaching their institutional

client base, and our colleagues for their sound contribution.

We hope you will find the survey of interest and look forward to pursuing discussions

regarding investment risk practices with you.

Jean-René GIRAUDCEO and co-Founder

INTRODUCTION

KEy FInDInGs

4


Institutions say “Managing investment risks first and foremost”

Almost 9 out of 10 institutional investors surveyed define their asset allocation using risk-

based approaches, whether entirely or limited to certain buckets. It should not come as

a surprise given the increased resources the financial industry invests in sound risk

management practices.

Board’s decision key in adopting risk-based investing approaches

Despite tightening regulatory requirements, 62% of organisations state that the rationale

behind adopting a risk-based investing approach relates to their board’s decision. The risk

awareness among board members has risen significantly in recent years as much as the

importance of CROs within institutions.

Controlling the maximum drawdown and the volatility comes first

Institutional investors seek to control as much a direct downside risk measure (58% mention

the maximum drawdown) as an indirect one (56% cite the volatility). While the first enables

capturing the tail risk, the second (empirically) provides serious hints when it exhibits

significantly increasing levels.

No ‘perfect’ strategy to control risks but hedging overlays offer broad possibilities

It is commonly agreed that the diversity of investment risks an institution faces generally

requires combining several strategies to efficiently hedge them. Nonetheless, 42% of investors

favour the numerous risk mitigating possibilities offered by hedging overlay approaches.

Risk awareness = Frequent risk monitoring

Nearly half of the respondents monitor their portfolios’ risk at least on a weekly basis whereas

only 17% do so four times a year or less. Whether driven by internal or external factors,

institutions are more and more incentivised to better assess the various risks they face.

ETFs / Index funds and derivatives best suited for systematic loss control strategies

A little less than half of the informants consider ETFs / Index funds as the most appropriate

investment vehicles to incorporate within systematic loss mitigating solutions. Exchange-

traded derivatives are mentioned by 35% of investors in this regard, about twice the figure

for OTC derivatives.

Key fINDINGs

thE rEsponDEnts

6

Industry Breakdown


Of the respondents, we notice strong participation from two countries: France and Switzerland

with 27% and 26% respectively. The other informants are based in the United Kingdom (14%),

in Benelux countries (11%), in Germany (8%), with the remaining being based in Italy, Nordic

and other European countries (14%).

Koris International 2014 European Institutional risk-Based Investing survey was undertaken between september 29th and october 15th, 2014. During this period, 74 decision makers from 12 countries representative of the main European institutional investors (pension schemes, insurance firms, family offices, corporate treasuries, endowments / foundations and other institutions) have kindly contributed to our online and telephone survey. this publication incorporates responses from European institutions that collectively manage Eur 250bn.

Geographic Breakdown

4%5%

5%

8%

11%

14% 26%

27%

France

Switzerland

United Kingdom

Benelux

Germany

Italy

Nordic countries

Other European countries

49%

30%

9%

5%4%

3%

Pension scheme

Insurance company

Family office / Multi-family office

Corporate treasury

Endowment and foundation

Other

The RespONDeNTs

Pension Scheme Breakdown

7

Insurance Company Breakdown

Focusing on the sub-sectors for pension plans that provided responses, defined contribution

(DC) schemes represent around half of the total. Defined benefits (DB) plans roughly account

for a third and hybrid plans take the remaining share. DC schemes are gaining ground in

Europe, and elsewhere, as a growing number of public and private sponsors cannot bear

anymore the burden of final salary pension schemes. According to the European Insurance

and Occupational Pensions Authority (EIOPA), 58% of pension plans in Europe are DC based,

including 17% of ‘DC with guarantees’.

11%

53%

36%

Defined Contribution (DC)

Defined Benefit (DB)

Both DB and DC

14%

27%

32%

27%

Composite

Life / Pensions

Health

P&C

Pension schemes and insurance companies make the bulk of participants, respectively

representing 49% and 30% of the overall institutions polled. The remaining institutions

that participated in our survey include family offices / multi-family offices (9%), corporate

treasuries (5%), endowments / foundations (4%) and other organisations (e.g., state

investment companies, pension administrators, etc. 3%).

