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Constructing a Portfolio that Successfully Manages Downside Risk

Constructing a Portfolio that Successfully Manages Downside Risk. Annual Conference May 23, 2012. Jerry A. Miccolis , CFA ® , CFP ® , FCAS CIO, Brinton Eaton. Constructing a Portfolio that Successfully Manages Downside Risk. Constructing a Portfolio that Successfully Manages Downside Risk.

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Constructing a Portfolio that Successfully Manages Downside Risk

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  1. Constructing a Portfolio that Successfully Manages Downside Risk Annual Conference May 23, 2012 Jerry A. Miccolis, CFA®, CFP®, FCAS CIO, Brinton Eaton

  2. Constructing a Portfolio that Successfully Manages Downside Risk Company confidential

  3. Constructing a Portfolio that Successfully Manages Downside Risk Juan Carlos Artigas Global Head of Investment Research World Gold Council Company confidential

  4. Constructing a Portfolio that Successfully Manages Downside Risk Kenneth R. Solow, CFP® Chief Investment Officer Pinnacle Advisory Group Company confidential

  5. Constructing a Portfolio that Successfully Manages Downside Risk Erick Goralski Director, Global Markets, ICG Structured Investments Deutsche Bank Securities, Inc. Company confidential

  6. Constructing a Portfolio that Successfully Manages Downside Risk Company confidential

  7. Constructing a Portfolio that Successfully Manages Downside Risk ModernizedModern Portfolio Theory Company confidential

  8. Modernizing MPT • More realistic asset distributions • Non-normal/fat tails • More representative investment horizons • Multi-period/compound returns/risk drag • Rules-based rebalancing • More meaningful risk measures • Shortfall risk • Conditional VaR • More useful dependency measures • Correlations  copulas Company confidential

  9. Asset class relationships are complex Company confidential

  10. We’ve moved from correlations… Company confidential

  11. …to copulas 1 0.5 0 -1 -0.5 0 0.5 1 -0.5 -1 Company confidential

  12. Constructing a Portfolio that Successfully Manages Downside Risk Dynamic Asset Allocation Company confidential

  13. Our sector rotation strategy is an example of DAA • Stable-weighting • Exit/entry signaling • Trade-offs between stability and responsiveness • Three “momentum” algorithms • Each has its own strengths/ weaknesses • Rules that determine which algorithm to use at different times • Dynamically move between responsiveness and stability based on market characteristics • Filtering • To avoid too-frequent trading • Parameters optimized based on 1990-2007 data • Tested “out of sample” with 2008-2011 data Company confidential

  14. How does this strategy compare to the S&P500 Total Return Index? Company confidential

  15. How does this strategy compare to the S&P500 Total Return Index? Company confidential

  16. Constructing a Portfolio that Successfully Manages Downside Risk Enlightened Tail Risk Hedging Company confidential

  17. Our three criteria for an effective buy-and-hold tail risk hedge • Sudden appreciation in severe market downturns • “Severe” denoting sudden, substantial, unexpected decline in market value across most major asset classes, as in 4Q08 (i.e., when diversification doesn’t help) • Appreciation to a degree sufficient to meaningfully offset the decline • No “give-back” during market recovery! • Very low cost • Minimize diversion of funds from productive use • No sacrifice of upside portfolio potential! • Minimal disruption to portfolio • Maintain what works in vastly more likely markets • “Don’t throw the baby out with the bathwater!” Company confidential

  18. Our criteria in a picture Company confidential

  19. Some combinations are promising Company confidential

  20. The combined effect can be game-changing Company confidential

  21. Constructing a Portfolio that Successfully Manages Downside Risk Company confidential

  22. For further reading on these ideas… Company confidential

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