More Related Content Similar to New Oak Creating An Effective Risk Modeling Framework (Pensions Risk Management) (20) New Oak Creating An Effective Risk Modeling Framework (Pensions Risk Management)1. Liability Driven Investing (“LDI”)
Effective Risk and Asset Modeling Requirements
Various Approaches to Managing to Liabilities
Dodd-Frank
LDI Financial Technology and Infrastructure Needs
31 October 2011
For more information please contact:
Ron D’Vari, CEO/Co-Founder
(212) 209-0855
rdvari@newoakcapital.com
Or visit us on the web at:
www.newoakcapital.com/solutions
2. TABLE OF CONTENTS 1
I | Various Approaches to Managing to Liability Benchmarks
I I | Liability Driven Investing and Alpha Strategies
I I I | Relatively New Alpha Strategies
I V | An Example of a Scalable Strategy: Quantitative Global Equity
V | Dodd-Frank and Its Impact on LDI
V I | LDI - Solutions and Infrastructure Needs
Appendix I| OpenRisk M
Appendix II| Investment Support Services
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
3. CREATING AN EFFECTIVE RISK MODELING FRAMEWORK FOR LDI 2
Comprehensive approach can meet complex institutional, product lines, and regulatory requirements
Asset Liability Management Approach
Various Styles
Basic cash-flow matched, key rate duration matched to full liability-driven investment with sophisticated asset allocation for
active management of surplus
Surplus Optimization
Using alternative, real and uncorrelated assets and styles
Unique long dated assets: Life settlements, Structured settlements
Real Assets: Real estate, Commodities
Dollar Neutral Strategies: Long/Short global equities, Long/Short ETF
Unique liquidity management: Short High Yield (“SHYLD”) Strategies (REO Finance, Supply Chain Finance, Asset Based
Finance)
Customized Solutions
Customized style and benchmark construction consistent to funding status and institutional profile
Separate accounts or commingled funds
Broad array of fixed income, equity, and alternative asset types and strategies including esoterics
Liquid Fixed Income: All liquid fixed income (Short Duration, Core, Core+, Long Duration)
Illiquid Fixed Income: Loans , structured products, specialty finance
Equities: Long/Short, Event Driven, International Quant Equities, ETFs, High Frequency, Private Equities
Real Investing: Real Estate, Land, Commodities
Multi-Strat Macro: Free-to-roam
Ongoing Risk Management and Reporting
Ongoing in-depth risk assessment, valuation, performance monitoring
Daily benchmark variance analysis and marked-to-market
Full cash flow scenario analysis
Periodic benchmark performance attribution
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
4. 3
I. Various Approaches to Managing to Liability
Benchmarks
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
5. 4
CHALLENGES OF MANAGING TO LIABILITY BENCHMARKS
Role of the benchmark
What risk to manage?
An Illustrative Case Study
Traditional liability benchmarks and choice of discounting
Static spread
Dynamic spread
How do you measure the manager’s performance in A/L
framework?
Impact of spread volatility on performance measurement
Distortion due to static spread assumption
Manager behavior and its impact on expected returns
Case for dynamic-spread liability benchmark
Role of Min-VAR Optimization in Asset/Liability Management
Key-rate-duration matched dynamic spread benchmarks
Key-rate-duration matched market-based benchmarks
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 4
6. 5
WHAT RISK(S) TO MANAGE TO?
Definitions
The following risks measure variability of:
Absolute Return Risk = Std. Dev. (Portfolio Return)
Relative Risk = Std. Dev. (Portfolio Return - Benchmark Return)
Relative-to-Liability Risk = Std. Dev. (Portfolio Return - Liability
Return)
Basis Risk = Std. Dev. (Benchmark Return - Liability Return)
How Should Risk Be Measured?
Portfolio vs. Cash (Total Return Risk),
Portfolio vs. Benchmark (Relative Risk), or
Portfolio vs. Liability (Relative-to-Liability Risk)?
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 5
7. 6
WHAT IS RELEVANT?
Choice of benchmark can be a critical determinant of returns
Market-based benchmarks - Basis Risk
Liability-based benchmarks - Absolute Risk
What seems to be most relevant?
The answer is “it depends!” or “it is regime dependent”
Short-Run Total/Absolute (sponsor) or Relative Risk
(manager)
Long-Run Relative-to-Liability Risk (sponsor)
Is there a pattern?
