Global Macro Strategies & Systematic Risk

(Previously 'Macro Asset Allocation Strategies') A 4-day course suitable for asset managers and investors who have had exposure to traditional asset allocation techniques but are keen to explore innovative and quantitative approaches to the global macro style. In addition, it will provide supplementary skills and robust techniques for those seeking greater understanding of underlying capital market dynamics and the major influences on systematic risk within the macro-financial environment. Why this course is timely and valuable: Investment risks are of a different order of magnitude from those seen just five years ago. Evidence will be presented to illustrate the manner in which most asset classes, to a much greater extent than previously, are correlated. This presents both challenges and opportunities to investors/traders. The biggest challenges are those which increase the likelihood of liquidity risk (e.g. “flash crashes”) and the consequent lack of a proper assessment of portfolio diversification. The basic themes would include the following: Differentiation of systematic and systemic risk Description of the main techniques of global macro fund management strategies Economic fundamentals driving asset allocation strategies Macro-financial factors determining systematic and systemic risk Macro/micro factors in context of global imbalances and de-coupling Exposure to emerging markets through exchange traded funds (ETF’s), futures contracts and other derivatives Intermingling of sovereign and private sector credit risk Credit Rating Agencies and validity of sovereign risk assessment models Structural credit risk within the Eurozone Hedging currency risk in a globally oriented portfolio Correlations between multiple asset classes – focusing especially on certain FX pairs and other assets which show high degrees of co-movement Measuring degree of risk appetite/aversion and systemic liquidity Commodities, emerging market business cycles and currency wars. Models for determining the degree of liquidity and correlation risk within capital markets “internals” Overview of Macro Analysis Rather than taking specific securities and considering valuations and expected returns in isolation, the emphasis is much more focused on the inter-connection of items from different asset classes. This is in accordance with contemporary markets, where determination of the appropriate valuation of (say) the US or UK equity markets is, arguably, more affected by developments in sovereign credit markets and foreign exchange (at present specifically the euro and European sovereign risk), or by geo-political developments, as it is by the internal indicators regarding GDP growth, employment data for domestic economies. The course will advocate a holistic approach to macro market analysis and investing and will explain this approach by examining inter-relationships across all relevant asset classes as expressed in the day to day co-movements revealed in global markets. Learning objectives A central theme of the course is to make the often cited notion of risk on/risk off more robust, and to provide a framework for quantifying the prevailing appetite for risk as guidance to investors and traders in their selection of different assets classes/sectors. The techniques presented will suggest that a proper framework for conducting rigorous analysis of underlying correlations between major asset classes – FX, fixed income instruments, commodities and global equity indices – will provide asset managers with vital clues as to when to implement strategies that are appropriate for a market environment which is supportive of taking on more risk (higher beta) or avoidance of more risk. Target audience The course is suitable for asset managers and investors who have had exposure to “traditional” asset allocation techniques but are keen to explore innovative and quantitative approaches to the global macro style. In addition, it will provide supplementary skills and robust techniques for those seeking greater understanding of underlying capital market dynamics and the major influences on systematic risk within the macro-financial environment. There will be a focus on real world examples with graphical case studies from many markets and from different asset classes. Course structure The course covers four days of lectures which will feature many specific examples and case studies. There will also be collective exercises using certain techniques which will have been explained in prior sessions. Each day will consist of four separate ninety minute sessions with coffee breaks in the morning and afternoon with a lunch break in the middle.