Assets under Management Breakdown

8


When it comes to insurance companies, the split is quite even among composite, life /

pensions and health with slightly less than a third for each sub-category. P&C insurers are

less represented, accounting for 14% of the insurance firms polled.

The institutions that participated in our survey have average assets under management

(AuM) of approximately EUR 4bn. Large investors are significantly represented among the

respondents with two third of the institutions holding more than EUR 1bn and 35% more

than EUR 2.5bn.

Average Target Asset Allocation for Pension Schemes

35%

31%

16%

12%

5%

40%

30%

20%

10%

0%

Greater than €2.5bn

Between €1bn and €2.5bn

Between €500m and €1bn

Between €250m and €500m

Less than €250m

2%3%3%

5%

18%

29%

40%

Fixed-income

Equity

Real estate

Other (Balanced funds, commodities etc.)

Hedge funds

Money market instruments

Private equity

Pension schemes are free of any Solvency II like regulation for the moment. Yet, the IORP II

Directive that will comprehend the amended / new requirements they will face may bring

some surprises. Instead of focusing on the ‘three pillars’ of pension plans (i.e., fixed-income,

equity and real estate), having a closer look at hedge funds is not without interest.

9

Average Target Asset Allocation for Insurance Companies

Prior to the Solvency II implementation date (January 1st, 2016), we notice the relatively high

average level of equity holdings for insurers polled. Given the punitive charges imposed by

the Solvency capital requirements on stocks, excluding so-called “strategic participation”, it

would be of interest whether the allocation to this asset class remains the same in a year’s

time, a few months before day one.

58%

15%

8%

6%

2%1%

Fixed-income

Equity

Real estate

Money market instruments

Other (Balanced funds, commodities etc.)

Private equity

Hedge funds

11%

Indeed, one may wonder whether the 3% average allocation to hedge funds would persist in

the coming months given the quite poor performance exhibited recently (as of 31/10/2014,

the HFRX Global Hedge Fund Index is down by -0.5% year-to-date versus +10.4% for the

S&P 500 NTR). To illustrate this, most have in mind some event driven funds that posted

substantial losses (i.e., double digits) after the failure of a number of tax inversion deals,

especially AbbVie finally removing its offer to buy Shire. Moreover, it is worth mentioning

that a portion of long / short equity funds equally yielded pronounced negative performance

as they did not perceive soon enough the growth-value rotation that occurred in the second

quarter of 2014.

usE anD pErCEptIon oF rIsK-BasED InVEstInG approaChEs

11

Unsurprisingly, a vast majority of the survey participants (almost 90%) define their asset

allocation using a risk-based approach, whether entirely or limited to certain buckets. Another

7% are not yet implementing risk-driven investment strategies (e.g., minimum variance, VaR /

CVaR target or hedging overlay) but are willing to do so.

Putting risk at the forefront when allocating assets instead of expected returns only is

gaining popularity among European asset owners and is reflected here. Given the difficulty

of estimating returns, even more in the current market’s environment, it should not come as

a surprise.

It is commonly accepted among institutional investors that taking risks is pivotal in meeting their long term return objectives. however, investing in non-risk-free assets, though their “nil riskiness” can be much discussed (cf Eurozone sovereign debt crisis), without adopting a robust risk management framework may yield serious disenchantment when markets tumble. the aftermath of the Lehman Brothers collapse has definitely changed how institutions regard investment risk.

Do you use a risk-based approach when defining your asset allocation?

61%

28%

7%4%

Yes, on your entire asset allocation

Yes, on certain portions of your asset allocation

No, but you are willing to do so

No, you only focus on expected returns

Use AND peRCepTION Of RIsK-BAseD INvesTING AppROAChes


12

Rationale behind the use of an investment approach based on risk

Mentioned by 62% of respondents, the board / investment committee decision comes

comfortably first in the reasons why their institutions have implemented an investment

approach based on risk. As we have seen an increased involvement of boards in understanding

and addressing risk over the years, it seems to be a logical step. Indeed, the rising importance

of risk management in organisations is well corroborated by the significant resources they

devote to the risk department (staff and technology) and the key role occupied by CROs

who, more often than not, directly report to their CEOs. The recurring market bubbles and

subsequent bursts may have just achieved convincing companies to focus first and foremost

on risk.