In down-markets there is reversion to liability-based approach
Absolute returns look ugly
Relative returns look horrific because liabilities outpace
markets
In up-markets market-based benchmarks rule
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 6
8. 7
RECENT EXPERIENCE
Up-market Period: 1984-2000, 2003-2007, 2009-2010
Market-based strategies outperformed liability benchmarks
Basis risk was profitable and led to huge pension surpluses
Sponsors tended to down play relative risk to liability
benchmarks
Contributions to pension plans were kept at minimum
Down-Market Period: 2000- 2003, 2007-2009, 2011
Liabilities have significantly outperformed portfolios and
market-based benchmarks
Basis risk has materialized and has led to huge pension deficits
Sponsors are re-evaluating relative risk to liability benchmarks
Contributions to pension plans are resuming and a must
Sponsors are reneging on their liabilitities
Extension of retirement age
Reducing post retirement health benefits
Cutting off defined benefit (e.g. California)
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 7
9. OPTIMAL ALLOCATION OF ASSETS - DIFFERENT APPROACHES 8
Modern portfolio management ignores risks vs. liabilities
Optimal Utility Function Approach
Optimization is generally cast in absolute risk-return space
Inter-temporal risk is measured in absolute terms
rather than relative to the liabilities Based on some
form of efficient frontier
Market-based benchmarks
Choice of benchmark is driven by risk-tolerance
(utility)
Liabilities ignored for the most part
Liability Immunization Approach
Optimization is cast in relative-to-liability risk-return space
Inter-temporal risk is measured relative to the
liabilities
Estimation of liabilities are key
Discounted-liabilities form the benchmark
Discounting methodology varies
Choice of discounting methodology can influence
results significantly
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 8
10. OPTIMAL UTILITY FUNCTION APPROACH 9
Establish Efficient Frontier and Utility Function
Select investable asset classes and corresponding indicative
market indices
Establish length of time and frequency of measurement most
relevant
Identify risk tolerance or a risk-return utility function
Establish Optimal Benchmark/Asset Mix
Optimize Sharpe Ratio by solving for optimal asset class on
efficient frontier and risk tolerance
Actively Manage
Optimize information ratio, i.e. alpha/tracking error
Risks vs Liabilities Are Ignored
Benchmark - Optimal Sharpe Ratio
Management - Optimal Information Ratio
PROPRIETARY AND CONFIDENTIAL
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11. 10
TRADITIONAL LIABILITY IMMUNIZATION APPROACH
Establish Liability Benchmark
Liability Cash Flows: Establish realistic liability (RL) or
participating liability (PL) cash flow stream
Discounting Methodology: Establish a discounting
methodology
Curve - Zero coupon curve + some spread
Treasury, agency, or swap
Tail Rate - A discount rate for flows past 30 years
Spread - Sufficient spread that meets the liabilities
in the long run and provide with additional risk-
adjusted return
Manage Assets vs. Benchmark
Add alpha over liability benchmark through
Actively manage key-rate duration around liability
benchmark
Actively manage spread exposure
Discounting methodology affects funding status
Static spread discounting of liabilities could distort funding status significantly
PROPRIETARY AND CONFIDENTIAL
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12. 11
TRACKING ERROR ATTRIBUTION IN ASSET LIABILITY
Asset and Liability Performance
Asset = Duration/Curve Move+ Spread Moves + Credit Blow Ups
Liability = Cash Flow Changes + Duration/Curve Move
Asset/Liability Return Differences
Actuarial gain or loss
Mismatch in duration/curve exposure
Spread volatility
Credit blow ups
Management performance may be hard to isolate
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 11
13. AN EXAMPLE OF A STUDY RUN IN APRIL 2001 12
Various Allocations Considered
Immunized Portfolio Liabilities
Date: April 01 Aggressive Moderate* Conservative Moderate
Spread to Treasury (bp) 150 125 100 125
Average Quality A-/BBB+ A- A A-
Minimum Quality BB BB BBB- BB
Effective Duration 11.4 11.6 11.8 11.6
Portfolio Expected Return (IRR) 7.3% 7.1% 6.8% 7.1%
Relative Expected Return 0.2% 0.0% -0.2% 0.0%
Relative Volatility 2.3% 0.0% 1.2% 0.0%
Absolute Volatility 8.0% 7.6% 7.1% 7.6%
Efficient
Frontier
Portfolio
Cash 0.0%
Equity 50%
Fixed - Core 40%
High Yield 10%
Portfoli Expected Return 10.18%
Relative Expected Return 3.08%
Relative Volatility 14.17%
Portfolio Standard Deviation 9.34%
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 12
14. BASIC RISK/RETURN DATA 13
Cash
Expected Return 4.50%
Equity
Expected Return 9.0%
Standard Deviation 17.5%
Correlation to Core 0.3
Correlation to High Yield 0.4
Correlation to Long Bond 0.15
Relative Std Dev to Liability 17.97%
Economic Downturn Stress Senario -29.2%
Fixed Income
10 year T reasury Yield 5.30%
30 year T reasury Yield 5.85% Long Duration Liability
10s Yield Beta to 30s Yield 1.20 Core High Yield Aggressive Moderate Conservative (Moderate)
Spread over T reasury (bp) 0.75% 3% 1.50% 1.25% 1% 1.25%
Expected Return 6.05% 7.80% 7.35% 7.10% 6.85% 7.10%
Duration 4.5 4 11.44 11.63 11.82 11.63
T reasury Yield Standard Deviation 0.50%
Spread Standard Deviation 0.25% 0.45% 0.40% 0.25% 0.20% 0.25%
Spread Correlation to T reasury 0.40 0.50 0.2 0.4 0.4 0.4
Return Standard Deviation 2.89% 3.29% 8.01% 7.47% 7.19% 7.47%
Sharpe Ratio 0.54 1.00 0.36 0.35 0.33 0.35
Expected Relative Return to Liabilities -1.05% 0.70% 0.25% 0.00% -0.25% 0.00%
