quarterly - cfa institute...image and personal branding will affect what others say about you, what...

Issue 20 | January 2016 | www.cfasingapore.org

Quarterly

CFA Charter AwardsFixedincomestrategies

Emergingmarketsrisk

Riskmodeltesting

Unknown

Blind spot

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others

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Known to self Not known to self

Systemicrisk

Movieindustryinvesting

J o h a r i W i n d o w

www.linkedin.com/company/cfa-society-singapore

www.twitter.com/CFASingapore

www.facebook.com/CFASocietySingapore

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Dear Members,

Over the past 8 years, CFA Singapore has been ramping up its membership activities. In the mid-2000s, we organised 20 to 30 events annually. Since 2013, we have organised more than 100 events a year. Last year, we had about 120 membership-related events such as professional development, networking, career development and continuing education workshops.

Since the early 2000s, we have used the secretariat services of AB Maximus. In consideration of the growing scale of our activities, we decided that it was time to take the secretariat function in-house. With effect from 4 January 2016, we have a team of four full-time staff headed by executive director Francis Er. We are now operating out of our new office at International Plaza at Unit 25-09.

The proprietor of AB Maximus, Mr Th’ng Beng Hooi, CFA, has done a commendable job providing us secretarial support for the past 15 years. We appreciate his professionalism and service to the volunteers, members and candidates, and thank him and his team for their support and dedication. We will strive to improve our service level as we progress with our in-sourcing model. Do look out for more of our exciting activities. In this issue, we have the following activity highlights of the past quarter. Professional Development Committee

• In conjunction with the Singapore International Film Festival, leading practitioners from the film industry spoke about its financing structure and supply chain, as well as how to manage risk when investing in movies. Movie industry investing | pp10

• Nobel laureate Robert Engle and his team at V-Lab calculate systemic risk to identify the weakest links of the world economy should there be a financial meltdown. We supported CFA Institute in a Livestream telecast where Professor Engle discussed how he quantifies systemic risk and his observations of the risks found in major

economies, especially China. Systemic Risk | pp14

• Well-known economist Russell Napier spoke about when to invest in emerging markets. Emerging Markets Risk | pp18

• Goldman Sachs fixed income portfolio manager Jonathan Xiong, CFA, MBA, provided insights into the investment management philosophy and macro-themes adopted by his firm’s Fixed Income, Currencies and Commodities division. Fixed Income Strategies | pp22

• The adoption of multi-factor models in computational finance by US investment firms was pioneered by Jason MacQueen. MacQueen spoke about determining the reliability of equity risk models. Risk Model Testing | pp26

Candidate Programs, Membership and Career Development Committees

• Ms Louise Tagliante, the founder of Protégé, a mentoring programme focused on the professional development of women in Asia, shared her insights into success in the corporate world. CFA Charter Awards | pp4

• Edmund Ang from Dale Carnegie Training helped CFA members discover their personality types. Your Personality Type | pp28

We ended the year with a buffet party at Mischief, organized by our Networking Committee. We thank you for your past support and look forward to take the Society to greater heights with your continued support.

Jan Richards, CFA CFA Singapore Society President

BOARD MESSAGE

4

Raymond Gui, CFA

EMERGING MARKETS risk External debt and currency devaluation

18

SYSTEMIC risk Where is it concentrated?Professor Robert Engle

14

RISK MODEL testing26

Jason MacQueen

22FIXED INCOME strategies

CFA CHARTERawards

4

MOVIE industry investing10

Professor Russell Napier

www.cfasingapore.org |

Jonathan Xiong, CFA, MBA

Mark Montgomery, Jomon Thomas, Aditya Shastri, Dr Jim Frazier, Joseph Cohen

| www.cfasingapore.org

CFA CHARTER AWARDS

At the recent CFA Charter award ceremony, Ms Louise Tagliante, the founder of Protégé, a mentoring programme focused on the professional development of women in Asia, shared her insights into success in the corporate world.

Dr Aaron Low, CFA, was also a keynote speaker. The event took place at M Hotel on 5 November 2015.

At the 2015 CFA Charter Awards ceremony, career coach Louise Tagliante urged recipients of the CFA charter not to overlook the importance of interpersonal skills. She cited the findings of well-known leadership gurus such as Mark Murphy, Harvey Coleman, Joseph Lutt and Harrington Ingham. Technical skills not everything

46% of new hires fail within 18 months, according to a 3-year study on 20,000 new hires. The study found that 26% of new hire failure was because they can’t accept feedback, 23% because they’re unable to understand and manage emotions, 17% because they lack the necessary motivation to excel, 15% because they have the wrong temperament for the job, and only 11% because they lack the necessary technical skills.

Employees counselled by Ms Tagliante have equated long hours with promotion and bonus but it is more complex than that. Experts believe that only 10% of career

success can be attributed to the day-to-day work that one is tasked with and the quality of results in this area. This would include qualifications, company and industry knowledge, experience, competencies. Coleman attributed 30% of success to image and 60% to exposure.

Image accounts for 30% of success

Image and personal branding will affect what others say about you, what you are known for and your impact on others. Ask yourself: Are you passionately engaged at work? Are you assertive, passive or aggressive? How flexible are you in accommodating others? Do you offer solutions and options or do you criticize and make negative remarks? The status quo may be unsatisfactory but do you challenge it with appropriate candour?

Ms Tagliante also cautioned against expressing one’s wild side through dressing in the work place. A good corporate dress image may not be the most fashionable, but it is able to give your colleagues and customers


the perception that your work culture fits in with theirs. Your brand must not be irrelevant or elitist because that shows a lack of self-awareness and a lack of discernment of your impact on other people.

A good example of successful dressing is Steve Jobs’ iconic black turtleneck, blue jeans and New Balance sneakers. His dress code became the Silicon Valley geek image, and he was much more recognizable than executives who wore ties and suits.

Exposure accounts for 60% of success

According to Harvey Coleman, the most important factor is exposure, which accounts for 60% of success. Exposure refers to how publicly visible you are. Who knows about you: Your bosses’ boss? The CEO? Senior people? Internally within the organization, or externally within the industry?

How well are you able to share your success with other people without being narcissistic? Ms Tagliante encouraged the new charterholders to join social activities that are appropriate to their skills, interests and jobs. Ms Tagliante shared how she became a personal friend of the President of VISA International when she joined a charitable race in Australia to raise funds for handicapped and underprivileged children.

“If you don’t move out of your comfort zone, if you don’t take risk, you will won’t get what you really want,” said Ms Tagliante.

“Surround yourself with sponsors and mentors who see the greatness within you, even when you don’t see it yourself.”

Louise Tagliante Managing Director Differentiate

Ms Tagliante is the founder and owner of Differentiate and its renowned mentoring programme, Protégé.

She has more than 30 years corporate experience in the financial services sector, having worked both globally and regionally in senior leadership roles at organisations such as IBM Australia, Visa International and ABN Amro Asia Pacific, prior to founding Differentiate in 2006. She created Protégé in 2013 to support young women to find their own voice and ensure they have a 'seat at the table'.

She currently serves on the Executive Committee of the Financial Women's Association Singapore (FWA) where she created and manages its Advancing Women in Finance mentoring programme, winner of the AWARE New Initiative Award 2013. In addition she volunteers with AWARE and sits on its fund-raising committee. In 2009 she was awarded The International Alliance of Women (TIAW) World of Difference Award for community work supporting its Microcredit Village Bank programme.

Ms Tagliante has lived and worked in Asia since 1993 and is currently based in Singapore. She is married to Mario and is a Director of his game fishing business located in Maldives.

“Don’t overlook the support you can get from your spouse as a mentor, even though you may not agree on many things. My husband is able to help me to reframe things in a better way because he looks at things very differently from me,” said Ms Tagliante. She is married to Mario (below), who was also present at the ceremony.