Day 1 Overview of Global Macro Style Overview Of The 'Macro' Style of Investing Session Themes Definitions and description of the macro style Contrast with other investment styles Relevance of macro vs. micro to global business cycle History of the macro style – George Soros, Jim Rogers etc. Current popularity of macro hedge funds Asset allocation models driven by “big picture” judgments Themes in geographical and sector investing Differentiating macro fund style for client marketing purposes Learning Specifics Top down/bottom up approaches to asset allocation. Overview of portfolio construction Overview of sector analysis Geographical sectors World GDP Statistics etc Case study: George Soros Quantum Fund Preparation Text: The Alchemy of Finance, George Soros, (Wiley 2003) Major Macro Market Influences Session Themes Geo-political events – political crises, currency wars, trade policy Activities of supra-national bodies e.g. IMF, EU, UN, G20 etc. Monetary policies of US, EU and China – QE, capital controls Role of Chinese PBOC in debt and FX markets Protectionism, monetary policy and “fixed exchange rates” Dispute with China regarding value of renminbi Increasing role of new EM economies, minor currencies Growing demand for, and scarcity of, commodities Thematic rotation Learning Specifics Eurozone (EZ) crisis Asian inflation Civil disorder in Islam states Currency 'war' Resource economies Australia Canada Chile Case study: Global Imbalances Trade deficits/surpluses Savings glut and distortion to global interest rates Preparation Text: Fixing Global Finance, Martin Wolf (Yale University Press 2009) Learning Specifics Rare Earth Minerals Systematic Risk Session Themes Global imbalances-surplus nations/deficit nations Major changes in domestic economic policies/tactics Sovereign risk – role of major Credit Rating Agencies (CRA’s) Sovereign CDS market – how reliable are rates quoted? Safe haven/“flight to quality” – preferred asset classes – US Treasury bonds, gold, Swiss Franc Behavior of USD, JPY and Swiss Franc in financial crises Explanation of the new focus on risk on/risk off asset classes and episodic market liquidity concerns Learning Specifics China/US relations Middle East Credit Ratings Agencies Characteristics/depth of US Treasury market Japanese Yen Swiss Franc US Dollar Index Case study: Problems with Eurozone and peripheral nations European Financial Stability Facility Learning Specifics Irish debt crisis EFSF ESM Fundamental Analysis, Economic “Narratives” and Quantitative Techniques Session Themes Fundamental bottom up analysis based on “micro” factors versus top down “macro” asset allocation models Examination of key correlations between sectors/geographical regions Co-movement of geographical/business sectors and FX pairs –which may have “predictive” capabilities? Are traditional notions of portfolio diversification dead? Trading versus investment – long term/short term strategies New risks in wake of 2008 crisis and new views of risk Fat tail events are more common- expect the unexpected Learning Specifics New trading techniques have changed correlations between asset classes Algorithmic trading Relationship between equity markets and USD Case study: Is alpha dead? Barclay's claim that with stock dispersions historically low it is becoming very hard for fund managers to gain edge by seeking out alpha. Barclays Study from July 2010, by head of quantitative strategies. Day 2 Global Indices/Sector Investing and Exchange Traded Funds Global Equity Indices Session Themes Indices of world’s major markets – S&P 500, FTSE, DAX, NIKKEI Emerging market Indices – Mumbai, Shanghai, Bovespa etc. Core BRIC economies – extended Goldman Sachs definition Index futures and exchange traded derivatives Total returns versus index futures – no dividends Tax advantages of using certain derivatives e.g. CFD’s OTC global derivatives/index related swaps Credit Default Swaps for sovereigns, major multi-nationals De-coupling – myth or reality? Evidence from 2008/9 suggests that de-coupling disappears in crisis Learning Specifics Summary of all major market equity indices and their derivatives. Financial infrastructure for: China, India, Brazil, Russia Have the EM market decoupled from mature economies? Derivatives indices and other proprietary indices for sectors/sovereigns Market Indices Exchange Traded Funds Session Themes Overview of the funds available, packaging, fiduciary/trust arrangements, liquidity of ETF’s, exchanges where traded ETF’s are structured products – costs, benefits, surging popularity SPY, proxy for S&P 500 is most traded instrument daily in US markets Trade in real time – easy access to trading not end of day funds Many track MSCI indices or some arbitrary sector Inverse funds, leveraged