To a lesser extent, regulatory requirements are another reason motivating the adoption of

risk-based approaches for 24% of participants. The unprecedented wave of regulations in the

21st century has yielded significant changes in the ways businesses operate and European

institutional investors are not immune. Especially hit, insurance companies have little more

than a year to comply with the Solvency II regulatory requirements. Pension schemes will

be subjected to (the still much discussed) IORP II in the forthcoming years once a consensus

is reached among involved parties. Both regulations state the protection of members and

beneficiaries / policy holders as the utmost objective yet solely Solvency II as for now imposes

stringent risk-based capital requirements.

Mostly faced by family offices and private banks, client pressure appears a less important

driver, cited by 10% of investors. However, risk awareness seems to have made its way to

wealthy clients with more and more requiring to understand how investment solutions

control risk, especially the drawdown risk, prior to considering whether or not to invest.

62%

24%

10%4%

70%

60%

50%

40%

30%

20%

10%

0%

Board / Investment committee decision

Regulatory requirements (e.g., capital requirements)

Client pressure or requirements

Other

13

Which risk measure are you aiming to control?

Initially used by proprietary traders and derivative fund managers, the maximum drawdown

has now gained popularity among institutional investors. Relatively easy to understand,

aiming to measure the loss (absolute or relative) suffered by a given portfolio or bucket

allows capturing the tail risk unlike volatility, though extreme levels are a strong hint. The

investors that took part in our survey placed maximum drawdown as the main indicator they

are willing to monitor (almost 60%). An interesting empirical fact is that controlling the loss of

a portfolio also generally (but not systematically) results in containing its volatility, the latter

having proved higher throughout down cycles.

Obviously, volatility is all but abandoned by institutional investors, with 56% of our survey

informants seeking to control this risk measure. Volatility peaks we have recently experienced

can prove particularly damaging as they usually come along with pronounced drops in asset

values. Having to soundly balance cash inflows and investment revenues with cash outflows

to beneficiaries / policy holders, institutions understandably want to have an overall variance

as little as possible without impairing their ability to meet return objectives. It is worth noting

that different volatility measures exist: ‘basic’ variance estimates, the most widely used in

the financial industry, does not distinguish between positive and negative returns, whereas

semi-variance estimates only consider the deviations below the mean or a set target (e.g.,

below zero).

Lagging behind is the tracking error (cited by fewer than 20% of respondents), which is a

measure simply consisting of an estimate of the standard deviation of excess returns with

regards to a given benchmark. Recent developments in the financial industry, such as Core-

Satellite approaches where the Core is made of safer assets, often passive vehicles, and

Several answers possible

58%56%

17%

8%

60%

50%

40%

30%

20%

10%

0%

Maximum drawdown

Volatility

Tracking-error

Other


14

the satellite seeks to generate alpha via active strategies, strongly incite pension schemes,

insurers and other institutions to unleash the tracking error constraints put on active

managers. However, one must not overlook that this indicator is very much considered

by a number of investors allocating to ETFs / Index funds (especially those holding such

instruments for short term purposes).

Other risk measures firms aim to control principally include credit risk in that they can

only invest in notes, bonds or asset backed securities benefiting from a minimum rating.

Corporates allocating their cash reserves represent the majority of institutions falling in that

category. They very often establish investment guidelines prohibiting investing in securities

rated below A- (long term) and A-2 (short term) as they seek to optimise their cash balances;

their core business does not entail managing financial assets.

There is a wide set of investment approaches based on risk control and we consider three

categories: static risk optimisation, derivatives and dynamic-risk control. It should nonetheless

be mentioned that derivatives ‘alone’ are not restricted to a specific strategy. In fact, they can

be only used as investment vehicles to implement a specific strategy (e.g., through a target

VaR solution or a hedging overlay)

Static Risk Optimisation

Which risk-based approach have you implemented within your portfolios?