At the Charter Awards ceremony, Dr Aaron Low, CFA urged charterholders to create value for the financial industry. Here are excerpts of his speech.

Spread the word

Educate your clients so they know their rights as well as basic investment principles. We have published the statement of investor rights to help investors demand a high standard of service from their financial services professionals.

Each year in May, we celebrate Putting Investors First Month globally to unite the industry in embracing this principle. Join these activities and show the world what the CFA charter means.

Also, your local society may have an advocacy committee that tackles industry issues. For example, advocacy committees comment on new regulations to promote fair markets. They often conduct outreach in support of investors’ interests, among other activities.

Share your CFA program knowledge and principles

Leadership means sharing, teaching, and engaging. It means mentoring and inspiring colleagues and young people who aspire to enter our profession. It also means fostering a culture of integrity at work.

If you are a hiring manager, hire a CFA charterholder or encourage those around you to pursue the charter. Enlist the capabilities of another charterholder on your team.

Foster higher standards in your firm. You can urge your firm to comply with the asset manager code of professional conduct or the global investment performance standards, if they haven’t already done so.

Continue to promote professionalism, ethical conduct, and uphold the integrity of capital markets. These are indispensable principles for maintaining professionalism in the industry and sharing the value it brings to society.

Keep in mind that as investment professionals, we are stewards of wealth and that comes with immense responsibilities.

Join your local CFA society

How do we define community at CFA institute? Simply put, a community is a group of people who agree to grow together. You will find a local community of like-minded professionals here in Singapore by becoming part of CFA Singapore.

Your society offers continuing education, career activities, networking and social events. And many are involved in advocacy outreach and investor education.

Societies collaborate globally to share ideas and leverage each other’s resources. This adds value to your membership, so that, for example, a member in Seattle can benefit from the expertise of a member in London, and vice versa.

Many of the men and women leading our societies are unpaid volunteers. They would welcome you stepping forward to join them. You will be amazed at how volunteer work can enrich your professional and personal development.

Dr Aaron Low, CFA, Immediate past Chairman of CFA Institute


Jan Richards, CFA, President of CFA Singapore

At the Charter Awards ceremony, Society President Jan Richards, CFA urged charterholders to volunteer through the Society’s committees. Here are excerpts of her speech.

It has been 28 years since CFA Singapore started in 1997 – the first CFA Society in Asia. We now have about 3,600 members – the eight largest worldwide. We have over 100 events every year, 12 board members and 8 active committees. Everyone is welcome to volunteer on our committees.

Our Networking Committee organizes an event almost every other week, where you can meet people of your level or to possibly hire. These events are held at bars and bistros. There are also fun events like go-karting.

Our Membership Committee brings up the visibility of the charter within the industry.

Our Professional Development Committee organizes fascinating talks every week. These lunch time talks are free to all our CFA Singapore members.

Our Advocacy Committee engages regulators and provides feedback for the formulation of regulations in the community. Having a say in the formulation of regulatory framework enables us to help drive the investment management decision making process.

Our Asset Management Committee promotes professional standards and ethical practices for the asset management sector. It promotes investor awareness and education, and works with key stakeholders to address industry issues.

Our Career Development Committee organizes career events to help people who are uncertain over their

career. Some may even find new careers and jobs through attending our career events.

Our University Outreach Committee reaches out to undergraduates to help them get on the right track.

Our Candidate Programs Committee promotes professional CFA designations and related programs and supervises the academic affairs of CFA Singapore, such as the maintenance of high standards in the curriculum and teaching of such programs.

Membership with CFA Singapore only costs a nominal fee of S$50 a year.


“Getting the charter is the beginning of one’s journey in the finance industry. The CFA charter provides you with an opportunity to engage the global CFA community. I personally have benefited tremendously from being part of this global community.

Please join the committees that we have. There is a lot more you can learn from the committees and a lot more we do together. CFA Singapore is one of the top ten CFA Societies in the world,” said Mr Ahuja.

Rasik Ahuja, CFA, Deputy President of CFA Singapore

Spotted at the Charter Awards ceremony: Mr Ahuja networking with Gerard Lee, CFA, CEO of Lion Global Investors (left).

Loh Hoon Sun, Managing Director of Phillip Securities (left) with Simon Ng, CFA, CFA Singapore Board Member.


Arun Kelshiker, CFA, MBA, Board Member of CFA Singapore

“The CFA charter is one of the most challenging qualifications in the industry. It commands genuine respect within the industry and with peers,” said Mr Kelshiker, who was event organizer for the evening.

Left to right:

Md Mehedi Hasan, CFA Senior Investment Officer, Infrastructure Development Co Ltd, Bangladesh

Ruhina Rahman, CFA Planning Analyst, Chevron Bangladesh

Shoaib Ahmed, CFA Liabilities Manager, HSBC in Bangladesh

Md Zubayer Ibna Zahir, CFA Assistant Vice President - Client Service, HSBC in Bangladesh

Bangladesh has yet to form its own local CFA society. In the meanwhile, CFA Singapore is the preferred local Society for residents of Bangladesh who pass all 3 levels of their CFA exam.

Kanol Pal, CFA, CFA Singapore Board Member (right) with Charter award recipient, Teresa Lam, CFA.


MOVIE INDUSTRY investing

In conjunction with the Singapore International Film Festival, leading practitioners from the film industry spoke at a CFA Singapore lunch time talk. They spoke about the industry’s financing structure and supply chain, and provided insight into how to manage risk when investing in movies. The panel speakers were• Mark Montgomery

(President of Xeitgeist Entertainment Group)

• Jomon Thomas (CEO of Xeitgeist Entertainment Group)

• Aditya Shastri (Head of Filmed Entertainment at B4U)

• Dr Jim Frazier (Academy and Emmy Award Winner)

• Joseph Cohen (President of American Entertainment Investors)

The Professional Development event took place at SGX Auditorium on 3 December 2015.

Joseph Cohen (bottom right) is a mezzanine financier for the film industry. His company, American Entertainment Investors, invested in The Man who Knew Infinity, a film adaptation of the biography of Indian mathematics genius Srinivasa Ramanujan. Filming began in August 2014 at Trinity College in Cambridge and was completed about a year later. It premiered at the Toronto International Film Festival in September 2015.

He said: “Investments in the film industry can generate returns with relatively low correlation to stock and bond markets. The film industry is highly complex with many players, ranging from producers, financiers, distributors, talent to completion guarantors. You can get a lot of financial leverage in the film industry. Leverage cuts both ways. If the project does well, leverage increases your IRR. If the project does not do well, equity investors in the last part of the film making chain can sustain significant loss.

“I like to think that I can take

mezzanine type risk and get equity type return. Many film investors use mezzanine funds to reduce their committed capital. If the film does very well, my IRR can be very high. But if it does not, I get my returns on a mezzanine basis. I try to generate IRR of about 20% for what I consider to be fairly low-risk investments.”

Casting Indian talent may be one way to raise box office proceeds -


by appealing to the huge mass of movie consumers in India. The Man who Knew Infinity stars Indian actor Dev Patel, the protagonist of Slumdog Millionaire fame.

Also on the panel of experts at the Professional Development talk was Aditya Shastri, Head of Filmed Entertainment at B4U, a leading worldwide television network channel for Bollywood entertainment. Mr Shastri highlighted the exciting outlook for the Indian movie market over the next 15 years.

Largest movie market

“India has a population of 1.3 billion, of which 300 million speak English, live with an American culture, as well as understand and relate to every international product. It is a group of people who wants

everything, and they want it right now.”

The huge number of media consumers there was also why more people saw the Titanic in India than in America.

