what can save active investment management? - nomura · 10/3/2017 · what can save active...

© Nomura

Making choices in new dimensions

3 October 2017

What can save active investment

management?

Global Markets

Quantitative Strategies

EMEA

Anthony Morris

In their report for the Norwegian Government Pension Fund, Ang,

Goetzmann and Schaefer (2009) found that active management added

value in which asset class?

1. Equities

3.7%

2. Fixed Income

7.41%

3. Private Equity

11.11%

4. Real Estate

11.11%

5. None of the above

66.67%

Who has the biggest impact on your fund’s performance?

1. CIO

13.73%

2. PM

19.61%

3. Investment committee

29.41%

4. Operations/other back office

37.25%

What can save active management?

1. Artificial intelligence

18.37%

2. Cloud computing

0%

3. Big Data

22.45%

4. Meditation

14.29%

5. Ray Dalio’s management culture

6.12%

6. Jared and Ivanka

6.12%

7. MiFID 2/other regulation

10.2%

8. Other

22.45%

What is the world’s oldest profession?

1. Prostitution

35.85%

2. Military

9.43%

3. Hunting/Gathering/Farming

43.4%

4. Fiduciary management

11.32%

Source: Nomura.

Active management will survive

The Threat: active management, as currently done, fails to demonstrate value-added

The Opportunities: there are other ways to be active


“The evidence…indicates that these 115 mutual funds

were on average not able to predict security prices well

enough to outperform a buy-the-market-and-hold

policy…”

-Michael Jensen (1967)

From “The Performance of Mutual Funds in the Period 1945-1964”, presented at the Annual

Meeting of the American Finance Association, Washington D.C.

50 years ago, the problem surfaced

“…there is very little evidence that any individual fund

was able to do significantly better than that which we

expected from mere random chance…”




50 years ago, the problem surfaced

Source: “Bonds are different: Active versus passive in 12 points”, Baz et al (2017), PIMCO Quantitative Research.

- Are bonds any different?

50 years later, the problem is still with us

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0

1

2

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1st quartile 2nd quartile 3rd quartile 4th quartile

t-s

tat

of

alp

ha

Quartiles of US Fixed Income Fund Managers

Alpha t-stat

99% confidence

95% confidence

90% confidence

“There is no evidence that active fixed income

management has added value”

Ang, Goetzmann, and Schaeffer (2009)

Source: “Evaluation of Active Management of the Norwegian Government Pension

Fund—Global”, released December 14, 2009

The biggest threat to active management?

"The evidence does indicate....a pressing need on the

part of the funds themselves to evaluate much more

closely both the costs and the benefits of their

research and trading activities…"




Jensen’s advice—rethink the business model

Source: “Bonds are different: Active versus passive in 12 points”, Baz et al (2017), PIMCO Quantitative Research.

Diagnosis: No alpha, and everyone bets on High Yield

Active fixed income has become a carry cliché

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0

1

2

3

4

1st quartile 2nd quartile 3rd quartile 4th quartile

t-s

tat

Quartiles of US Fixed Income Fund Managers

t-stat of alpha

t-stat of High Yield exposure

99% confidence

95% confidence

90% confidence

Source: Nomura, Bloomberg.

Active outperforms passive, but not the benchmark

50

100

200

400C

um

ula

tive

to

tal

retu

rns

(lo

g-s

ca

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)

BBG Barclays US HY bondindex

Big US HY Active Managers

JNK US Equity


- CDS index: better liquidity, diversification, performance, and zero credit analysts/traders

New way to be active—upgrade format

50

100

200

400

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Cu

mu

lati

ve

ex

ce

ss

re

turn

s (

log

-s

ca

led

)Nomura HY CDS Index BBG Barclays US HY bond index (ex. ret over duration)

High Yield is a bundle of at least three exposures—but are they the best available?

New way to be active—decompose and recreate

Source: Nomura, Bloomberg. Analysis based on monthly returns from 1997-2017.

-0.20

0.00

0.20

0.40

0.60

0.80

1.00

1.20

Duration HY Credit MBS Curve Rates Vol Alpha(p.a.)

Beta

to

fac

tor

Big US Manager

15Source: Nomura, Bloomberg.