Relative Return Standard Deviation 6.64% 6.81% 2.29% 0.00% 1.18% 0.00%
Information Ratio -0.16 0.10 0.11 n.a -0.21 n.a
Economic Downturn Stress Senario
Equity Return -29%
Fixed - Yield Changes
10 yr Treas Yield Change -1.00% Long Duration Liability
30Yr Treas Yield Change -0.75% Core High Yield Aggressive Moderate Conservative Moderate
Spread Change 0.25% 0% 0.35% 0.25% 0% 0.25%
Fixed - Returns 9.43% 10.20% 11.92% 12.91% 13.35% 12.91%
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 13
15. 14
COMPARISON OF DIFFERENT STRATEGIES
Initially 15% Overfunded Example
Immunized
Aggressive Immunized & Aggressive Immunized & Aggressive Immunized +
Market Based
Tail+Surplus in Equity Surplus in Equity Surplus in Equity
Approach
(Future O verlay) (Future O verlay) (No Future O verlay)
Portfolio Weights - % Liabilities
Cash 0.0% -25.0% -15.0% 0.0%
Equity 58% 25.0% 15.0% 15.0%
Fixed - Core 46% 0.0% 0.0% 0.0%
High Yield 12% 0.0% 0.0% 0.0%
Long Duration 0.0% 0.0% 0.0% 0.0%
Aggressive 0.0% 115.0% 115.0% 100.0%
Moderate 0.0% 0.0% 0.0% 0.0%
Conservative 0.0% 0.0% 0.0% 0.0%
Total - % Liabilities 115.0% 115.0% 115.0% 115.0%
Long Term Expectations
Liability Expected Return 7.10% 7.10% 7.10% 7.10%
Portfoli Expected Return - % Liabilities 10.18% 9.58% 9.13% 8.70%
Relative Expected Return - % Liabilities 3.08% 2.48% 2.03% 1.60%
Relative Volatility 14.17% 8.31% 8.29% 8.28%
Relative Information Ratio 0.22 0.30 0.24 0.19
Sharpe Ratio 0.47 0.41 0.40 0.40
Economic Downturn Scenario
Portfolio 1-Yr Return - % Liabilities -11.30% 5.28% 8.65% 7.54%
Liability 1-Yr Return - % Liabilities 12.91% 12.91% 12.91% 12.91%
Relative 1-Yr Return - % Liabilities -24.21% -7.63% -4.26% -5.37%
Ending Surplus (Deficit) - % Liabilities -9.21% 7.37% 10.74% 9.63%
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 14
16. RESULTS SUMMARY 15
Optimal Sharpe ratio allocation, when viewed from relative
stand point, is
Highly risky in economic downturn scenario
Not highest information ratio
Variations of immunized strategy can lead to
Superior relative risk profile
Modest give up in expected return
Much lower exposure to economic downturn scenario
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 15
17. DISTORTION DUE TO STATIC-SPREAD DISCOUNTING IN VOLATILE SPREAD MARKETS 16
Introduces
Funding status mismeasurement
Measurement tracking error
Makes it harder to distinguish impact of
Credit calls/mistakes
Curve bets/mismanagement
Leads to sub-optimal spread allocation
Tracking error risk leads to risk avoidance
Managers may under invest in spread products and miss
opportunities to earn higher yields
Static spread discount rates distorts funding status and leads to sub-optimal
sector allocation
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 16
18. 0
100
200
300
400
500
600
700
800
Agency 1-3
24
Agency 3-7
44
Jan-03
Agency 7-10
54
Agency 10+
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
51
Max
Agency TOT
39
Credit Cards
72
75%
Disc MBS (P<=100)
0
Prem. MBS (P>=100)
86
Mean
15-Year MBS
Source: Salomon Yield Book and State Street Research
90
Monthly Spread History - Jan 1989 to Jan 2003
Agency MBS
86
25%
AAA/AA Corporates 1-3
60
AAA/AA Corporates 3-7
Min
100
AAA/AA Corporates 7-10
167
AAA/AA Corporates 10+
AAA/AA Corporates TOT
113 105
A Corporates 1-3
119
A Corporates 3-7
A Corporates 7-10
142 145
A Corporates 10+
154
A Corporates TOT
141
BBB Corporates 1-3
302
17
BBB Corporates 3-7
318
BBB Corporates 7-10
280
BBB Corporates 10+
267
BBB Corporates TOT
291
BB Corp.
707
CASE FOR DYNAMIC-SPREAD LIABILITY BENCHMARKS -HISTORICAL SPREAD VOLATILITIES 17
19. 18
TRADITIONAL ALTERNATIVES TO STATIC SPREAD DISCOUNTING
Two Alternatives
Market-based Spread
Examples include:
Single-A long corporates
Swap spread
High-grade corporate option-adjusted
spread
Portfolio Spread
Some use duration-weighted option
adjusted spread of the portfolio
Both Alternatives May Not Be Optimal
Market and portfolio asset mix may not be
necessarily optimal from absolute volatility
standpoint
Traditional alternatives to static spread discounting are not necessarily optimal
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 18
20. 19
OPTIMAL RISK-CONSTRAINED DYNAMIC SPREAD METHODOLOGY
Benefits
Minimizes tracking error and other forms of risk
such as VAR vs. static-spread liability benchmark
Based on an optimal allocation among spread
sectors across all maturities
Downside risk constraints can be used to control
allocation of risk
It is equivalent to highest Sharpe ratio portfolio in
absolute space
Optimal Dynamic-Spread methodology leads to benchmarks with minimum
variance w.r.t. static-spread liabilities
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 19
21. 20
OPTIMAL RISK-CONSTRAINED DYNAMIC SPREAD METHODOLOGY - BASIC STEPS
Step 1: Target Return Over Treasury
– Establish required long term spread to meet long term
liabilities
– Add a target strategic added value
Step 2: Define Investible Fixed Income Universe
– Treasuries, Agencies, ABS, CMBS, AAA-AA Corporates, A
Corporates, BBB Corporates, BB Corporates, Mortgage Pass-
Throughs
Step 3: Collect appropriate historical volatility of option-
adjusted spreads (OAS) for all sectors
Step 4: Define Allocation Constraints
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 20
22. OPTIMAL RISK-CONSTRAINED DYNAMIC SPREAD METHODOLOGY - BASIC STEPS 21
Step 5: Perform Risk Constrained Optimization
– Objective: Min VAR (or Single Downside Risk)
– Constraints:
• Duration Weighted OAS = Target Return Over Treasury
• Other constraints such as
Duration Spread < x1
Spread Product % < x2
ABS and CMBS % < x3
High Grade Corporates <x4
High Yield % <x5
Etc.