India’s huge digital distribution

India has over 12,000 movie theatre screens connected digitally via satellite. Technology is also taking movie content from India to Europe and the Middle East. From being inward looking, India productions have evolved to cater to the tastes of the larger world. Some global successes include Slumdog Millionaire, The Lunchbox, Namesake and Life of Pi.

There is huge demand for media entertainment. More than 160 million households subscribe for television in India and more than

Aditya Shastri is the Head of Filmed Entertainment at B4U. He has held positions in major entertainment companies such as the Managing Director of 20th Century Fox, CEO of UFO Moviez and CEO of People Pictures.

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80% of them pay to receive content via cable and satellite. In the past, 90% of TV revenue came from advertising, and 10% revenue from content subscription. Subscription revenue has increased to about 40% and advertising now accounts for 60%.

In February 2015, Star TV (Indian subsidiary of 21st Century Fox) launched a mobile app in India called Hotstar for watching the latest movies, Live Sports and television. The app has had over 25 million downloads and more than 100 advertisers.

Financing structure

The Man who Knew Infinity was produced by Xeitgeist Entertainment Group. Xeitgeist President Mark Montgomery shared insights into the financing structure of film-making.

“We produced The Man who Knew Infinity at a cost of about US$10 million. After we firmed up the producers and actors, we estimated expenses of around US$6.5 million in cash, of which around US$1.5 million was from internal resources. We had to raise another US$5 million. We offered anchor investors a 30% return on their investment. So, that brings our cost to US$6.5 million.

“We looked at cornerstone investors and mezzanine investors like Joseph Cohen’s company. These anchor investors typically invest US$2 million each for a US$10 million production.

“The mezzanine investor then links up with a bank. Of the US$2 million, he may put in US$500,000. The bank loans him US$2 million at a low interest rate. The investor exits his investment as soon as we have made the film and sold it. His is a low-risk investment with a fairly high return for putting in a fairly small portion of the capital.

“We get sales agents who sell the film to the rest of the world as well as the US (domestic) market. On the initial production budget of US$6.5 million, the sales agent gets about 10%, which brings the cost to about US$7.2 million.

“We typically try to sell the film progressively over the period of time leading up to the completion of film production. Each sales agent is allocated the right to distribute to a specific geographic territory. After that, we appoint the US sales agent. Films are typically released nationwide outside the US only after its domestic nationwide premiere.

“When we sell the film to distributors in America, we get a minimum sales guarantee. This is paid to us in the form of upfront cash before the film is released at the box office. The minimum sales guarantee provides an exit route for our anchor investors.

“After this stage, the quantum of net proceeds to Xeitgeist depends on how well the film does at the box office. Films like The Man who Knew Infinity have the potential to generate box office sales of US$150 million or more.

“Typically, 60% of box office returns go the distributors and exhibitors for prints and advertising, as well as for theatre costs. The remaining 40% is deposited in a cash management account managed by an independent administrator who disburses the share of profit at the end of the day to each party involved. As a production company, Xeitgeist also takes management fees for putting the film together, and for taking on producer and executive producer roles.

“We try to produce cross cultural films with a budget of US$15 million or less,” said Mark.

Mark MontgomeryPresidentXeitgeist Entertainment Group

Mark Montgomery co-founded Xeitgeist Entertainment Group with international producer Jomon Thomas and the Academy Award winning cinematographer Dr Jim Frazier in 2011. As the co-funder and Executive Producer at Xeitgeist, Mark’s latest films include THE MAN WHO KNEW INFINITY (starring Jeremy Irons, Dev Patel, Stephen Fry, Toby Jones and Devika Bhise) and DAMASCUS COVER (starring Jonathan Rhys Meyers, John Hurt, Olivia Thirlby, Navid Negahban and Jürgen Prochnow)

Mark has 25 years of experience in film and television finance, production and distribution and has an extensive global network.


Managing risk

“To mitigate financial risk, you must first have a great story. Then, you need to have a good actor to enable the sales agents to do their job. We find great stories that good actors want to be in. The great stories, in our view, are about people’s lives. “There are the high budget movies with special effects that definitely have a place in the market. And then, there are the low budget independent films like ours that create memories and become a part of you.

“You also need a really great team: You need a talented director. You need high quality costumes and a cinematographer with a superb eye. Even after you have done all of that, a must-have is a well-connected sales agent.

“Investors looking at movie investment need to connect the whole chain and a company like Xeitgeist understands that chain,” he said.

Environmental investments

One of the panelists, Dr Jim Frazier, urged investors to make pro-environmental investments.

“We are rapidly losing biodiversity on this planet. The sea has become warmer, more acidic and polluted by radioactive substances. The lungs of the earth - our forests, are being decimated. If we continue on our present path, our children will not know the world that we now have. I wanted to harness the power of the film and music industry and put it in the Symphony of the Earth. We intend to plough the profits from the Symphony into an educational film that will be issued to all schools on the planet for free.”

Symphony of the Earth is Dr Frazier’s environmental feature film that aims to change attitudes to the world’s current environmental crisis.

Jomon ThomasCEO

Xeitgeist Entertainment Group

“The Man who Knew Infinity is about an Indian mathematician who lived in the early 1900s in a village in India. How do you make that into a commercially viable film that touches emotionally? Somebody said people never forget their first love and the money they wasted on a bad movie. It is very important to Xeitgeist that we make movies that touch people emotionally.”

Dr Jim Frazier is an Australian inventor, naturalist and cinematographer who invented the Frazier lens. He travelled the world filming wildlife for Sir David Attenborough’s many television series.

Dr Frazier's career as a wildlife cinematographer has been spread over more than 40 years, with an Emmy Award, 3 Golden Tripods, a US Industrial Film & Video Gold Camera Award, an Honorary Doctorate and over 40 national and international awards for his work that include the acclaimed Cane Toads: An Unnatural History.

He was winner of a Technical Oscar in 1997 for his invention of the Frazier lens System, which has revolutionised the international film industry, an ingenious lens that provides an extended depth of field and an ability to have both the foreground and background in focus. The lens has been used by leading filmmakers including Steven Spielberg, James Cameron and in television commercials. In October 1998, Jim was presented with the John Grierson International Gold Medal for pioneering work in micro/macro cinematography of invertebrate animals leading to the design of the Frazier lens System.

E


Robert Engle, Nobel laureate, is well-known for his contribution to the art of forecasting stock market volatility.

In an interview conducted by CFA Institute Content Director, Larry Cao, CFA, Professor Engle discussed how he quantifies systemic risk and his observations of the risks found in major economies, especially in China.

This article is a transcript of CFA Institute’s Livestream interview with Professor Engle that took place on 24 November 2015 in China.

SYSTEMIC RISK Where is it now concentrated?

Q: What was the motivation behind developing the ARCH model?

It was a long time ago when I started working on the ARCH model. In the beginning, it was a macro-economic model. I had been reading Milton Friedman’s Nobel Prize address, where he said a lot of business cycles could be explained by uncertainty. That is, when the future looked uncertain, businessmen wouldn’t invest. Consumers wouldn’t buy. Instead, they’d save. Consequently, when uncertainty is high, you may expect the economy to deteriorate.

So, I was trying to figure out to how to build a model that described this. How do you let uncertainty change over time? The ARCH model turned out to be the answer, but it was a different way of thinking about things. It turned out not to have so many macro-economic implications and lots of finance implications.

Q: What thesis did you put together to solve the problem?

When we think about uncertainty, we think about things like the variance. We always thought the variance was a number. When building a time series model, we think about how the variance changes over time. My good friend Clive Granger (whom I share the Nobel Prize with) said, “You should try this experiment: You fit a model, and then you take the residuals and square them. And then you fit an auto-regression of those squared residuals.”

When I fitted the model to consumption data, I was astonished to find how statistically significant that was. So, I knew there was auto-correlation in the squared residuals - which is really what the ARCH model was designed to pick up - that is, volatility clustering.