A static risk optimisation program relies on a single-period model and is based on the

assumption that optimal portfolio weights are constant over time. To this end, the rebalancing

process has to be determined at the managers’ discretion. Moreover, it must be noted that the

strategies considered within this category (‘smart betas’, max. Sharpe ratio etc.) are assumed

to use a static approach, as illustrated in the academia, yet they can also be implemented in

a dynamic fashion.

15

Investing in smart beta strategies has increasingly been embraced by institutional investors

as they are willing to diversify their exposures from the over-concentration features inherent

in traditional indices (i.e., price or market cap weighted). Three techniques belonging to the

smart beta fields are mentioned by the survey respondents: minimum variance (used by 28%),

maximum diversification (27%) and risk parity (14%). Individually, such strategies may face

prolonged periods of underperformance relative to their cap-weighted index universe (e.g.,

S&P 500 min variance strategy vs. the S&P 500 Index). Carried out potentially to mitigate this

risk, 5% of investors declared allocating to solutions using several risk factors (e.g., quality,

momentum and volatility). Furthermore, as the Markowitz approach (maximisation of the

Sharpe ratio) is still common place in the active management field, it is logically cited by a

quarter of participants.

derivatives

Derivatives are very flexible instruments able to hedge a significant number of specific

risk exposures (without potentially costly divestments): inflation, currency, interest rates,

volatility, longevity, tail risk etc. Traded on exchanges or over-the-counter (OTC), they consist

of a large range of instruments: Options, credit default swaps, total return swaps, futures

forwards and swaptions among others.

28%27%

24%

14%

7%

30%

20%

10%

0%

Minimum variance

Maximum diversification

Markowitz (max. Sharpe ratio)

Risk parity

Other



16

Dynamic-Risk Control

Dynamic-risk control can be referred to as a multi-period risk optimisation. Using constantly

updated data, dynamic-risk control programs aim to determine the portfolio’s optimal asset

allocation in the subsequent period (i.e., post rebalancing, triggered by objective pre-set

criteria) as it assumes the probability distribution of asset returns and risk factors vary over

time conditional upon information availability.

Partly reflecting the large proportion of pension schemes and insurers that took part in this

survey, hedging overlay strategies appear as the most commonly utilised when it comes to

controlling risks with derivatives (implemented by 42% of investors). As a reminder, overlays

designed for hedging purposes are strategies that employ derivative instruments to offset

certain portfolio exposures, whether partially or entirely. In addition to usually preventing

divestments (i.e., selling an asset or a portfolio), hedging overlays offer a wide range of risk

mitigating possibilities (e.g., currency, inflation, interest rates, volatility or tail risks). They

may appeal to many institutional investors other than their main users, pension plans and

insurance firms, and are mostly put into effect via futures, forwards and total return swaps

(linear payoff structure) and options (asymmetric payoff structure).

A structured product is generally a pre-packaged investment strategy created by the

combination of at least two vehicles (e.g., one or several securities, index products,

derivatives, etc.) in order to adjust the underlying assets’ initial risk and return structure. Of

the investors surveyed, a fourth claimed using structured strategies, which, by definition,

can be tailored to a large set of asset classes and specific risk criteria. Indeed, some products

offer risk mitigation via principal protection (e.g., zero coupon bond combined with a call

option) or collar strategies (e.g., equity index floor protection financed by a cap on the upside

gains). However, structured products can be very costly and somehow opaque; they may

incorporate leveraged / short, hard-to-price underlying assets and ‘exotic derivatives’.

42%

25%

50%

40%

30%

20%

10%

0%

Hedging overlay

(interest rate risk, FX risk, inflation risk etc.)

Structured products


17

30%

25%

21%

8%

30%

20%

10%

0%

Target volatility

Dynamic loss control strategies

(e.g., portfolio insurance techniques)

Target VaR / CVaR

Target tracking error

Controlling the variance of a portfolio remains determinant in most investment decisions

as confirmed by 30% of respondents implementing target volatility strategies. A strategy

following a target volatility approach will move from risky assets (e.g., stocks) to safer assets

(e.g., government and investment grade bonds) in order to achieve the desired volatility

level. To a much lesser extent, 8% of informants replied using target tracking error strategies.

