Mitigating Downside With The Sortino Ratio_2
Post on: 29 Июнь, 2015 No Comment
Intuition @ SxSW 2015
We are delighted to announce we will be exhibiting at SxSW Interactive. 13-17 March. You can find us at the Ireland @ SxSW Stage beside the Digital Music Lounge and close to the Trinity Street Entrance.
Collateral Management
Managed Futures
Rising Greenback Is No Picnic for US
The first six weeks of 2015 saw 411 companies in the S&P 500, the US benchmark index, report earnings for Q4 2014. Of this number, 299 companies beat consensus EPS estimates and 108 missed.
Many of the companies who missed – as well as many of those who beat – the estimates attributed some part of their negative results to the “strong dollar” and “currency headwinds.” Ominously, a large number of US corporations have lowered guidance for 2015 earnings due to the same two factors.
Since the end of June last year, the US dollar is up 17% against the euro, 15% against the yen, and 10% against sterling. The greenback’s performance against emerging market currencies has also been stronger – it is up 0.8% against the Chinese renminbi, 3.5% against the Indian rupee, 23% against the Brazilian real, and 45% against the Russian ruble.
US firms typically do not hedge FX exposures in their ex-USD revenues, so they suffer whenever the dollar is strong. Very few companies worldwide hedge their currency exposure to translation of their assets held in non-home currencies back to home currencies. Both of these factors have hit US corporations’ earnings.
The strong US dollar also impacts US exports, making them more expensive. According to the US Census Bureau, the US international trade deficit increased to USD 505.0 billion in 2014 from USD 476.4 billion in 2013, with US exports down to USD 2,345.4 billion in 2014 from USD 2,850.5 billion in 2013. Most of these numbers represent manufactured goods moving both into and out of the US. The three largest countries exporting to the US are China, Germany, and Japan, while the three largest buyers of US goods and services are Hong Kong, The Netherlands, and the UAE.
Intuition Know-How can help you develop a deeper understanding of reported earnings, stock market reaction to lowered guidance, how corporations use foreign exchange, and national accounts including the balance of payments.
Relevant tutorials include:
- Corporate Finance – Measuring Business Performance – Free Cash Flow
- Corporate Finance – Measuring Business Performance – Economic Profit
- The Foreign Exchange Business
- Foreign Exchange – Factors Influencing Exchange Rates
- Trade Finance – An Introduction
- Macroeconomics – Gross Domestic Product (GDP)
- Macroeconomics – Balance of Payments
- Economic Indicators – National Accounts
Transaction Banking & The Unintended Consequences of Regulatory Change
The business model that large global and regional banks follow has gone through massive change in recent times – not news for anyone involved. Much higher regulatory capital requirements, forced abandonment of previously lucrative business, and radical changes affecting many of the businesses large banks continue to pursue – not to mention enhanced requirements in relation to liquidity, asset quality, stable funding, and mortgage product offerings – all make it much harder to grow revenues while contributing massively to compliance and control costs. JPMorgan Chase estimated in its 2013 Annual Report that it complies with more than 1,000 new capital and liquidity requirements, 11,000 pages of new mortgage and securitization rules, more than 1,000 pages of new rules solely for implementation of the Volcker Rule, and 83 new US rules and 837 new European rules affecting its derivatives business.
Against this backdrop, the importance of performing services for clients that consume almost no capital looms ever larger. One of the most important services of this type is transaction banking. Encompassing a slightly different mix of products and services from institution to institution, the main constituents include services such as cash management and trade finance. Transaction services encompass cash management and working capital solutions, including receivables, payments and cards, and liquidity and investments. Trade services include supply chain finance, trade finance, and export and agency finance.
The transaction banking business is mostly free of regulatory capital charges, except for any direct lending done in conjunction with financing trade. As such, it has become an important source of revenue for the world’s global and regional banks.
Intuition Know-How can help you develop a deeper understanding of transaction banking.
Relevant tutorials include:
- Transaction Banking – An Introduction
- Transaction Banking – Payments Services
- Transaction Banking – Cash Management Services
- Transaction Banking – Regulatory Influences
- Trade Finance – An Introduction
The Evolving Challenge of Collateral Management
The use of collateral, especially as margin against counterparty credit risk, has been a feature of over-the-counter derivatives markets since the early 2000s. Banks’ OTC derivatives business with other market center banks, major regional banks, hedge funds, and private bank clients has been transacted under tight margining requirements for many years.