Clive and I talked a lot about statistics, economics and econometrics when we were together. It was a very productive relationship that we had.


Q: One of the major applications of the ARCH model was the VaR. Has VaR proven helpful in understanding and forecasting market volatility?

I’d say it the other way around: Forecasting market volatility is a good way of calculating VaR. It’s pretty much the best way to calculate VaR. It makes it very easy to see how VaR changes over time. Because volatility is changing over time, that means that risk is changing over time.

Q: How did the ARCH model perform during the global financial crisis in 2008?

One of the embarrassing moments that I remember after getting the Nobel Prize was when a reporter asked me a similar question. He said, “If your model is good enough to win the Nobel Prize, did it predict the financial crisis?”

I didn’t have an answer for him at that time, but we have gone back to see what the model did do. We have a website, V-Lab, which is a volatility laboratory. Starting from the early part of the financial crisis, we published volatility forecasts from Generalized AutoRegressive Conditional Heteroskedasticity (GARCH) models every day. So, we could see how the models did in forecasting volatility.

The record showed our volatility forecasts during the financial crisis deteriorated only marginally from what they were before and after the financial crisis. In other words, it really did do a pretty good job of predicting the risks during the financial crisis. Correspondingly, VaR did a pretty good job of telling you what the quantiles of the predictive distribution looked like.

So, I felt like I could go back and tell this reporter what I had discovered, which was that GARCH models were able to predict the financial crisis

one day in advance!

But I think there is a great lesson to this story, and I have devoted a lot of research to this lesson. The lesson is: VaR, for all its wonderfulness, is a way of forecasting risk one day in advance. And when we forecast risk, there are some applications for which that is just the right answer. But there are lots of other applications for which we need to know: What are the risks likely to be in the long run?

Q: What have you found to be the main limitation of VaR, and how does the SRISK measure help to resolve that?

We tried to find out how to manage risk over a long time horizon. I believe that much of what caused the financial crisis can be attributed to what we call risk myopia. You probably know that market volatility was very low before the financial crisis. At that time, bankers were continually talking about how they had to find ways to get more risk so that they could make more return. This is the problem of risk myopia: What they thought was a one-day risk should have been handled as though it was a six-month risk or a one-year risk.

What is the difference between long run risk and short run risk? Well, I think a nice way to describe long run risk is that there is a risk that the risk will change. So, it might be low today, and it might be low in the future. But it might be high in the future. And if it goes up, you have to consider that as part of your risk.

In this light, SRISK is a long run risk measure. “S” stands for systemic. It is a long run risk measure that we use on financial institutions because we would like to know if they have enough capital cushion to withstand the shock of another financial crisis. SRISK is another way of calculating how much capital they would have to raise if we had another financial

www.cfasingapore.org | Page 15

Professor Engle was awarded the 2003 Nobel Prize in Economics for his research on the concept of autoregressive conditional heteroskedasticity (ARCH). He developed this method for statistical modelling of time-varying volatility and demonstrated that these techniques accurately capture the properties of many time series.

Professor Engle is an expert in time series analysis with a long-standing interest in the analysis of financial markets. His ARCH model and its generalizations have become indispensable tools not only for researchers, but also for analysts of financial markets, who use them in asset pricing and in evaluating portfolio risk.

He is currently the Director of the newly created NYU Stern Volatility Institute and is the Co-Founding President of the Society for Financial Econometrics (SoFiE), a global non-profit organization housed at NYU.

Professor Robert EngleMichael Armellino Professor of Finance

Stern School of Business

New York University


crisis in order for them to continue to perform their functions normally.

Q: Other than VaR, what other factors contribute to SRISK?

We were interested in how volatility changed over the long run. We were also interested in how big the capital cushion is relative to the liabilities of the firm.

If you think about how a bank works: it takes deposits from us, and invests them in assets. If these assets go up in value, the bank makes a profit. If these assets go down in value, it may not have enough cash left to pay back the loans that you and I have made to them. So, a bank should ideally have a capital reserve that is in a sense, the equity or net worth of the bank. That is, the assets that it has above the liabilities.

If the bank has sufficient net worth, the deterioration of its assets doesn’t leave it in insolvency – then it can withstand a financial crisis. That’s what we are trying to measure. We use accounting data on liabilities and market data on equities. Those are the two major inputs. We are interested in the volatility part of this model.

If we ask how much a financial institution would need to raise in a crisis, we are asking a question that is pretty hard to answer. In the middle of a crisis, it is very hard to raise capital. The main source of capital during a financial crisis is going to be the government / tax payers. You are asking: What is the bailout going to be for this financial institution? If we add up the bailout for the financial institutions, we get the cost of bailing out the financial sector as a whole. We calculate that. If that is a very large number, we think that there is a very severe danger of a financial crisis.

Q: Where in the world is SRISK concentrated now? Is it in US, Europe, Japan or China?

If we think about a global financial crisis, then we are talking about banks and financial institutions all over the world needing to raise capital. How much does it cost to bail out all the banks in the world? We believe the answer today is US$3 trillion. That’s a big number, but it’s not an extraordinary number. It’s a little smaller than the Chinese currency reserves. This means China could bail out the entire world’s financial system if it wanted to.

We calculate this every week and we post this on the Internet. There are changes every week. The current global SRISK of US$3 trillion is lower than during the financial crisis in 2008 and 2009, and lower than during the European financial crisis in 2011. During both crises, SRISK was about US$4 trillion.

Ideally, that number should be zero, which means that you are not going to have to bail out any of these banks. Then, there won’t be a financial crisis.

If you look at Europe, you see a story of improving SRISK. The banks are being recapitalized, but it isn’t happening everywhere. It is happening pretty well in Germany and in Italy. The SRISK for Germany is down to about US$150 billion. The SRISK for Italy is less than US$100 billion now.

But France and the UK are having a hard time getting their banks stabilized. We are quite concerned about the financial sector in France and the UK. France has 3 enormous banks that are very slowly strengthening their balance sheets. The UK financial sector has relatively constant SRISK. Both of them are at about US$300 billion. So, it is not necessarily the countries that had trouble during the financial crisis that are having a hard time bringing down their SRISK.

That is why I think Europe is a cause for concern from a global growth perspective. Europe is not growing. Draghi is proposing more monetary stimulus for Europe - a stronger dose of quantitative easing, because it is

not growing. He sees these numbers the same way that we do, probably better. He sees our numbers also, I think.

A much happier story is in the US, where the SRISK has been falling quite rapidly since the first financial crisis. It had a small peak after the second one. Now, it is down to the same level that it was at before the first financial crisis happened. It’s not zero, but it’s a lot closer to zero.

The banks are improving their SRISK every year, whereas the insurance companies are actually taking on more risk. We are concerned that the insurance industry is potentially the systemic risk of the future. With such low interest rates, insurance companies can’t simply invest in corporate bonds and expect to get enough return to pay their policy holders their liabilities. Insurance companies are taking on more and more risk on the asset side of their balance sheet and that is translating into the risk that we see at V-Lab.

Asia has a different story from the US. In Japan and China, SRISK has been increasing pretty steadily since the first financial crisis. China had no SRISK in 2008 and this has increased. Even if you not are worried about the level of SRISK, you should be worried about its rate of change.

If you add up the SRISK of all the financial institutions in China, it is the country with the largest SRISK in the world right now. And Japan is second to it. So, these two giant Asian economies both have banking sectors that are under-capitalized by our measures.

Over the last year, China’s SRISK declined dramatically as its stock market went up extremely rapidly for 6 to 9 months. And then, it collapsed, in what’s now called the stock market turbulence. As it collapsed, the SRISK went up again. Right now, it’s where it was before the stock market increase happened.

www.cfasingapore.org | www.cfasingapore.org | Page 17

Q: How has SRISK evolved in China since you started tracking it?