To a certain extent, the rise of passive investing (from 8% of Global AuM in 2003 to 15% in

2013, according to the Boston Consulting Group) has probably led to target tracking-error

approaches being less praised by investors assuming an index vehicle delivers a return more

or less equal to the underlying index minus the expense ratio1.

The target VaR / CVaR (employed by 21% of investors) is a more advanced risk control

technique as it enables gauging the potential absolute or relative loss a portfolio may suffer

within a given likelihood and horizon. As a reminder, the Value-at-Risk measures the potential

loss in value of a portfolio over a defined period for a given confidence interval. On its end,

the CVaR estimates the expected loss in excess of the Value-at-Risk. Some target volatility

strategies aim at approaching a long term volatility level deemed optimal with regards to the

underlying assets. The rationale behind Target VaR / CVaR approaches is always to ensure

that the risk inherent in the fund remains below the target set ex ante (no one willing to

experiment higher potential loss above what is considered as ‘acceptable’).

Mr Jean-Louis Blanc, director at Caisse de Pensions Bobst Mex SA, a private Swiss DC pension

scheme, tells us that “The risk framework implemented by our institution, and defined by the Board, aims to control the drawdown risk with the use of consolidated reporting. As such, it is based on a quantitative risk measurement, inherent in our strategic allocation, and on an annual risk ceiling in compliance with the return target. The risk approach we have chosen is a target CVaR (Conditional Value-at-Risk) with a 95% confidence level over a one-year horizon.” Moreover, he

adds that, “The investment committee assesses the diverse tactical asset allocation opportunities according to its market views based on a set of indicators (e.g., European and US key rates, PMI levels, market valuations, etc.) while keeping a close watch on the scheme’s risk exposure.”

1 Readers may refer to Bonelli (2014) which discusses this specific issue.



18

How often do you monitor the risk of your portfolios?

Monitoring the risk of investment portfolios is a challenging task that requires institutional

investors devoting significant financial, technological and human resources. Increasingly

demanding regulatory requirements coupled with fast-paced market environments have

strongly incentivised financial actors to better, and more regularly, assess the risks to which

they are exposed to. Of the companies surveyed, 51% admit watching their portfolios’ risk

at least every week, whereas only 17% do so four times a year or less. In between, 32% of

informants monitor risk on a monthly basis, also a rather famous rebalancing frequency.

Furthermore, risk monitoring can obviously range from ‘basic’ observations (e.g., volatility,

tracking error or maximum loss suffered on a given period) to more complex projections

(e.g., yield curve or CVaR).

Consultancy firms are frequently involved in the risk monitoring and assessment of

institutional portfolios. Indeed, “The risk exposure of our pension scheme is evaluated quarterly by an independent external consultant who produces a report for the investment committees,” says

Mr Blanc of Caisse de Pensions Bobst Mex SA. He continues, “Then, the exposure determined by the consultant is compared with our risk ceiling (CVaR with a 95% confidence level over a one-year rolling horizon), hence enabling the investment committee to take allocation decisions.”

32%

26%

25%

14%

3%

30%

20%

10%

0%

Monthly basis

Daily basis

Weekly basis

Quarterly / Semi-annual basis

Annual basis

The fact that dynamic loss control strategies have been adopted by one fourth of institutions

surveyed is of particular interest. Such strategies aim to limit the absolute or relative loss a

portfolio may suffer. The drawdown estimates enable rebalancing the portfolio with a view to

ensure the risk budget is preserved and the money allocated in a risk efficient fashion. Lastly,

institutional investors have benefited from much sounder dynamic loss control strategies

with regards to the portfolio insurance techniques that appeared in the eighties. The several

pronounced drawdown episodes we have experienced in the past years may be a driver for

dynamic loss control strategies to be more widely adopted.

