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CFA West Michigan Society

CFA West Michigan Society. Christopher T. Vincent, Principal, CFA Lessons From The Financial Crisis and a Blueprint for Investing in the Current Environment. Luncheon Presentation: Thursday, November 11 th , 2010. Outline. Lessons: Risk, Innovation, Liquidity, Policies, Dodd-Frank

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CFA West Michigan Society

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  1. CFA West Michigan Society Christopher T. Vincent, Principal, CFA Lessons From The Financial Crisis and a Blueprint for Investing in the Current Environment Luncheon Presentation: Thursday, November 11th, 2010

  2. Outline • Lessons: Risk, Innovation, Liquidity, Policies, Dodd-Frank • Environment: Fiscal, Legislation, Monetary Policy – QE2 • Asset Mix: Equity Risk Premium • Fixed Income Portfolio: 2009, 2010, 2011

  3. Risk in Bond Funds • Difficult to discern Ex-Ante • Core vs Core Plus • Mean/Average Morningstar Intermediate Fund: (4.7%) in 2008 • Lehman Brothers Aggregate Bond Index: 5.2% in 2008 The Morningstar Intermediate-Term Bond Category represents the average annual composite performance of all mutual funds listed in the Intermediate-Term Bond Category by Morningstar. The Barclays Capital U.S. Aggregate Index (formerly Lehman Brothers Aggregate Bond Index) is an unmanaged index that represents the investment grade bond market. It is composed of securities from the Barclays Capital Treasury, Government-Related, Corporate and Securitized Indices.

  4. Innovation • Technological/Scientific Progressive1 • Financial Cyclical1 • Most frequently is found in bond portfolios • ABS (“Shadow Banking System”) • Credit (Rating) Crisis2 1 “Risks and Rewards or Financial Innovation: Creative Destruction Or Destructive Creation?” Loyola University Chicago Symposium, 10/4/10 2 FRB Chicago; Agarwal Barrett, et al. The ABS Markets, The Crisis and TALF

  5. Liquidity (Confidence) • Fractional Reserve Banking System “But the crisis demonstrated that, in a crunch, shortages of liquidity can be just as hazardous as shortages of capital. Indeed, it was often hard to tell one from the other.” 1 1 WSJ OP/ED by Alan S. Blinder on Basel III

  6. Liquidity Q: “How did you go bankrupt?” A: “Gradually and then suddenly.” AIG versus Lehman Brothers Hemingway, The Sun Also Rises

  7. FOMC Policies • TLGP • TALF • MMF Pricing

  8. Dodd-Frank • www.FCIC.gov • Systemic risk: Determining the level of such risk will largely “remain subjective”. Ben S. Bernanke, Federal Reserve Chairman

  9. Dodd-Frank • Law will prevent taxpayers from ever “again having to foot the bill for Wall Street’s mistakes.”1 • Unsecured creditors will “bear losses.”2 1 President Obama signing the 2 Wall Street Reform and Consumer Protection Act

  10. Dodd-Frank CFA Institute Survey1: • 75% did not believe the law would prevent future crises • 66% graded Congress’s reform efforts “poor” or “failing” 1 Guest editorial by James Allen, CFA in the September/October issue of FAJ; Vol. 66, Number 5

  11. Investment Environment • Fiscal stimulus winding down (1.0%-1.5% GDP hit per quarter) • ? Bush tax cuts extension • ? Fiscal commission 1 ISI Morning Policy Report; 10/26/10

  12. Investment Environment Legislative/Regulation: ↓/? Dodd-Frank ↓/? Basel III ↓/? Health Care

  13. Investment Environment Monetary Policy: QE2 to address deflation concerns $600 billion package

  14. Investment Environment QE2 Scenarios: FailSuccessToo Successful Deflation Growth with Low Inflation Inflation (Expectations) Rise InvestmentInvestmentInvestment Long HG Debt Equities TIPS/Commodities/RE

  15. Asset Mix Equity Risk Premium; Increased due to: Two bear markets in a decade/“Flash Crash” Demographics Household B/S

  16. Household Balance Sheet Volatility • Rolling 5-year standard deviation of % changes in household net worth • This is another powerful force depressing (household sector) sponsorship of the stock market Household balance sheet volatility Source: Federal reserve, Credit Suisse.

  17. Fixed Income Demand • The volatility of household net worth has risen because of equity volatility and house price declines Source: Credit Suisse, Haver Analytics

  18. Corporate Bond Risk Premiums Source: Barclays Capital. Data as of November 1, 2010

  19. “Trade of the Year” in 2009 Source: Bloomberg. Data retrieved November 9, 2010

  20. “Trade of the Year” in 2010 Source: Bloomberg. Data retrieved November 9, 2010

  21. Bond Portfolio • Duration: Short • Inflation: TIPS • Quality: High Yield • Quality: BBBs • Sectors: Energy, Materials, Commodities, REITS • Sectors: Yankees • Structure Amortizing Securities, Floaters • Low Duration

  22. Questions?

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