When I first started tracking it 5 years ago, China’s SRISK was no.5 in the world. Then, it was no.4. Then, it was no.3. Then, it was no.1 for about two or three years. And then, this year, it dropped to third or fourth again. And then, it came back up again.

China has a different economy from most of the other countries that we’re talking about. The question is whether this analysis of the equity divided by the liabilities is an appropriate way of measuring risk in China.

Q: Why is China’s SRISK so high?

Chinese banks have made loans over the years to a lot of state-owned enterprises and a lot of municipal governments. Many of these loans were going to be paid back by growth in real estate values, and by profits that were going to come from construction or profits from state-owned enterprises. In many cases, the borrowing companies did not have the resources to pay back the loans.

But because these are state-owned enterprises, there is an implicit guarantee from the government that they are ultimately going to pay back the loan. So the banks ended up extending new loans to them so that they can pay back the old ones.

So, even though there are loans being made, they were actually not performing. They are not paying interest. The value of these loans is probably substantially less than what the accountants say the value is. So, the stock market gives the banks low valuation.

When we invest in Chinese companies, we have to decide how much are these companies really worth and investors have given low market values to the banks. I think this is one of the reasons for China’s high SRISK.

When we talk about systemic risk in the western economies, we are often concerned that when the stock market valuation gets low enough, these companies will be in trouble. If they are too big and important to fail, the government will bail them out. Expecting that bailout, they took on too much risk in the first place. So the question of whether they get bailed out or not is not as important as whether the risk is being correctly assessed.

From this point of view, China is very much like western countries because the banks are all state-owned. There is no possibility that a China state-owned bank is going to fail. In fact, they will be recapitalized by the government. So, we probably won’t see a financial crisis in China. The banks will continue to make loans in unproductive industries because these are the industries that are supported by the government and they are viewed as low risk investments by the bank managers. And this will lead to a slow stagnation of the financial sector in the Chinese economy. Who holds the risk in China if it is not the bank managers that are taking the risk, nor the borrowers? It is the government that is taking the risk for the entire economy. The problem with the government taking the risk for everyone is that capital is not allocated based on which are the best companies. It is based on which are the politically connected ones. If there is no risk of default, then everybody can borrow at the same very low rate. This is what we see: the credit spread is very low in China.

Without any possibility of default of these enterprises, there is no credit risk. There is no reason for banks to allocate capital to the strong companies instead of to the weak ones. We expect that to be an important drag on the Chinese economy.

Q: What do you see ahead for the Chinese financial markets?

I see enormous challenges in the Chinese economy. I also see an economic and political system that can potentially meet these challenges. It‘s so refreshing from an American point of view to see that when there is a problem and a solution, the solution can be implemented overnight. In the US, we would have to debate on the solution for 6 months in Congress and then it will probably get voted down anyway. While I see a lot of turbulence ahead for the Chinese economy, I also see a committed economic team that has a lot of ideas as to what to do about it.

I think one of the things we are going to see is some corporate defaults, because we have to have risk premium for weak companies. So, if you are a bond holder, you might want to look at your portfolio and make sure that you are not holding a lot of weak companies. Switch to strong companies. I think the banks will be recapitalized when necessary. I don’t think there is so much risk in the banking system.

That may not be true of the shadow banking system, the wealth management and trust systems where you get much higher rates of return than you do in the bank. The government guarantees are implicit and not explicit for these products. And, if you invest in the ones that overpromise and they don’t have enough capital, I think there is a chance that these will fail in the not too distant future. This is a suggestion to treat credit risk as an important part of your portfolio.

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Professor Russell Napier spoke at a CFA Singapore luncheon talk organized by the Professional Development Committee on 29 October 2015. The well-known economist and investment strategist analysed when to invest in emerging markets.

EMERGING MARKETS risk External debt and currency devaluation

When a managed exchange rate is over-valued, it will induce an internal price adjustment, often deflation, that is bad for asset prices. A choice of a devaluation is also potentially bad for asset prices depending upon the scale of the foreign currency debt burden. When, then, is a good time to invest in emerging markets?

First of all, never just look at the valuation of the equities because one’s investments can be hit by a devaluation in the emerging market’s currency.

Secondly, a country that devalues its currency increases its risk of default on external debt. Professor Napier believes that countries with foreign currency borrowings exceeding 35% of GDP find themselves in a trap.

The trap is: The borrowing nation that lets its currency devalue too far will generate insufficient hard

currency stream to pay back the debt, leading to a default on the loan.

Devaluation increases external debt burden

The best example of this is Thailand during the Asian currency crisis in 1997. In the early 1990s, high savings rates (40% of GDP or more), strong economic growth (8% to 9% p.a.) and interest rates as high as 13% led to huge capital inflows. Many Thai companies borrowed USD extensively from foreign financial institutions to lower their cost of debt. In 1996, the Thai economy began to slow, its real estate boom began to unwind and non-performing loans soared. In 1997, a crisis unfolded when currency speculators sold massive amounts of baht for USD.

60

65

70

75

80

85

90

95

100

105

110

2010 2011 2012 2013 2014

Figure 1: JP Morgan emerging markets currency index

To avoid the burden of servicing USD debt on a weakened baht, Thailand used its foreign exchange reserves to defend its currency peg. This use of reserves to buy back baht caused a major tightening of monetary policy and worsening domestic credit conditions. After draining most of its foreign reserves and enforcing tight money that resulted in credit distress for baht borrowers, it was forced to switch to a flexible exchange rate regime in July 1997, causing the baht to devalue and causing solvency issues for those who had borrowed USD.

East Europe markets at risk of insolvency

Brazil is another example of how currency devaluation raises a country’s debt burden. The Brazilian Real depreciated from less than 3 BRL/USD in Feb 2015 to about 4 BRL/USD in Sep 2015. During this period, its external debt rose from 24% to 45% of GDP.

Emerging markets currencies have been on the decline in recent years (figure 1 on previous page) leading to increasing external debt burden. In the table on the right, countries that now have external debt to GDP ratios suggesting that they are heading toward default are boxed up in pink. Most of them are in Eastern Europe.

“One of the things you often hear today aboutEastern European countries is that they are the safest emerging market in which to invest your money,” said Professor Napier.

“The most likely countries to default on debt today are not in Asia, nor in South America but in Eastern Europe. They have borrowed a huge amount of Euro which I believe has taken them to a level where they will not be able to repay,” he said.

Eastern Europe may look very similar to Asia. Everything seems fine as long as capital is going in. But as soon as capital begins to come out of a country with a large external debt burden, it finds itself having to chose between two tough options: Devalue its currency and increase its risk of defaulting on external debt. Or, use deflationary policies with higher domestic interest rates to lower producer prices, boost export competitiveness, and attract capital inflow.

Emerging Markets Risk

Russell Napier


Gross External Debt

1Q2015(USD bn)

As % of GDP Sep 2015

As % of GDP Feb 2015

Argentina 149 23% 28%

Belarus 38 75% 53%

Brazil 699 45% 24%

Bulgaria 43 91% 90%

China 863 8% 8%

Chile 145 64% 52%

Columbia 106 41% 25%

Croatia 53 98% 100%

Czech Republic 113 61% 64%

Georgia 13 102% 81%

Hungary 173 144% 147%

India 476 22% 22%

Indonesia 298 35% 22%

Kazakhstan 99 66% 34%

Korea 419 32% 28%

Malaysia 184 70% 68%

Mexico 420 39% 32%

Mongolia 19 158% 158%

Pakistan 56 21% 24%

Peru 62 33% 29%

Philippines 75 26% 20%

Poland 329 69% 67%

Romania 100 56% 59%

Russia 556 50% 33%

Serbia 37 100% 80%

South Africa 144 48% 42%

Thailand 138 39% 39%

Turkey 393 62% 49%

Ukraine 126 147% 101%

Uruguay 14 29% 44%

Venezuela 119 23% 27%

Figure 2: Data from Wold Bank / IMF

Exchange rates as at 10 September 2015


Russell Napier


Russell Napier

The problem with deflation is that it undermines corporate cash flow, which affects the corporate sector’s ability to expand. Capital investment, employment rates and consumer spending power would be dampened, and this could lead to economic recession.