Moreover, prudential regulations such as the Solvency II Directive may have a significant

impact on the nature and frequency of risk controls implemented by institutions. Mr Alban

Jarry, Head of Solvency II Program at La Mutuelle Générale, the third French mutual insurance

company, tells us that “Own Risk and Solvency Assessment (ORSA) becomes the reference document in risk management for insurance firms. Aimed at firms’ governance and supervisory authorities, it provides a clear picture of current and forecasted risks.” He adds, “In general, Solvency II second pillar facilitates the analysis of the risks inherent in an entity as it is based upon decision and monitoring processes. As such, it enables producing bespoke indicators for the governance.”

19


thE spECIFIC CasE oF systEmatIC loss Control stratEGIEs

21

Systematic loss control strategies are rule-based mechanisms aiming to hedge the potential

(absolute or relative) loss of a portfolio / bucket. To do so, investors may use specific hedging

overlays, portfolio insurance strategies or structured products.

It is commonly accepted that the timing of rebalancing is a key parameter for preserving

a portfolio’s value. Of the investors polled, 45% regard the bad rebalancing timing as the

main drawback weighing on systematic loss control strategies. Readjusting the asset mix

when markets are stressed (e.g., significant price drops in one or more asset classes) can

significantly damage the potential benefits of asset allocation / security selection decisions.

Either calendar-based (e.g., monthly basis) or risk-based (e.g., trading bands), portfolio

rebalancing carried out in overbought / oversold markets may bring important costs (mainly

opportunity and transaction costs) if not designed with sufficient care.

Weak participation to the upside is also mentioned as a major disadvantage of such strategies

(cited by 42% of respondents). Controlling the potential loss a portfolio may endure via rule-

based approaches implies giving up a portion of the upside gains (e.g., versus a market index)

to enable a downside protection. Nonetheless, the amount given up must be ‘acceptable’

(according to each institution’s specific needs) as benefiting from asymmetric payoffs is the

main reason why investors chose systematic loss control strategies.

45%42%

24%21%

14%

50%

40%

30%

20%

10%

0%

Bad rebalancing timing (e.g., buy high / sell low in oscillating markets)

Weak participation to the upside

Possibility of being locked up in cash (e.g., risk budget fully consumed)

Systematic approach lacking of ‘human rational thinking’

Other

The speCIfIC CAse Of sysTemATIC LOss CONTROL sTRATeGIes

Drawbacks of systematic loss control strategies perceived



22

The fundamentals of risk-driven investment strategies, limiting losses, may rely upon a risk

budget (e.g., a level of VaR or maximum drawdown set ex-ante) to determine the allocation to

the performance assets (e.g., equity). The inherent mechanism incorporates a reserve asset

(e.g., cash or derivatives used to diminish the exposure to an underlying portfolio) whose

role is to ensure the respect of the risk control objective. When ill-conceived, systematic

loss control strategies can end up being ‘crystallised’ in the reserve asset if the risk budget

becomes fully consumed, a downside mentioned by 24% of participants.

Would a systematic approach enjoy greater efficiency if supplemented with ‘human rationale

thinking’? A fifth of the institutional investors that participated in this survey tend to believe it

would. ‘Blindly’ following a model’s decision to increase risk when markets are ‘overbought’,

for instance, may not be the wisest decision. Notwithstanding, should human choices get the

upper hand on a rule-based loss control strategy, it could not be labelled ‘strictly systematic’.

To investors wanting the “best of both worlds” (i.e., an approach based on systematic and

discretionary processes), well-designed hybrid strategies may be an appealing option.

As discussed before, Exchange-Traded Funds (ETFs) and index funds are increasingly used by

institutional investors willing to easily and at little cost benefit from the returns of a wide set

of indices / strategies. Of the respondents, 45% regard those vehicles as the most appropriate

when it comes to implementing systematic loss control strategies. On the one hand, long-only

ETFs, the overwhelming majority of such instruments traded in Europe, may be a particularly

good fit for structured products and portfolio insurance strategies. However, the latter need

to incorporate a reserve asset (e.g., cash or low-duration / zero coupon bonds) in order to

control the potential absolute or relative loss. On the other hand, inverse or short ETFs can

be used to hedge a given portfolio’s risk exposure. It is worth noting that only a few of those

15%

8%

17%18%

35%

45%

50%

40%

30%

20%

10%

0%

ETFs / Index funds

Exchange-traded derivatives

OTC derivatives

Active funds

Securities

Other

Which vehicle(s) would you use to implement systematic loss control strategies?