Step 6: Mark-to-Market Duration Weighted Spread
Periodically
• Keep sector weights constant
• DWLOAS = Duration-Contribution Weighted Liability OAS
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 21
23. ONGOING EVALUATION OF DYNAMIC-SPREAD LIABILITY BENCHMARK 22
Dynamic Spread Liability Return For Each Period
– DSLV1 = Cash flows discounted at Treasury+ beginning DWLOAS1
– DSLV2 = Cash flows discounted at Treasury+ ending DWLOAS2
– Return Liability = DSLV2/DSLV1 - 1
– Note: Process has to be unitized to each cash flow disbursement
Review Funding Status and Surplus/Deficit Status
– Portfolio - DSLV
– Required return over treasuries
– Appropriateness of VAR
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 22
27. 26
ISSUES NOT CAPTURED BY DYNAMIC-SPREAD LIABILITY BENCHMARK
Duration Weighted Liability OAS (DWLOAS) does not
reflect downgraded issues leaving the benchmark each
month!
This can lead to significant over-statement of liability
benchmark returns
Solution: Key-rate-matched Market Based Benchmarks
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 26
28. KEY-RATE-MATCHED MARKET-BASED BENCHMARKS 27
i n
Blended Benchmark Wi * MktSeci
i 1
Definitions
– Sum of Square of Key Rate Errors = Sum (BB_Kduri minus Liab_KDuri)^2
– BB_KDuri = Blended Benchmark Key-Rate Duration I
– Liab_KDuri = Static Spread Liability Key-Rate Duration I
Solve for Wi’s
– Minimize Sum of Key Rate Errors Squared
– Subject to chosen constraints
Revisit optimization periodically
– Key-rate drift
– Funding level
– Risk tolerance
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 27
29. KEY-RATE-MATCHED MARKET-BASED BENCHMARKS 28
• Marking-to-Market Liabilities
– Discount liability cash flows at
Treasury + Duration-Weighted OAS of the Benchmark
• Benchmark Return = RB = Σ { Wi * Ret Secti }
• Benefits
– Better Reflects Market Conditions – Less subject to
market spread volatility
– Clear Mandate - Managers are more accustomed to
managing portfolios against market-based
benchmarks
– Transparent – More transparency of manager’s
active management added value
– More Observable – Can be independently measured
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 28
30. 29
SUMMARY
Optimal portfolios in absolute space can lead to significant risk vs.
liabilities
Static-spread liabilities can introduce significant mismeasurement
of funding status and distort active management
Dynamic-Spread Liability Benchmarks improve funding distortions
but introduces credit migration and performance measurement
ambiguities
Key-Rate-Matched Market-Based Benchmarks mitigate many
issues related to funding status and performance measurement
Should lead to clearer definition of risk and more optimal
active management in volatile markets
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved. 29
31. 30
II. Liability Driven Investing
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
32. CREATING AN EFFECTIVE RISK MODELING FRAMEWORK FOR LDI 31
LDI == Disciplined Approach to Investing
Level I: Comprehensive portfolio strategy and capability analysis
Asset-Liability Assessment
Various Fund Due Diligence
management and operational evaluation
risk measures, scenario analysis, drawdown, performance analysis and attribution
Level II: Liability-Driven Investing
Asset and strategy allocation
Portfolio construction & optimization
Level III: Ongoing asset management and evaluation of emerging asset classes
Distinguished by thoughtful and in-depth ongoing risk assessment, valuation, performance
monitoring and attribution for broad array of fixed income, equity, and alternative asset
types and strategies including esoterics
Customized Strategies:
Fixed Income – Short duration, Core, Core+, Long Duration, Immunization,
Equity – Quant Equity (US, Non-US, Global), Long Only130/30, Long/Short
Alternatives - Structured Products, Asset-based Lending, Specialty Finance, Esoterics
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
33. CREATING AN EFFECTIVE RISK MODELING FRAMEWORK FOR LDI 32
LDI Challenges
Asset Management Infrastructure
Tailored and Integrated Front To Back Office Solutions - Full turn-key front-to-back solutions and services
Front Office: Decision support infrastructure, portfolio management workstation, up-to-date portfolio risk analytics & reporting, trade order
management and execution, valuation, asset liability management and relative value analysis tools
Middle Office: Trade capture and processing, services, interface with depository and custodial services, collateral management, counterparty
management, performance attribution and benchmark comparison
Back Office: Investor reporting, integration with third party administrators, performance attribution
Solution Elements
Quantitative and fundamental valuation, pricing and risk analysis of:
equities, fixed income, real estate, commodities
Hedge fund strategies, fund of funds
Private equities
Structured products
Derivatives
Esoterics
Emerging assets
Valuation of hard -to-value assets including residential, commercial, consumer, equipment, project finance loans and structured products
Cash flow forecasting, sensitivity analysis, stress testing , scenario analysis, relative hedge analysis, economic/rating agency/statutory capital
Daily, weekly, monthly portfolio and security valuation and risk analytics for broad array of fixed income, equity, structured products,
derivatives, and alternative asset types
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
34. KEY LDI REQUIREMENT - KNOWLEDGEWARE 33
Market Experience, Technology and Process
Core Competencies: Experienced professionals providing independent and transparent solutions
Experienced
Disciplined Processes Advanced Technology
Professionals
• Team comprised of traditional and • Transparent • Accessible throughout the entire
emerging assets as well as geo-political • Well tested process – allocation, portfolio
experts with deep experience in • Understood throughout organization management, risk management
trading, portfolio and risk management • Open technology to provide
• Scalable
• Quantitative and fundamental skills • Focused on both assets and liabilities customized analytics, data