When to investHere are some questions to ask when assessing the currency risk of an emerging market.1. Does the country have a large

external surplus? Or, is its current account turning around into an external surplus?

2. Is its capital account in surplus, or turning around?

3. Does that look sustainable? If it is sustainable, there is no downside risk to devaluation of its currency. Instead, the currency is likely to appreciate. Some of the major current account surpluses are in Asia.

The next question is: Where are the multi-national companies, that are flushed with cash, investing? Much of that cash is offshore. MNCs can now borrow at interest rates that are at the lowest in this generation.

Professor Napier believes that MNCs’ acquisitions of offshore assets tell investors when it is a good time to invest.

Foreign exchange reserves rise when the government manages its exchange rate. A growing external surplus either through the current account or the capital account (or both), a rising exchange rate, a rising savings rate, easing of liquidity, rising asset prices as well as rising foreign direct investments are signs that assets in that market are reasonably valued. That is when to start investing in emerging markets.

Obstacles to recovery

Th e c u r re n c i e s o f e m e rgi n g markets have already devalued significantly. When one’s currency comes down, the country should reduce imports and boost exports to improve its external accounts. However, improvement in external accounts has been marginal. Currency devaluation has not been effective because exports from emerging markets have not caught up with shifts in demand trends.


Professor Napier addressed CFA Singapore members at Capital Tower.


Professor Napier is the well-known author of The Solid Ground investment report and Anatomy of The Bear: Lessons From Wall Street’s Four Great Bottoms. He is founder and course director of the Practical History of Financial Markets at The Edinburgh Business School. In 2014, he founded the Library of Mistakes, a business and financial history library in Edinburgh.

He has worked in the investment business for 25 years and has written global macro strategy for institutional investors since 1995. He has a Masters in Law from the University of Cambridge, is a Fellow of the CFA Society of the UK and an Honorary Professor at Heriot-Watt University.

Professor Russell NapierCo-Founder

Electronic Research Interchange www.eri-c.com

The lower the emerging market’s exchange rate has to go to effectively boost exports, the greater its risk of going bankrupt if the country has a large external debt.

There are emerging markets that have built their economies for 30 years on producing household goods like TV, clothes and shoes for the baby boomers in the developed world who were very pro-consumption. By the time this great demographic bulge reach their fifties and sixties, they are not buying as many goods as before. And yet, the capital investment in many emerging markets is to produce goods for that era.

“The baby boomer generation is still spending, but on services instead of goods. The more the baby boomer generation buys experiences and not stuff, the more difficult it is for emerging markets to accumulate external account surpluses,” said Professor Napier.

The second point about emerging markets is this: They export commodities to China for fixed assets investment, which structurally, is not going to grow the way it has grown. Because these problems are structural and not cyclical, they could last for a long time.

China is the one country with complete flexibility to devalue without defaulting. Its gross external debt is small: 8% of GDP compared to over 20% for the rest of emerging markets economies.

More importantly, two-thirds of all of China’s foreign currency borrowing is done by its banking system. The ultimate counter-party of PRC commercial banks remains the state, and the state owns the banks.

While China’s devaluation increases the risk that its commercial banking system defaults on the US dollar debt extended by foreign banks, that is highly unlikely to happen. It is much more likely that the state stands behind the commercial banks that it owns, and makes sure that they have sufficient dollars to pay back the banks in Singapore and Hong Kong.

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FIXED INCOME strategies

Risk premiums

What returns should one expect from any investment, be it a stock, a bond or a certificate of deposit?

At the very least, one must be compensated for inflation. Secondly, one must be compensated for a real interest rate on top of inflation. These two factors make up one’s cash return.

When the Federal Reserve does a quantitative easing program by setting interest rate at zero while inflation is positive, what they wish investors to think is this: “It is not rational to be invested in cash. Move your funds to sovereigns, corporate credit and equity.”

Next, consider the market yields on bonds of varying maturities (that is, the term structure). This is the return on sovereign debt. Debt issued by large industrialized nations such as US, Germany, France, UK and Japan are denominated in and backed by local currencies. The sovereign debt of emerging markets is denominated in USD.

As one’s appetite for risk increases, he then moves to the private

sector. Debt issued by a corporate is supported by the cash flow that its businesses generate. Since its credit-worthiness is less than a sovereign, the yield on corporate credit has a spread over sovereign debt.

Equity investments, which are even more risky, must compensate with an equity risk premium. Thus, the expected return on equity investments can be decomposed into the following layers: inflation, real rate, term premium, credit premium and equity risk premium.

Above all this, private equity investments command a premium for the asset’s illiquidity or lengthy investment horizon.

“Private equity can be thought of as levered public equity with liquidity premium embedded on top,” said Mr Xiong.

Sources of alpha

The following types of premiums can be generated through active portfolio management by hedge funds.

1. Behavioral biases - Some

Fixed income portfolio manager Jonathan Xiong, CFA, MBA spoke at a CFA Singapore luncheon talk organized by the Professional Development Committee on 11 November 2015. He provided insights to the investment management philosophy and macro-themes adopted by the Goldman Sachs Fixed Income, Currencies and Commodities division, which manages close to US$800 billion.


Private

Sovereign

investors behave irrationally when there is a market sell-off

2. Non-profit maximizing market participants

One example is the pension fund that has liabilities of payout benefits to retirees. To completely hedge that liability risk, it buys a bond with a matching cash flow and discount rate, without caring about the bond price or yield.

Another example is the traveller who uses money changer kiosks at airports. The foreign exchange spread charged by such kiosks is at least 15% higher than what is shown by market information providers such as the Bloomberg terminal.

3. Time-varying risk premia – the compensation for deciding to hold on longer to an asset.

4. Intermediation

Financial intermediaries such as Goldman Sachs and Morgan Stanley can trade without losing money by facilitating a market

making activity with a return profile that resembles arbitrage.

5. Informational advantages

Some investors do not know how to make use of information that is already in the market. Those who do will have an advantage.

Account for risk

Active decisions are made on 3 factors whenever one buys a bond: duration, country and tenor (outstanding maturity). However, as these 3 factors are dependent on each other, risk-adjusted returns (Sharpe ratio) on the fixed income portfolio is affected. In computational finance, the auto-correlation bias between these 3 factors increase the portfolio standard deviation, σp. A higher σp implies a lower Sharpe ratio.

To remove auto-correlation bias, Goldman Sachs believes in isolating exposures in its actively managed sources of alpha. For example, every position is hedged against currency risk.

It has 9 specialist teams for the following strategies.

1. Tactical duration – are interest rates going up or down?

2. Country exposure – bets on countries’ interest rates

3. Government debt / swaps – which part of the yield curve to invest in intra-country, arbitraging physical bonds against future bonds and other derivatives?

4. Currency exposure – bets on foreign exchange rates

5. Commodities – liquid futures

6. Sector allocation – investment grade credit, high yield or emerging markets’ sovereign bonds?

7. Liquid mortgages – the

TRADITIONAL PREMIUMS(Long only)

Credit

Equity

Inflation

Real Rate

Term

Liquidity

ALTERNATIVE PREMIUMS (Long/short, Leverage,

Tractical trading)

Non-profit maximizing market participants

Informational Advantage

Behavioral Biases

Intermediation

Time-varying risk premia

GSAM investment philosophy. For illustrative purposes only.