funds, managed funds Tracking error-weakness in inverse or short funds over the longer term Non-US based ETF’s Commodity based – GLD owns gold – not futures Can an ETF collapse? Learning Specifics Review of major index ETF’s from US market SPY, QQQQ, IWM, DIA Inverse ETF’s For equities, commodities Non-US based ETF’s Examination of limitations of inverse ETF’s for major indices allowing one to be long an instrument which is short an index. Specific inverse ETF’s e.g. SDS, FAZ,EWV,EUO Commodities Session Themes Traditional notion -commodities were negatively correlated to equities -replaced by more coupled relationship because of increased role of China and other resource hungry economies Resource services based ETF’s – e.g. oil services, exploration etc. Resource based ETF’s – industrial metals, agricultural, energy Physicals versus derivatives exposure to commodities Much greater access for retail and small fund investors to this asset class Commodity Index exchange traded funds Learning Specifics Commodity indices Energy markets Base metals ETF’s DBB, DBC, DBA China and Copper China uses more than half the world’s iron ore and more than 40% of its steel, aluminum, and coal and is largest consumer of copper. China is the biggest player in the copper market, buying 35% of the global supply Sector Rotation and Business Cycles Session Themes Is the business cycle still valid? Global dynamics have invalidated much traditional macro-economic theory regarding economic cycles Greater emphasis on cycles in the financial economy Correlations between certain business sectors and geographical funds e.g. semiconductor stocks and funds for Taiwan, Korea Using ETF’s for exposure to fixed income instruments Playing the Treasury yield curve with ETF’s of different durations ETF’s based on bond prices and bond yields Examination of ETF’s which provide exposure to emerging market sovereign debt, high yield debt and investment grade corporate debt Learning Specifics Comparison of early and late cyclical sectors, industrials, discretionary Specific ETF’s SMH, XSD and EWT, EPP Is the notion of a business cycle still valid? Examine the relationship between Consumer Staples and Consumer Discretionary Sectors, Early/Late Cyclical Sectors, Industrial, Financials Examine ETF’s related to business cycles: XLP,XLY,XME, XLI,XLF,KBE Day 3 Key Macro Influences and Risks: Foreign Exchange, Monetary Policy and Sovereign Risks Risk Management In A Globally Inter-Dependent World Session Themes Previously considered minor/local issues have global impact Investment based on fundamental analysis can experience large unexpected impact from events such as crisis in Greece/Ireland Relationship of macro volatility and market liquidity Protection of portfolios during highly volatile periods Technical indicators which can act as precursors to episodes of heightened volatility Volatility trading with options on FX, equity indices Traditional notions of portfolio diversification are outmoded Learning Specifics Using derivatives/futures for short term protection Volatility Indicators such as CBOE VIX Historical volatility Implied volatility from options and derivatives Volatility trading Case study: Using correlation analysis between key FX pairs such as AUD/USD and AUD/JPY and major ETF’s to anticipate market inflection points Historical analysis of co movements of AUD/USD and SPY and EEM based on tutor’s inter-market tools/analytical framework Foreign Exchange Market Characteristics Session Themes De-centralized, 24 hours, spot/forwards FX market is largest capital market – size, key currencies Major participants – role of banks, hedge funds, governments Speculation, settlement of international transactions, interventions and official exchange rate policy Carry trade – AUD/USD, AUD/JPY, NZD etc Use of carry trade by shadow banking system - leverage Role of high yielding currencies e.g. Australian dollar Resource currencies Learning Specifics US Dollar Index Carry Trade Resource Currencies Australian Dollar Canadian Dollar Managed Currencies Singapore Dollar Chinese Renminbi Case study/discussion: BIS Triennial Survey of FX & Derivatives Market “The objective of the survey is to provide the most comprehensive and internationally consistent information on the size and structure of global foreign exchange markets” Preparation Text: Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity, September 2010 Sovereign Risk Session Themes Deterioration in public balance sheets –high debt/GDP ratios Global imbalances – surplus/deficit nations Symbiotic relationship of US/China Hilary Clinton- “How do you get tough with your banker?” re Sino/US diplomacy Increasing role of sovereign CDS market Sovereign debt re-structuring- bail outs/bail-ins