• Deep understanding of intrinsic values management an actionable reporting,
• Covering both liquid and illiquid assets
• Comprehensive - asset and liability • Complex liability structures
sides
Decision
Traditional and Making
Emerging Assets
Integrated Reporting
Infrastructure
Evaluation, I Asset
nvesting, and Liability Risk Analysis
Trading Management
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
35. KEY LDI REQUIREMENT -KNOWLEDGEWARE 34
Enablers
Knowledge-
Asset Management, Risk
Management, Solutions, Kno Driven
Experience wledge-Driven Support Advice and
Services Services
Seasoned Senior
Management with Scalable Integrated
Management Deep Operating and Team of
Cross Functional Expertise
Integrated Technology,
Granular Data, Open Analytics
Infrastructure Platform, Flexible Reporting
Process and Workflow
Transparent Disciplined
Disciplined Processes
Scalable Customizable Solutions
Efficient
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
36. 35
III. Relatively New Alpha Strategies
PROPRIETARY AND CONFIDENTIAL
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37. EXAMPLES OF RELATIVELY NEW ALPHA STRATEGIES 36
Emerging Sectors (New Media , Renewable)
Equity - High Frequency, Global Quant Equity
Merchant Banking
Distressed and/or Illiquid Fixed Income
Distressed Real Estate
Specialty Finance
Esoterics
Frontier Investing
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
38. ALPHA STRATEGIES AND STYLES 37
Market-Based Fixed Income
Short-Duration, Core, Core+, Long Duration, High Yield, Emerging Markets, Real Portfolios
Global Quant Equities
Long only, Long/Short, 130/30 US-only, Non-Us, or Global for small, medium, large and all cap
Hedge Funds and Fund of Funds
Myriad of strategies
PRIVATE EQUITY
Renewable
New Media
Cloud-computing
Merchant banking
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
39. ALPHA FIXED-INCOME AND REAL ESTATE STRATEGIES 38
Broad Based Asset Expertise Is Utilized Through Internal and External Resources
Active Trading
High Quality; High Yield; Leveraged Loan; Emerging Markets
Distressed Debt and Real Estate
Structured Products
Residential: REO Bridge Finance, Nonperforming Loans; REO Equity
CRE Recapitalization
Consumer Finance
Specialty Finance
Asset-based Finance
Supply Chain Finance
Insurance Linked: Premium finance, life settlement, longevity swaps
Esoterics: Structured settlement, Intellectual Property, Litigation
Real Estates
Debt, Equity, Distressed
Operating Companies and REITS
Core, Value Add, Opportunistic
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
40. EMERGING STRATEGIES: MANAGING COMPLEX PRODUCTS FROM LOANS TO SECURITIES 39
Credit crisis has created unique opportunities within structured credit universe
Spectrum of issues within structured credit leads to highly attractive and
scalable skill-based asset management opportunities
Structured product expertise, technology and process knowledge
is highly specialized and leads to significant operational leverage
Residential
Real Estate
Commercial
Exotics
Real Estate
Structured
Credit Expertise
and Tools
Specialty Consumer
Finance Credit
Leveraged
Finance
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
41. 40
IV. An Example of a Scalable Strategy:
Quantitative Global Equity
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
42. 41
GLOBAL QUANTITATIVE EQUITY
Example of Equity Investment Philosophy
Well-defined investment philosophy and well disciplined process.
We term our Philosophy Fundamental Objective
We believe human behavioral biases drive many existing market inefficiencies
We use both quantitative and qualitative research methods to exploit these inefficiencies
Our Philosophy’s practical and analytical process dominates “emotionally driven”
approaches
Our Process manages multi-dimensional risks by using rigorous risk controls
Fundamental Quantitative Practical
PROPRIETARY AND CONFIDENTIAL
41
©2011 NewOak Capital LLC. All rights reserved.
43. 42
GLOBAL QUANTITATIVE EQUITY
Quant Equity Investment Experience and Approach
We have vast expertise in equity valuation techniques across equity asset classes. Our
team have outperformed their benchmarks in long only, long short, and market neutral
strategies. We have experience in both public and private equity analysis throughout
the world and across company size.
Factor Analysis
Valuation
Long/Short Relative Value
Proprietary Nonlinear Transaction Cost Analysis
Portfolio Optimization and Trading
Includes transaction cost management
Risk Management
Scenario Testing
Time Series
Attribution Analysis
PROPRIETARY AND CONFIDENTIAL
42
©2011 NewOak Capital LLC. All rights reserved.
44. 43
GLOBAL QUANTITATIVE EQUITY
Quant Equity Investment Process
We base our Investment Process upon three main concepts:
Alpha Driven
High alpha stocks are purchased and held – except when alpha data is suspect
Stocks become sell candidates when alpha drops below the top quintile
Risk Controlled
Stocks chosen to replace stocks sold are chosen to help control risk as well as to
raise portfolio average alpha
Market, Size, Style, and Energy risk are kept close to benchmark exposure –
Northfield, BARRA, Axioma are useful tools
Region, Sector, and Region/Sector weights are kept to within +/-10% of benchmark
weights
Transaction Cost Sensitive
Alpha must exceed estimated transaction costs
Transaction costs are non-linear as trade sizes increase
PROPRIETARY AND CONFIDENTIAL
43
©2011 NewOak Capital LLC. All rights reserved.
45. 44
GLOBAL QUANTITATIVE EQUITY
Quant Equity Investment Experience and Approach
We Believe Human Behavioral Biases are the key to Quantitative Modeling.
Cause of Inefficiency Factor Group Factor Group Description
How attractively is the stock priced
Emotional Investor Behavior Relative Value relative to industry peers?
Imperfect Reaction to New Momentum/Sentiment Are analysts and investors upgrading
Information their view of the stock?
Are insiders at the company acting
Separation of Ownership and Insider/Management as if the stock is cheap in a
Management
shareholder-friendly way?
Has the stock appreciably
Impatient Trading and/or Short-term Short-Term/Technical out/underperformed its industry
Overreaction
peers recently?