Sources of returnSources of return


DISCLOSURESReferences to indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only and do not imply that the portfolio will achieve similar results. The index composition may not reflect the manner in which a portfolio is constructed. While an adviser seeks to design a portfolio which reflects appropriate risk and return features, portfolio characteristics may deviate from those of the benchmark High-yield, lower-rated securities involve greater price volatility and present greater credit risks than higher-rated fixed income securities. High-yield, lower-rated securities involve greater price volatility and present greater credit risks than higher-rated fixed income securities.Valuation levels for the assets listed in the Account statements and other documents containing prices reflect GSAM’s good faith effort to ascertain fair market levels (including accrued income, if any) for all positions. The valuation information is believed by GSAM to be reliable for round lot sizes. The prices are indicative only of the assumed fair value of the positions on the relevant date. These valuation levels may not be realized by the Account upon liquidation. Market conditions and transaction size will affect liquidity and price received upon liquidation. Current exchange rates will be applied in valuing positions in foreign currency. For portfolio valuation purposes it is the responsibility of the custodian, administrator or such other third party appointed by the client, to obtain accurate and reliable information concerning the valuation of any securities including derivative instruments which are comprised in the portfolio. The information that GSAM provides should not be deemed the official pricing and valuation for the Account. GSAM is not obligated to provide pricing information to satisfy any regulatory, tax or accounting requirements to which the Client may be subject.This material has been issued or approved for use in or from Singapore by Goldman Sachs (Singapore) Pte. (Company Number: 198602165W) and Goldman Sachs Asset Management (Singapore) Pte. Ltd. (Company Number: 201329851H).

Index BenchmarksIndices are unmanaged. The figures for the index reflect the reinvestment of all income or dividends, as applicable, but do not reflect the deduction of any fees or expenses which would reduce returns. Investors cannot invest directly in indices. The indices referenced herein have been selected because they are well known, easily recognized by investors, and reflect those indices that the Investment Manager believes, in part based on industry practice, provide a suitable benchmark against which to evaluate the investment or broader market described herein. The exclusion of “failed” or closed hedge funds may mean that each index overstates the performance of hedge funds generally.This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities. This material is provided at your request for informational purposes only. It is not an offer or solicitation to buy or sell any securities.THIS MATERIAL DOES NOT CONSTITUTE AN OFFER OR SOLICITATION IN ANY JURISDICTION WHERE OR TO ANY PERSON TO WHOM IT WOULD BE UNAUTHORISED OR UNLAWFUL TO DO SO. Prospective investors should inform themselves as to any applicable legal requirements and taxation and exchange control regulations in the countries of their citizenship, residence or domicile which might be relevant.

Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur.This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. This material is not financial research and was not prepared by Goldman Sachs Global Investment Research (GIR). It was not prepared in compliance with applicable provisions of law designed to promote the independence of financial analysis and is not subject to a prohibition on trading following the distribution of financial research. The views and opinions expressed may differ from those of GIR or other departments or divisions of Goldman Sachs and its affiliates. Investors are urged to consult with their financial advisors before buying or selling any securities. This information may not be current and GSAM has no obligation to provide any updates. Views and opinions expressed are for informational purposes only and do not constitute a recommendation by GSAM to buy, sell, or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change, they should not be construed as investment advice.Economic and market forecasts presented herein reflect a series of assumptions and judgments as of the date of this presentation and are subject to change without notice. These forecasts do not take into account the specific investment objectives, restrictions, tax and financial situation or other needs of any specific client. Actual data will vary and may not be reflected here. These forecasts are subject to high levels of uncertainty that may affect actual performance. Accordingly, these forecasts should be viewed as merely representative of a broad range of possible outcomes. These forecasts are estimated, based on assumptions, and are subject to significant revision and may change materially as economic and market conditions change. Goldman Sachs has no obligation to provide updates or changes to these forecasts. Case studies and examples are for illustrative purposes only.Although certain information has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness. We have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. Views and opinions expressed are for informational purposes only and do not constitute a recommendation by GSAM to buy, sell, or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change, they should not be construed as investment advice.

ConfidentialityNo part of this material may, without GSAM’s prior written consent, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorised agent of the recipient.© 2015 Goldman Sachs. All rights reserved.Compliance code: 172032.OTHER.PF.MED.OTU, 172436.PF.OTU Date of First Use: November 11, 2015

US mortgage market is an inefficient market where one can find alpha.

8. Corporate credit

9. Emerging markets – long short positions that profit from the yield spread between two countries.

Divergent monetary policies

One development Mr Xiong highlighted was the US decision to embark on a higher interest rate path in contrast to the quantitative easing policies pursued by other large economies like Europe and Japan.

After the Fed hinted at future tapering of its asset purchases, interest rates rose not just in the US but across the developed world. Mr Xiong and his team believe that this shift was caused by investors exiting interest rate risk and did not reflect the fundamentals of each country. He pointed out the following as a possible bet: Even though unemployment rates have been falling in the US over the past 4 years and rising in France, bond yields have converged in these two countries. Thus, a macro-oriented relative value trade might then be to position for US and French 10-year rates to diverge given the significant differences in economic conditions between the two countries. “It is of less concern to me whether the overall bond market is going up or down. What I care about is the relative trade that can be made between two markets,” he said.


Mr Xiong is the co-portfolio manager of Goldman Sachs Asset Management’s Global Opportunities Strategy fund within its Global Fixed Income team. He joined Goldman Sachs as a managing director in 2011.

Prior to joining the firm, Mr Xiong was a managing director and senior portfolio manager / global investment strategist on the Global Macro / Global Tactical Asset Allocation team of Mellon Capital Management (AUM US$20 billion) for over 11 years. From 1998 to 2000, he was an investment analyst with McMorgan & Co, where he foxued on US equities and fixed income portfolios.

Jonathan Xiong, CFA, MBAHead of Fixed Income Alternatives Group

Goldman Sachs Asset Management

E

Convergence of US and French bond yields despite diverging economic fundamentals.


The adoption of multi-factor models in computational finance by US investment firms was pioneered by Jason MacQueen. He spoke at a CFA Singapore luncheon talk organized by the Professional Development Committee on 13 November 2015, on determining the reliability of equity risk models.

There are 3 main types of equity risk models. All three are all multi-factor models, which try to quantify the common characteristics of different securities, and determine the return sensitivity to these factors.• Statistical factor models derive

their factors from factor analysis of the covariance matrix of security returns.

• With cross sectional models, you input the betas into the various factors and estimate the factor returns by doing cross sectional regression.

For example, a cross sectional regression could have as each data point an observation on how the security’s return over a specific time period is affected by factors such as its trading volume, dividend yield, market capitalization, earnings, sales, industry information or total assets.

• With time-series models, instead of doing cross sectional regression period by period, you input the factor returns and you do regression analysis stock by

stock. That is, regression of the time-series returns on the stock against the time-series returns on the factors. In this case, your objective is to estimate the betas.

Many standard risk models use data on market movements and the industry / sector as these factors usually account for much of stock risk. International risk models usually have currency factors to quantify currency risk. Models based on the Arbitrage Pricing Theory model use macro-economic factors.

During normal market conditions, most sensible risk models give reasonable estimates of portfolio risk or tracking error, a portfolio’s beta to its benchmark and its split between factor risk and stock specific risk. The main differences between each model lie in the factor decomposition they provide for fund managers. In turbulent market conditions such as the global financial crisis, models usually perform less well. Models also perform differently for different stocks. R-squared

EQUITY RISK MODEL TESTING

Customised risk models provide factor decomposition

www.cfasingapore.org | www.cfasingapore.org | Page 27

Jason MacQueen pioneered the use of multi-factor stock selection models in the USA and Japan.

In 1980, he founded QUANTEC, the first firm to develop risk models for equity markets outside the USA. The firm ultimately built risk models for all of the developed markets and most of the emerging markets. QUANTEC was sold to Thomson Reuters in 2001.