- HY Credit : Nomura US HY CDS Index instead of US HY Cash Bond index

- MBS : Nomura USD iVRP instead of US MBS Index

- Rates Vol : Nomura USD iVRP instead of US 1m10y

Making active better by upgrading formats

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Recreated using betterformatsDecomposed and recreated


Don’t fight the Fed, or Basel

New way to be active—do more than one thing

50

100

200

400

800

199

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Cu

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log

-s

ca

led

)

HFRI Macro Index

Active management will survive

But not all active managers will

Survivors will need to be active in different ways

The Threat: active management, as currently done, fails to demonstrate value-added

“Stock-picking” and market-timing are the core activity of active managers

But zero evidence that this generates value over benchmarks

The Opportunities: there are other ways to be active

Improving formats (e.g. CDS index vs corporate bonds)

Do more than one thing (e.g. not just carry or trend)

Unbundling (decompose, recreate better)

Markets (going where curves are still steep)


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Short Volatility/Variance: Each of the Nomura Volatility Risk Premium Indices (the “indices” and each an “index”) reflects a short position in

volatility. This means that should realised volatility or implied volatility increase, which is often the case in distressed equity markets, the index is

likely to post negative returns. Losses can be significant and the indices can go to zero. The losses increase with the amplitude of daily

movements, positive or negative, of the S&P 500 Index.

Convexity Risk: The return of each variance swap depends on variance (which is volatility squared). This means that in respect of realised

volatility, the return is convex and not linear. This means that the losses incurred in a scenario where volatility spikes can be significantly larger

than should the return of the variance swap have been linear in volatility. Similarly, the loss incurred by the increase in volatility (in absolute terms)

will be greater than the gain made by a decrease in volatility by the same amount.

Indices Calculated at Bid – Early Unwind Costs: The indices are calculated based on listed bid prices of option contracts on the underlying

equity index. On dates other than variance swap contract expiry dates, in respect of any investment products linked to the strategy Nomura

International plc as product provider has no commitment to provide unwind levels, and if provided, unwind levels cannot be defined methodically

but will be determined by Nomura International plc as product provider taking into account the prevailing bid-offer for volatility in the market for the

relevant notional exposure.

Potential Limited Exposure to the Variance Swap Contracts: The indices enter notional short positions in the variance swap contracts on

trading days when the implied strike level is greater than or equal to the exponentially weighted underlying equity index returns over the last twenty

trading days. On trading days where it is not, no notional short position is entered into. This means that the indices can have a reduced or even

zero notional short position and exposure at times. No assurance can be made that such criterion will be successful in avoiding variance swap

contracts which would subsequently lead to a loss. Furthermore, such criterion may mean that for a variance swap contract which may otherwise

have posted a gain, the weight could be zero and cause the indices to miss out on such positive performance.

Important risks and disclosures in relation to the Nomura Volatility Risk Premium Indices and

Certificate

Potential risks for the Nomura Volatility Risk Premium Indices and

Certificate

28

Implied Variance Levels Determination: The indices determine the implied variance strikes for any variance swap contracts notionally sold that

day and determine the mark-to-market value of variance swap contracts previously entered into and held by the indices. The implied variance

levels are determined based on the bid prices of option contracts on the underlying equity index listed on the CBOE and such levels may differ

from the levels Nomura International plc or any other market participant determines for implied variance levels.

Movements in Implied Volatility Will Affect the Value of the Indices: The indices take notional short positions in variance swap contracts on the

underlying equity index. The relationship of variance swap contract’s price to implied volatility is such that, all else being equal, the price of the

variance swap contract is expected to fall as implied volatility decreases, and the price of the variance swap contract is expected to rise as implied

volatility increases. The indices’ notional short exposure to the variance swap contracts is therefore effectively similar to a short position in the

implied volatility of the underlying equity index. Therefore, each day, changes in implied volatility levels will affect the value of the

indices. Specifically, increases in implied volatility will increase the prices of the variance swap contracts in which the indices hold notional short

positions, which will reduce the value of the indices.

Performance Risk: The indices seek to achieve returns based on the “volatility risk premium” relating to prices of variance swap contracts on the

underlying equity index. A volatility risk premium strategy is designed to capture returns based on the difference between implied (i.e. expected)

volatility and realised (i.e. actual) volatility that is often observed in U.S. equity options markets. As the indices target returns based on the volatility

risk premium related to the underlying equity index, the strategy will tend to perform well when the implied volatility of the underlying equity index,

measured at the time the notional short positions in the variance swap contracts are taken, is greater than its actual realised volatility. On the other

hand, the strategy will tend to perform poorly when the actual realised volatility of the underlying equity index exceeds its implied volatility,

measured at the time the notional short positions in the variance swap contracts are taken. For example, the indices will perform poorly when the

underlying equity index is unstable and experiences large, sudden changes in value, in which case the indices can experience sharp, severe

losses. Additionally, there is no limit to the amount by which the value of the indices may decline. Therefore, the value of the indices may decline to

zero or may even be negative.

Important risks and disclosures in relation to the Nomura Volatility Risk Premium Indices and

Certificate

Potential risks for the Nomura Volatility Risk Premium Indices and

Certificate

28

what can save active investment management? - nomura · 10/3/2017 · what can save active...

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