News Analytics Does stock price reflect qualitative
Incomplete Information Set
information?
PROPRIETARY AND CONFIDENTIAL
44
©2011 NewOak Capital LLC. All rights reserved.
46. 45
GLOBAL QUANTITATIVE EQUITY
Quant Equity Investment Process
We divide the world into 90 categories by Region and Economic Sectors.
Region 0 1 2 3 4 5 6 7 8
Australi Middle
United Europe UK & Asia Latin
Sector FTSE AWI Weight a & New Japan Canada East &
States ex UK Ireland Pacific America
Zealand Africa
0 Oil & Gas 4.23% 1.27% 1.55% 0.18% 0.78% 0.12% 0.83% 0.71% 0.66%
1 Basic Materials 1.20% 1.38% 1.13% 0.88% 0.99% 0.61% 0.76% 0.48% 0.83%
2 Industrials 4.80% 2.45% 0.42% 0.23% 1.73% 1.64% 0.22% 0.15% 0.21%
3 Consumer Goods 4.25% 3.02% 1.05% 0.08% 1.24% 1.85% 0.05% 0.08% 0.34%
4 Health Care 4.50% 1.71% 0.74% 0.10% 0.09% 0.43% 0.00% 0.21% 0.01%
5 Consumer Services 4.93% 0.98% 0.79% 0.37% 0.53% 0.65% 0.17% 0.22% 0.26%
6 Telecommunications 1.39% 1.24% 0.59% 0.05% 0.70% 0.35% 0.11% 0.26% 0.30%
7 Utilities 1.45% 1.21% 0.35% 0.09% 0.36% 0.41% 0.03% 0.10% 0.22%
8 Financials 6.80% 4.43% 1.83% 1.48% 3.34% 1.37% 1.32% 0.63% 0.92%
9 Technology 6.75% 0.63% 0.10% 0.00% 1.43% 0.56% 0.12% 0.01% 0.00%
Portfolio Weights are controlled, relative to these categories, as part of a rigorous risk
control process which also controls for market beta, style, and size risks.
PROPRIETARY AND CONFIDENTIAL
45
©2011 NewOak Capital LLC. All rights reserved.
47. 46
GLOBAL QUANTITATIVE EQUITY
Quant Equity Investment Process
We believe experience-driven insights into the data are critical to the Process.
Bad Earnings Data: Spreadsheet Manual Entry
Conditions Change: Morning Earnings Surprise
Conditions Persist: Short-Term Price Reversal Window
Complex Industry Schemes: Japanese Financials, European Industrials
Global Correlations: Oil and Financials
Good managers confirm the quantitative results, they don’t obey it.
PROPRIETARY AND CONFIDENTIAL
46
©2011 NewOak Capital LLC. All rights reserved.
48. 47
GLOBAL QUANTITATIVE EQUITY
Quant Equity Team’s Investment Performance
Our team has outperformed their benchmarks since 1996
Managed 5-star Morningstar international equity long-only fund
Responsible for $10 billion in long-only mandates
Demonstrated value-add from both long and short positions
Time Strategy Benchmark Period
Asset Class Benchmark Period Return Return Alpha
International BNY 2004 to 9.8% 7.1% 2.7%
130/30* ADR/FTSE 2010
Long Only MSCI EAFE 1996 to 5.9% -0.9% 6.8%
International** 2002q1
US Large Cap*** S&P 500 1996 to 9.4% 6.8% 2.6%
2010
US SMid Cap*** Russell 2500 1996 to 17.5% 9.3% 8.2%
2010
* Returns are gross of fees.
Note on the Benchmark and Universe: The fund Benchmark changed from the Bank of New York ADR Index to the FTSE All-World ex US Index on
1/1/2007 to reflect the expansion of the portfolio’s composition. Through November 2006, our universe consisted of the 650 most liquid ADRs and US
GDRs. On December 1, 2006, our universe expanded to include 4,000 of the most liquid common equity shares on local exchanges in the global markets
ex-US. Data referring to excess return over a “Benchmark” refers to the Benchmark that was in effect at the time in question.
** Long Only International performance was produced at ING/Aeltus Investment Management in mutual fund and institutional separate account vehicles
including a five star Morningstar rated mutual fund.
*** Large Cap and Smid Cap performance was produced at ING/Aeltus Investment Management in mutual fund and institutional separate account vehicles
from 1996 until 2004.
PROPRIETARY AND CONFIDENTIAL
47
©2011 NewOak Capital LLC. All rights reserved.
49. 48
GLOBAL QUANTITATIVE EQUITY
Quant Equity Product Research & Development
We have developed a superior International Small Cap Model:
Global
SC Fund Alpha Predicted Actual
9/30/2003 Tracking Error Tracking Error
Inception 2003 14.63% 16.50% 1.88% 3.9% - 4.1% 6.0%
2004 30.42% 43.22% 12.80%
2005 22.51% 50.62% 28.11% Periodicity Hit Rates
2006 32.55% 45.15% 12.60%
2007 13.56% 23.21% 9.65% Monthly 69%
2008 -52.03% -46.02% 6.02% Quarterly 93%
2009 61.24% 69.32% 8.09% Annually 100%
Part Year - Nov 2010 14.13% 19.81% 5.67%
Annualized Since Inception 13.21% 24.90% 11.69%
Time Period September 2003 to November 2010;
PROPRIETARY AND CONFIDENTIAL
48
©2011 NewOak Capital LLC. All rights reserved.