In the late 1990s, Mr MacQueen and his colleagues developed a statistical risk model-based technique for the American Stock Exchange to enable it to offer ETFs on actively-managed mutual funds without knowing the underlying holdings.

In 2003, Mr MacQueen co-founded R-Squared Risk Management to develop customised hybrid risk models for institutional investors. The firm was acquired in 2014 by Northfield Information Systems. Mr MacQueen is Northfield’s Director of Research.

He is also the founder and first Chairman of the London Quant Group (a non-profit organization for quantitative investment technnology), as well as a Director of the Society of Quantitative Analysts in New York.

Jason MacQueenChairman

Alpha Strategies

E

statistics have indicated considerable variability of model accuracy, from an average of 42% for the top 500 stocks by market cap to 20% for an all-inclusive dataset of about 9,000 stocks. Models in which the market and industry factors are market-cap-weighted tend to work best on cap-weighted portfolios of large stocks.

Most investment firms use standard risk models. To develop customised hybrid risk models for institutional investors, Mr MacQueen co-founded R-Squared Risk Management in 2003. The firm was acquired in 2014 by Northfield Information Systems, a market leader in financial modeling tools. Mr MacQueen is Northfield’s Director of Research.

Identifying unintended bets

Custom risk models are designed to reflect the investment process of a particular fund management house as closely as possible, on customised definitions of factors, industry classifications, and so on. These models are built so that the firm’s managers can identify and quantify specific bets, as well as check for significant exposure to unintended bets that need to be minimised or hedged. The drawback is they only work for fund managers with well-defined investment processes.

Mr MacQueen considers the following when testing equity risk models for reliability:1. How well does the model forecast portfolio risk,

benchmark risk and tracking error?

2. How well does the risk model forecast the beta of the portfolio to the benchmark?

3. Are the forecasts biased up, down or unbiased?

4. How well each model distinguishes between high and low risk portfolios.

“It is prudent to look at your portfolio on the basis of two risk models. If they tell you different things, one of the models may not be telling something,” said Mr MacQueen.


YOUR PERSONALITY TYPE

Edmund Ang (Manager, Instruction, Dale Carnegie Training) helped CFA members discover their personality types at the Society’s career development event in December. The seminar equipped participants with tools for identifying and relating to personality types that are different from their own. These were tools that enabled one to improve professional as well as personal relationships.

Participants were taken through a test that established each person’s dominant personality profile. The profiling identified participants as one of four major personality types: Driver, Analytical, Expressor or Amiable. More than 60% of the participants turned out to be either Driver or Analytical types.

They were then grouped according to personality type. Individual participants took turns at the microphone, sharing insights into their personality attributes and preferred engagement approach.

“Knowing how to relate to different personalities is useful for building rapport with your bosses or with interviewers,” said Mr Ang.

The participants also got to try out Dale Carnegie Training’s career development stack. Each participant performed a self-assessment test using objects in the stack that represented different aspects of one’s career. This was followed by small group sharing by individual participants about an aspect of his or her career to improve on.

More than 70 CFA members were at Dale Carnegie Training’s personality seminar organized by our Career Development Committee. The seminar was held at SGX Auditorium on 7 December 2015.

Object Meaning

Rock Confidence

Teeth Communications

HWTF Book Human Relations

Conductor’s Foot Leadership

Flag with + sign Positive Attitude

Bottle of Aspirin Stress

Fire Cracker Enthusiasm

Above, L-R:• Tolmas Wong, CFA (Event Organizer

/ Deputy Chairperson of Career Development Committee)

• Edmund Ang (Event Speaker)

• Kanol Pal, CFA (Event Organizer / Chairperson of Career Development Committee)

Career Development Stack

CAREER DEVELOPMENT

Quarter 4 2015

Dale Carnegie Training seminar on personality profiling



CFA Charter Awards Ceremony

L-R: Francis Er | Rasik Ahuja, CFA, CFAS Deputy President | Dr Aaron Low, CFA | Gerard Lee, CFA | Jan Richards, CFA, CFAS President

L-R: Kanol Pal, CFA, CFAS Board Member | Delvin Tan, CFA | Yap Hong Wee, CFA | Salman Jaffer, CFA

AdvocAcy

Panel Discussion: How rampant is portfolio pumping in Singapore?

cAndidAte progrAms

Panelists, left to right

| Alan Lok, FRM, MBA, CFA Director, Capital Markets Policy, Asia Pacific

CFA Institute

| Guruprasad Jambunathan, FRM Associate Director, IREVNA

| Tan Lay Hoon, CFA CFAS Secretary

| Daryl Neo Co-founder, Handshakes

| Andrew Quek

CFA Singapore Year-end Party


CFA Charter Awards Ceremony

Panel Discussion: How rampant is portfolio pumping in Singapore?

netWorKing

• L-R: Seow Hock Hin, CFA, CFAS Board Member | Maggie Tang, CFA | Joyce Xu, CFA | Jan Richards, CFA, CFAS President at the year-end party organized by the networking committee on 17 December 2015.

University Investment Research Challenge

@UIRC Training Session: Senior members from CFA Singapore share insight into research and presentation. L-R: Tolmas Wong, CFA | Jack Wang, CFA, CFAS Board Member | Th’ng Beng Hooi, CFA.

UniversityoUtreAch

Ezion CEO Chew Thiam Keng (left) with the Group’s Head of Corporate Finance, Alan Chong, in a Q&A session with UIRC participants.

UIRC participants visit Starhub for a company presentation.

Training by Bloomberg for student participants of the University Investment Research Challenge (UIRC).

The CFA Singapore Quarterly features the latest in thought leadership, best practices and investor education activities of investment professionals in

Singapore. Written by financial journalists for veterans as well as those aspiring to greater heights as an investment professional, this quarterly newsletter

commissioned by CFA Singapore is produced by NextInsight (www.nextinsight.net) and circulated to about 10,000 CFA charterholders .and program

candidates. Email or call Sim Kih ( [email protected] ) at 6438-2990 for feedback and inquiries.

Date Details Speakers Venue Committee21 Jan Other People’s Money:

Masters of the universe or servants of the people

Professor John Kay Capital Tower, L9 FTSE Room

Advocacy

25 Jan Networking Drinks N.A. OverEasy (Orchard), Liat Towers

Networking

27 Jan 2016 Economic Outlook Manu Bhaskaran, CFA Suprita Vohra, CFA Ng Hsueh Ling

UBS Singapore, L49 Raffles Auditorium

Professional Development

28 Jan Outlook of RMB and Asian High Yield Market

Raymond Gui, CFA Capital Tower, L9 FTSE Room


30 Jan University Research Challenge Finals Bloomberg Auditorium

University Outreach

17 Feb Asian High Yield Fixed Income Feng Zhi Wei Capital Tower, L9 FTSE Room


24 to 26 Feb Business Finance Mandarin Workshop: Analysis of financial reports in MandarinThis workshop equips participants with a comprehensive grasp of the terminology in Chinese financial statements, and covers ways to detect fraud and window dressing. Participants will get hands-on practice in the analysis of business reports and news articles. Basic Module: Introduction to financial statements (7 CE hours)Intermediate Module: Analysis of financial statements (14 CE hours)

Wang Xin Bin, CFA, ACCA

25 Feb Manage Your Own Career Andrew Jones Career Development

21 to 23 Mar Advanced Financial Analysis Series Module 1: Advanced Financial Modelling (core model)Module 2: REIT Financial ModelingModule 3: Advanced Excel for Data Analysis

7 CE hrs / 7 CPD hrs (all modules)

Hamilton Lin

Upcomingactivities

All events listed are subject to change without prior notice. Details are correct as of date of publication.Please visit our website at www.cfasingapore.org for more details.

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