23

specific instruments are available in Europe and are not as heavily traded as their US peers,

hence providing an insufficient liquidity for most European institutions.

Not only are derivative flexible instruments able to possibly hedge even very specific

risk exposures but they also can provide a synthetic exposure to a given asset class etc.

Among the investors surveyed, 35% consider exchange-traded derivatives (ETD) as very

suitable instruments for rule-based strategies mitigating losses, whereas 18% mentioned

OTC derivatives in this regard. When trading ETD, the clearing house acts as a central

counterparty, thereby mitigating the consequences should one counterparty (the buyer or

the seller) defaults. Conversely, the counterparty risk is inherent in OTC derivative contracts

– even if the vast majority of financial firms establish a list of authorised counterparties

following due diligence. In addition, it may cause serious harm should this risk materialise

(e.g., when it collapsed, Lehman Brothers participated in more than 900,000 outstanding

derivative contracts involving 8,000 different counterparties).

Centralised derivatives are most fit for institutional investors willing to hedge, or synthetically

replicate liquid exposures, and mostly include options and futures on interest rates,

currencies and equity indices. Regarding OTC derivatives, they offer investors a wider range

of instruments covering almost any asset class: ‘vanilla’ or non-standard underlying assets.

Notwithstanding, it must be noted that the European Markets Infrastructure Regulation

(EMIR) will impose mandatory clearing to certain ‘basic’ OTC contracts (e.g., basis swaps,

fixed-to-float interest rate swaps or untranched Index CDS, for two indices). Broadly

speaking, derivatives can be employed in hedging overlays, portfolio insurance strategies

and structured products.

Active funds are evoked by 17% of the informants as particularly suited instruments for

systematic loss control mechanisms. The rationale for investing in such funds, money market

funds apart, is the desire to generate alpha yet they may also constitute a cheaper, more

efficient and liquid alternative to Delta-1 products covering certain asset classes (e.g., high-

yield bonds or emerging market debt). Active funds would be likely to be employed within

portfolio insurance strategies.

Finally, securities are the vehicles the least mentioned as being tailored for systematic risk-

based strategies controlling the loss. Combined with derivatives, they are typically used in

structured products (e.g., an investment grade bond coupled with a call option). Moreover,

they may also be employed to synthetically replicate an index with few constituents (e.g.,

such as the SBI Domestic 1-3Y CHF) and implemented in portfolio insurance strategies, a less

likely outcome though.


rEFErEnCEs

25

Accenture. 2013. Global Risk Management Study. Risk management for an era of greater uncertainty – September 2013.

Amenc, N., P. Malaise, and L. Martellini (2004). Revisiting core-satellite investing: a dynamic model of relative risk management. Journal of Portfolio Management 31 (1), 64–75.

Bonelli, M. 2014. Exchange Traded Funds: Toward a Tailored Selection Approach. Inria Research Centre Sophia Antipolis – Méditerranée.

Blommestein, H. J. The Debate over Sovereign Risk, Safe Assets, and the Risk-Free Rate: What are the Implications for Sovereign Issuers? Ekonomi-tek Volume / Cilt: 1 No: 3 September / Eylül 2012, 55-70.

Boston Consulting Group. 2014. Global Asset Management 2014: Steering the Course to Growth – July 2014.

European Commission. 2009. Directive 2009/138/EC of the European Parliament and of The Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II).

European Commission. 2013. Directive 2013/58/EU of the European Parliament and of The Council of 11 December 2013 amending Directive 2009/138/EC (Solvency II) as regards the date for its transposition and the date of its application, and the date of repeal of certain Directives (Solvency I).