50. 49
GLOBAL QUANTITATIVE EQUITY
Quant Equity Product Research & Development
An additional model for the US market:
Annualized Alpha
14.0%
12.5%
12.0%
9.8%
10.0%
8.6%
7.7%
8.0%
6.0%
4.0%
2.0%
0.0%
International v FTSE AWI Smid Cap v Russ 2500 Large Cap v S&P 500 Index Large Cap v Russ 1000
ex US Index Index
Annualized Alpha
Top Decile Versus Benchmark
Time Period 2001 to 2010
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
51. 50
V. Dodd-Frank and Its Impact on LDI
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
52. THE DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT 51
The Dodd-Frank Wall Street Reform and Consumer Protection Act ("Act") passed in July
2010 and required several regulatory agencies including the SEC, CFTC and FDIC to
propose and finalize more than 500 rules in order to give shape and structure to the
sweeping reform of the financial regulatory system envisioned by the Act.
Several key regulations under Title VII of the Act related to the $600+ trillion
derivatives market are being finalized in 2011
General objectives are transparency, reducing systematic risk, ensuring orderly
markets OTC derivatives markets
Significant objective is to move the OTC derivatives transactions (“Swaps”) activities to
the regulated exchanges with clearing through central clearing houses
Use of clearinghouses “mutualize “ the counterparty risks among members hence
reduce the systematic risks
Implications:
The definition of “swap” is very broad
All parties will be affected and need to assess the relevant compliance rules,
operational risks, business costs, and how it affects them.
No one is exempted from record keeping, reporting, and rules of conduct
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
53. Fund Managers Under Dodd-Frank 52
Challenges and Requirements Ahead for OTC Derivatives Activities
Collateral management requirements including
Counterparty risk management
Liquidity management
Risk-based margining
•Marked-to-market and Value-At-Risk
•Collateral optimization
Operational
•Collateral amount verification
•Collateral movements mechanism and costs
Administrative
•Record keeping and reporting
•Rules of conduct
Hedge Fund Transparency
Fund-of-fund position aggregation
Collateral management validation and optimization
Hard-to-value assets and investor reporting
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
54. Fund Managers Under Dodd-Frank 53
Methodical Steps to Take
Types of Transactions
Currently involved in (“on the book”)
Contemplated transactions
Entity Classification
Highly Regulated – depends on level of activity as well as purpose
•SD – Swap Dealer
• MSP – Major Swap Participants
Eligible Financial Participants –ECP
•Can do bilateral transactions
•Must have a level of sophistication and financial means
Less Regulated - Commercial End Users (“CEU”)
• Must be using it for hedging or mitigate risk
•Cannot be a financial entity!
Execution and Clearing Requirements
Not all swap types require centralized execution and clearing but most do
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
55. COLLATERAL MANAGEMENT FOR INSTITUTIONAL ASSET MANAGERS 54
Integral part of risk and liquidity management
CREDIT RISK EXPOSURES
• SECURITIES LENDING
• PORTFOLIO LOANS
• OTC DERIVATIVES
• IF NOT ALREADY WILL BE 100% SUBJECT TO ISDA, CSA, AND COLLATERAL POSTING
COLLATERAL MANAGEMENT MITIGATES COUNTERPARTY CREDIT RISK BUT INTRODUCES
OPERATIONAL RISKS
CREDIT RISK MANAGEMENT LEADS TO COLLATERAL MANATEMENT
OPERATIONAL ISSUES
TIMELY FORECAST OF VARIATION MARGINS
• DERIVATIVES AND COMPLEX SECURITIES PRICING
SENARIO ANALYSIS
VALUATION AGENT AND DISPUTE MECHANISIM
COMPLEX DOCUMENTAION
OPTIMIZATION
TIMELY EXECUTION
REHYPOTHECATION CAN LEAD TO CASCADING EFFECTS
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
56. WHO NEEDS COUNTERPARTY AND COLLATERAL RISK MANAGEMENT CAPABILITIES 55
VAST ARRAY OF FINANCIAL INSTITUTIONS WITH COUNTERPARTY EXPOSURES
Banks • Global and Domestic Banking Institutions
Insurers
, REITS, Specialty • Life and P&C Insurance Companies, Reinsurers, REITS, Specialty Finance
Finance
Asset
Managers/Treasurers • Traditional and Alternative Asset Managers, Treasurers
Governmental Agencies • Central Banks, Sovereign Funds, Supra-nationals, Government Agencies
Pension & Endowments • Pension Funds, Foundations and Endowments
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
57. 56
VI. LDI - Solutions and Infrastructure Needs
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
58. LIABILITY DRIVEN INVESTING 57
LDI REQUIRES AN NTEGRATED APPROACH TO RISK, ASSET AND FINANCIAL MANAGEMENT
Front Office:
Portfolio
Workstation, Risk
& Trade
Management, AL
M
STRUCTURED: Middle
GLOBAL FIXED FIXED INCOME RMBS, CMBS, Office: Trade
INCOME DERVIATIVES ABS, CDO, CLO, Regulatory Reporting & Processing, Cleari
Compliance
ng, Valuation, Col
CSO, SIVS lateral
Management
INTEGRATED
APPROACH TO
WHOLE LOANS REAL ESTATE ALTERNATIVES ASSET
MANAGEMENT
SERVICES
GLOBAL EQUITIES PRIVATE Counterparty Back Office:
and Collateral Reporting, Performance
EQUITIES DERIVATIVES EQUITIES Measurement, Attribution
Management
Liquidity, Credit & Asset
Liability Management
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
59. ASSET MANAGEMENT/RISK MANAGEMENT ENVIRONMENT 58
INFRASTRUCUTURE REQUIREMENTS RAPIDLY RISING WITH THE SIZE OF OPPORTUNITIES
The environment is ideal penetrating and Well-Defined
capturing market share in regimented Strategies:
Fixed, Equities, Asset-
global fixed income, equity, and alternative Based
Lending, Specialty
asset management Finance
Front Office:
• The mounting importance of asset liability Counterparty and
Collateral Management Portfolio, Risk & Trade
Management
and credit management
• The growing demand for global fixed