But new regulations such as Dodd-Frank in the US and the European Market Infrastructure Regulation (EMIR) now require other financial institution clients to post collateral for both cleared and non-cleared OTC derivatives. This impacts asset managers, insurance companies, and other financial businesses who use derivatives to hedge their market risk exposures to interest rates, credit risk, equities, and commodities.
The rapid rise in collateral requirements has had a dramatic impact on the institutions involved. First, there has been a lot of debate as to whether there exist sufficient volumes of liquid, traded securities to fulfill new margin requirements. Second, the tasks involved in managing collateral as it flows from institution to institution have made the business of collateral management more important than ever.
Such tasks include:
- Identifying preferred eligible collateral inventories against dynamically changing haircut and concentration requirements
- Keeping tabs on all collateral posted and taken across multiple platforms, clearinghouses, and legal entities
- Reconciling differing requirements from a currency, credit risk, and liquidity perspective
- Optimizing collateral employed against financing costs, transformation requirements, and reusability
Intuition Know-How can help you develop a deeper understanding of collateral and its management.
Relevant tutorials include:
- Credit Risk Mitigation – An Introduction
- Credit Risk Mitigation – Collateralization
- Credit Risk Mitigation – Other Types of Mitigant
- C redit Risk Mitigation – Management & Realization
Managed Futures – The Shining Light in the Hedge Funds Sea of Mediocrity
By almost every measure, hedge funds have struggled to perform since the financial crisis, especially when compared to mainstream equity and fixed income investments to which they are considered alternatives. Tracking hedge fund performance broadly is notoriously difficult, as reporting of results to the various hedge fund index providers is voluntary and over time indexes reflect the results of only those funds that have not shut their doors, making them prone to survivor bias. Even with those caveats, it would be difficult to make the case for investing in hedge funds by examining their returns since the crisis.
The first measure widely considered is simple return. By weighting the excess of fund returns above a target return (such as the total return of the MSCI World Equity Index) against their volatility, the Sharpe ratio, we can measure risk-adjusted return above the benchmark. In order to capture risk-weighted excess returns against downside excess return volatility, the Sortino ratio can be used – higher values of this indicate better returns against lower risk. Finally, we can compare the ratio of a fund’s returns versus the benchmark in periods when the benchmark return was positive against the ratio of the fund’s returns versus the benchmark in periods when the benchmark return was negative. Often called the upside and downside capture ratios, these indicate the degree to which a fund’s returns gain more in positive periods and lose less in negative periods.
Over the past five years, no hedge fund strategy has outperformed the MSCI total return index. Using Credit Suisse’s various hedge fund indexes, the overall hedge fund universe had a return of 29% over the past five years versus 49% for the MSCI. The S&P 500 5-year return was 72%. This flows through to all the other measures.
For 2014, one hedge fund strategy outperformed both the MSCI and the S&P 500 – managed futures. Although the category includes some discretionary funds, it is mostly systematic funds that trade according to trend following strategies. “Systematic” refers to their use of computer calculations to determine trades with no interference by human traders. All of them attribute their impressive gains in 2014 to markets beginning to return to “normal,” meaning traders making decisions not based on guessing future central bank liquidity actions but instead taking risk based on views about the future.
With a 2014 return of 17%, managed futures outperformed the MSCI by 12%. Thanks to relatively low volatility of returns during the year, its Sharpe ratio was 1.21, outperforming all other hedge fund strategies and the S&P 500. Its Sortino ratio of 2.96 indicates superior returns and lower downside variance than the MSCI. With upside capture of 124% and downside capture of only 13%, managed futures showed it is possible to outperform by a wide margin in good months while losing only a small fraction in bad months.
Intuition Know-How can help you develop a deeper understanding of hedge funds (including managed futures) and fund performance.
Relevant tutorials include:
- Hedge Funds – An Introduction
- Hedge Funds – Investing
- Hedge Funds – Strategies
- Portfolio Theory – Performance Measurement Models