(Previously 'Macro Asset Allocation Strategies')
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.
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.
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.
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.
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
- 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
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
- Eurozone (EZ) crisis
- Asian inflation
- Civil disorder in Islam states
- Currency 'war'
- Resource economies
- Global Imbalances
- Trade deficits/surpluses
- Savings glut and distortion to global interest rates
- Preparation Text: Fixing Global Finance, Martin Wolf (Yale University Press 2009)
- Global imbalances-surplus nations/deficit nations
- Major changes in domestic economic policies/tactics
- Sovereign risk role of major Credit Rating Agencies (CRAs)
- 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
- China/US relations
- Middle East
- Credit Ratings Agencies
- Characteristics/depth of US Treasury market
- Japanese Yen
- Swiss Franc
- US Dollar Index
- Problems with Eurozone and peripheral nations
- European Financial Stability
- Irish debt crisis
Fundamental Analysis, Economic Narratives and Quantitative Technique s
- 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
- New trading techniques have changed correlations between asset classes
- Algorithmic trading
- Relationship between equity markets and
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.
Global Indices/Sector Investing and Exchange Traded Funds
Global Equity Indices
- Indices of worlds 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. CFDs
- 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
- 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
Exchange Traded Funds
- Overview of the funds available, packaging, fiduciary/trust arrangements, liquidity of ETFs, exchanges where traded
- ETFs 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 ETFs
- Commodity based GLD owns gold not futures
- Can an ETF collapse?
- Review of major index ETFs from US market
- SPY, QQQQ, IWM, DIA
- Inverse ETFs
- For equities, commodities
- Non-US based ETFs
Examination of limitations of inverse ETFs for major indices allowing one to be long an instrument which is short an index.
- Specific inverse ETFs e.g. SDS, FAZ,EWV,EUO
- 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 ETFs e.g. oil services, exploration etc.
- Resource based ETFs 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
- Commodity indices
- Energy markets
- Base metals
- DBB, DBC, DBA
China and Copper
China uses more than half the worlds 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
- 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 ETFs for exposure to fixed income instruments
- Playing the Treasury yield curve with ETFs of different durations
- ETFs based on bond prices and bond yields
- Examination of ETFs which provide exposure to emerging market sovereign debt, high yield debt and investment grade corporate debt
- Comparison of early and late cyclical sectors, industrials, discretionary
- Specific ETFs
- 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 ETFs related to business cycles: XLP,XLY,XME, XLI,XLF,KBE
Key Macro Influences and Risks: Foreign Exchange, Monetary Policy and Sovereign Risks
Risk Management In A Globally Inter-Dependent World
- 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
- 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 ETFs to anticipate market
- Historical analysis of co movements of AUD/USD and SPY and EEM based on tutors inter-market tools/analytical framework
Foreign Exchange Market Characteristics
- 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
- 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
- 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
- Sovereign/corporate risk anomalies
- Methodology of CRAs 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.
This Time is Different by Ken Rogoff & Carmen Reinhardt, (Princeton University Press, 2009)
US Dollar Reserve Currency Risk
- Multiple currency accounts for asset class hedges
- Quantitative Easing as Instrument of exchange rate policy
- Soros accusation that PBOC controls global FX market
- US dollars role as reserve currency
- Increasing use of swaps between EM states to avoid USD
- IMF and Special Drawing Rights (SDRs)
- 'Currency war' is it real? is anyone to blame? Who suffers?
- Shadow FX operations - interventions
- 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.
Macro Risks: Mitigating Systemic Risk, FX Risk and Correlation Risk
Systemic Liquidity Issues
- 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.
- 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
- 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
- Explanation of FX swap agreements
- Influence of interest rates on FX spot and forward rates
- Tail Risk Products
- Catastrophe Insurance
- Using futures and swaps to hedge a currency position
- Mechanics of setting up a hedge for FX risk in multi-currency portfolio
- 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
- 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.
- Discussion of financial contagion, disappearance of system liquidity when movements between multiple asset classes become too highly correlated
- Specific reference to tutors own work in Long/Short Market Dynamics (Wiley, 2007), Clive Corcoran
Harnessing New Trading Styles/Technologies
- 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
- Review of new legislation initiatives, new trading platforms and strategies for exploiting inter-market divergences.
- Opportunistic trading with FX and ETFs as part of satellite holdings.
- Critical event trading e.g. around releases of economic data etc.
The course director is an FSA registered adviser and provides wealth management services and investment advice to private clients and funds. He has been an independent trader, on both sides of the Atlantic, for more than 20 years. In recent years he has also been engaged as a course developer and tutor, providing executive education workshops and individual mentoring.
As an author he has written several books and three textbooks for those seeking the Investment Advice Diploma from the London based Chartered Institute for Securities and Investment (CISI), and for those seeking the Masters qualification from the CISI.
The course director has been a regular analyst/contributor to CNBC Europe and other broadcast outlets and has been a featured speaker at international trading expos. During the last year he was a keynote speaker and workshop presenter at conferences in London, Beijing, Hong Kong, Paris, Amsterdam and Brussels.
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