income and diversified equity products
• Increase in fixed income-focused
financial institutions Asset/Risk
• Global quant equity opportunities
• Global growth of multi-family offices Regulatory Reporting &
Management Middle Office:
Trade
Processing, Clearing, V
Compliance
• Ever increasing demand for articulated and aluation, Collateral
Management
transparent asset management by pension
plans, private wealth and financial
institutions
• The mounting complex regulatory risk
Back Office:
management and reporting requirements Credit Risk & Asset
Liability Management
Reporting, Performance
Measurement, Attribution
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
60. ANALYTICAL PLATFORMS NEEDS 59
TRANSPARENT, COMPREHENSIVE, AND SCALABLE
TM
Must be designed to leverage the best technology and expertise to provide best-in-class solutions to
optimize the following key concerns:
Transparent and comprehensive
Embracing modern technologies to overcome legacy platform issues
Incorporate valuation, attribution, scenario analysis & reporting
Performance Scalability
Fixed Income Equities
Customization Usability
Portfolio Alpha
Mgmt Models
Web-based Reporting
Credit Risk
Customizable Risk Models
Analytics Mgmt
Complex
Rapid Deployment
Securities & Derivatives
Loans
Multi-Entity
High Availability
Hosted Services, Cloud Computing
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
61. WORLD OF COMPLEXITY 60
Sophisticated Analytical & Execution Platform Needed
Cross-Asset Class Capability Is Required for A Comprehensive Counterparty and Collateral Management System
COMPLEXITY
COMPLEX SECURITIES
DERIVATIVES ILLIQUID LIQUID CONTINGENT
CLAIMS
SECURITIES AND DERIVATIVES
RMBS CMBS Consumer ABS HY & IG Bonds Esoteric Assets
LOANS/CREDITS
Residential Commercial Consumer / Student Corporate Esoterics Contracts
Mortgage Mortgage Loans Credit
GRANULARITY
Comprehensive state-of-the-art large scale analytical systems needed for valuation and risk management of complex securities and
portfolios .
Credit intensive analysis is needed for most instruments to uncover risks not apparent from traditional analysis.
Forward-looking views and scenarios to
Multivariate stresses needed to be applied around forecasts to capture alternate future states of the world
Interest rates, currencies, defaults,
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
62. OPEN RISK SOLUTIONS 61
Next Generation Portfolio and Risk Management Platform
Integrated platform – open, flexible, connecting risk management, portfolio management, trading,
collateral management, financial management and reporting
Multi-asset class covering, liquid, illiquid, complex and derivatives, US and international
Proprietary plus open-interface credit and factor models supporting risk management, alpha generation,
TM
and asset allocation
Fixed Income Equity Derivatives
Complex Stratus - Loan
Portfolio Risk Alpha & Risk Portfolio Electronic Risk & Collateral
Securities & Collateral
Management Management Models Management Trading Valuation Management
Esoterics Management
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
63. NEWOAK SOLUTIONS OpenRisk™ - OpenFixed 62
Next Generation Valuation & Risk Services
NewOak OpenRisk provides a comprehensive capabilities to managing multi-asset-class portfolios
Leveraging NewOak’s superior credit analytics and technology, NewOak can provide cost effective services across a variety of
important functions:
Deep-Dive Credit •See-through valuation, loss, cash flow analysis of structured products – RMBS, CMBS, CDO.
CLO, Esoterics
Analysis
Risk Reporting •Risk reporting across first and second order sensitivities
Cash Flow •Projected interest and principal (maturity, calls and prepayments) cash flows provided for static
Forecasting (fixed-rate) and user defined dynamic scenarios (customizable shocks)
Reinvestment Rate •The impact of changes in fixed rate and spread to benchmark upon projected cash flows
Analysis
Inflation Risk •Portfolio and asset class sensitivities to changes in realized and projected inflation rates
Horizon Analysis •Projected return and forward-looking risk profile from user-defined interest rate shocks
Drilldown Capability •Aggregate analytics provided at sector, subsector and cusip levels
With a customizable service model, NewOak can multiple deployment options:
Data Services
Hosted “Software-as-a-Service”
In-House installation and management.
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
64. COUNTERPARTY RISK MANAGEMENT 63
Opportunities and Perils In Counterparty and Collateral Management
Spectrum of complex documentation
COUNTERPARTY
interpretation, computation, valuation, optimi CREDIT ANALYSIS
zation, and execution leads to challenges and
opportunities for state-of-the-art collateral
management systems and operations CREDIT
TIMELY EXPOSURES
EXECUTION DERIVATIVES &
LOANS
COUNTERPARTY
Future RISK
Today MANAGEMENT
Legacy
OPTIMIZATION ISDA & CSA
VALUATION &
Monitoring
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.
65. FLEXIBLE SYSTEM APPROACH TO REDUCE OPERATIONAL RISK 64
Collateral Management Capabilities Is Becoming A Requirement
Systems to consolidate data across multiple
Documentation
Valuation/ platforms, sources and formats into a single
Sensitivities integrated framework.
CSA, Master Method
ISDA, Scripti
ng Agent
Position
Monitoring Tracking Cross Collateral Capability
Dispute Simulation
Resolution Liquidity Integrate Data from multiple sources and formats
Management
Optimization/
Credit
Netting
Rules-based workflow engine
Customizable Reporting and Stratification of Portfolio
Real-time reporting and status update
Collect
Collateral Web-based for global distribution
Management & Analyze
Reporting
Execute
PROPRIETARY AND CONFIDENTIAL
©2011 NewOak Capital LLC. All rights reserved.