European Commission. 2013. Report from the Commission to the European Parliament and the Council. The International Treatment of Central Banks and Public Entities Managing Public Debt with regard to OTC Derivatives Transactions.

European Commission. 2014. Proposal for a Directive of the European Parliament and of The Council on the activities and supervision of institutions for occupational retirement provision (IORP II).

European Insurance and Occupational Pensions Authority (EOIPA). 2013. Database of pension plans and products in the EEA: Statistical Summary.

Fleming M., A. Sarkar. 2014. Federal Reserve Bank of New-York – Economic Policy Review – The Failure Resolution of Lehman Brothers. Volume 20 Number 2.

iShares. 2009. Core-Satellite Investing (March).

Mantilla-Garcia, D. (2014). Dynamic Allocation Strategies for Absolute and Relative Loss Control. Working Paper, EDHEC Risk and Asset Management Research Center.

RefeReNCes


aBout KorIs IntErnatIonal

27

w w w.koris- intl .com

Koris International (“Koris”) is a duly registered financial investment advisory firm dedicated

to designing and developing dynamic asset allocation models controlling the drawdown

risk. The company operates with a team of 14 professionals, with backgrounds in the asset

management industry and academia, and benefits from the latest advances in financial

engineering.

Located in Sophia-Antipolis in France (head office) and in London, Koris is wholly owned by

its founders and has been operating for 12 years with key players in the asset management

industry through an ‘advisory’ business model entirely dedicated to asset allocation.

Koris offers solutions that meet the needs of asset management companies, private banks

and institutional investors throughout Europe. These advanced quantitative techniques are

designed to satisfy investors’ appetite for better risk control.

The strategies developed are implemented by renowned partner investment managers (Bank

of America Merrill Lynch, Lyxor AM, Rothschild & Cie Gestion, Fédéris GA, Banque Bonhôte

& Cie, etc.) via ETFs, index funds, securities, active funds, futures, total return swaps as well

as liquid alternative investment strategies through managed accounts.

ABOUT KORIs INTeRNATIONAL


http://www.koris-intl.com

Important InformationThese materials (“Materials”) have been prepared by Koris International (“Koris”) for informational purposes only. The Materials are intended to serve solely as a summary of survey responses provided to Koris by European institutional investors that took part in Koris International Institutional Risk-Based Investing Survey 2014 (the “RBIS Survey”). The number of European institutional investors polled for these Materials is small relative to the size of the European institutional investor marketplace, and these Materials are not intended to summarise the views of the European institutional investor marketplace at large. Furthermore, the information presented in these Materials does not represent any assumptions, estimates, views, predictions or opinions of Koris.

These Materials have not been verified for accuracy or completeness by Koris, and Koris does not guarantee these Materials in any respect, including but not limited to, their accuracy, completeness or timeliness. Information for these Materials was collected and compiled during the stated timeframe. Past performance is not necessarily indicative of future results and Koris in no way guarantees the investment performance, earnings or return of capital invested in any of the products or securities discussed in the Materials. These Materials may not be relied upon as definitive, and shall not form the basis of any decisions contemplated thereby. It is the responsibility of the recipients of these Materials (and the information therein) to consult with their own financial, tax, legal, or equivalent advisers prior to making any investment decision.

These Materials do not constitute, and shall not be construed as an offer to sell, an investment advice or a recommendation on specific investments by Koris.

ORIAS n° 13000579 (www.orias.fr).

Koris International is a Financial Investment Adviser registered under No. D011872 by the CNCIF, Association approved by the French financial markets authority (AMF).

KORIs INTeRNATIONAL

Espace Saint Philippe - Immeuble Néri 200 Avenue de Roumanille06410 Biot, France

46 New Broad Street London EC2M 1JH United Kingdom

Jérôme mALAIseInstitutional Client solutions

Gauthier LeIBeNGUThmarketing & sales

[email protected]+33 (0) 4 88 72 88 41 / +44 (0) 7584 654 827

[email protected] +33 (0) 4 88 72 88 36

For more information, please contact the authors

Economy & Finance

Koris international - 2014 European Institutional Risk-Based Investing Survey