Protection to different stakeholders – “haircuts” Collective Action and Contingency clauses How do CDS spreads relate to probability of default? How to estimate probability of default from CDS spreads Learning Specifics Sovereign/corporate risk “anomalies” Methodology of CRA’s in assessing country risk Relationship between spreads on sovereign bonds and USTs/Bunds and sovereign CDS rates Statistics on Debt/GDP Sovereign debt re-structuring Quality of domestic banking system and sovereign credit ratings Sovereign immunity Case study/exercise: Discussion of history of Sovereign Defaults Examples of Argentina, Russia Conclusions of authors regarding probability of defaults. Preparation Text: This Time is Different by Ken Rogoff & Carmen Reinhardt, (Princeton University Press, 2009) US Dollar Reserve Currency Risk Session Themes Multiple currency accounts for asset class hedges Quantitative Easing as Instrument of exchange rate policy Soros accusation that PBOC “controls” global FX market US dollar’s role as reserve currency Increasing use of swaps between EM states to avoid USD IMF and Special Drawing Rights (SDR’s) 'Currency war' – is it real? – is anyone to blame? Who suffers? Shadow FX operations - interventions Learning Specifics Monitoring developments in domestic monetary policy in US, UK, EU and Asian assists in FX trading and asset allocation Case study: Future of USD as reserve currency Role of China, Brazil and other newer economies in the IMF, bilateral trade agreements. Day 4 Macro Risks: Mitigating Systemic Risk, FX Risk and Correlation Risk Systemic Liquidity Issues Session Themes Events of 2007-9 highlighted a possibility, never seriously considered perhaps until October 2008, of systemic meltdown. Risks from structured finance – complexity, valuation, liquidity Originate/Distribute risk model weakness Financial system too tightly coupled with TBTF nodes Risk from bank failures - capital structure issues Eurozone risk – currency and sovereign risks China bubble risk – property bubble, over-extended banks Algorithmic trading – real and imaginary risks Confidence in the financial integrity of any major player is an all or nothing proposition. Learning Specifics U.S. Financial Crisis Inquiry Commission Report, January 2011 Vickers Report in UK Large scale asset sales pre-suppose liquidity but in turn can lead to critical contagions which can see markets lose confidence. LTCM crisis of 1997 Case study: The “Flash Crash” of May 2010 Report of the staffs of the CFTC and SEC to the joint advisory committee on emerging regulatory issues Preparation Text: Findings regarding the market events of May 6, 2010 CFTC/SEC Hedging of FX Risk and Tail Risk Session Themes Segregation/calculation of FX risk in portfolio Mechanics of FX forwards Using exchange traded derivatives to hedge Disadvantages of hedging Hedging FX Risk with Cross-currency swaps Black swan notions and prevalence of outliers Tail Risk Products – uses and abuses Learning Specifics Explanation of FX swap agreements Influence of interest rates on FX spot and forward rates Tail Risk Products Catastrophe Insurance Case study: Using futures and swaps to hedge a currency position Mechanics of setting up a hedge for FX risk in multi-currency portfolio Correlation Risk Session Themes Paradox of macro liquidity Liquidity is hardest to find when most needed. Correlations approach unity during financial contagion i.e. most assets move down together – no market liquidity Circuit breakers Dynamic hedging strategies Statistical arbitrage strategies break down through lack of liquidity Learning Specifics Illustrations from collapses/major losses of some major hedge funds using correlation strategies. Regression analysis Techniques for dealing with extreme beta and correlation events. Statistical tools for inter-market analysis. Case study/exercise: Discussion of financial contagion, disappearance of system liquidity when movements between multiple asset classes become too highly correlated Specific reference to tutor’s own work in Long/Short Market Dynamics (Wiley, 2007), Clive Corcoran Harnessing New Trading Styles/Technologies Session Themes Inter-market algorithms – new trading techniques Risk on/Risk off mode of trading and analysis Changing micro-structure of markets Multilateral Trading Facilities, dark pools Regulatory arbitrage Core/satellite holdings – opportunistic trading Using beta analysis as foundation for overall portfolio risk assessment Learning Specifics Review of new legislation initiatives, new trading platforms and strategies for exploiting inter-market divergences. Opportunistic trading with FX and ETF’s as part of satellite holdings. Critical event trading e.g. around releases of economic data etc. Course Summary & Close