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Chris Condon Financial Services
Chris Condon Financial Services 25 November 2011
Scenarios analysis: two approaches
Chris Condon
Fiduciary Investors Symposium CIO Forum
Mornington Peninsula, November 2011
Chris Condon Financial Services
Chris Condon Financial Services 25 November 2011
2
Chris Condon Financial Services
Chris Condon Financial Services 25 November 2011
3
Chris Condon Financial Services
Chris Condon Financial Services 25 November 2011
4
Chris Condon Financial Services
Chris Condon Financial Services 25 November 2011
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
Pro
babilit
y
Rate of return
Non-parametric distribution
Lognormal return distribution
Abandon mean/variance
5
Medical and IT
breakthroughs
Global
depression
Muddle through
with emerging
markets slowing
China has a
political
meltdown
Stocks rerated in
expectation of strong
growth from 2020
Chris Condon Financial Services
Chris Condon Financial Services 25 November 2011
Scenarios proposed by the Economist Intelligence
Unit
1 Further political turmoil in the Middle East
3 Pension funding crisis deepens in developed
countries
4 High inflation forces policy tightening in
emerging markets
5 Widespread social unrest caused by rising
food and commodity prices
6 Oil prices spike to US$150 a barrel
7 Tensions over currency manipulation lead to
increased protectionism
8 Sovereign debt default in the Eurozone
10 New financial regulation causes dramatic
drop in profitability in financial institutions
12 Continuing problems in the banking sector
force further nationalisations
13 Double-dip recession in the global economy
14 Political unrest in China
15 Developed economies fall into deflationary
spiral
21 Break-up of the Eurozone
24 Chinese economy crashes
2 The Internet and social media are a catalyst
behind rapid political and economic change
around the world
9 Governments sell off remaining holdings in
the financial sector
11 Asset price boom in clean tech industry
16 Housing industry in the US rebounds
17 Global GDP growth of 5% or greater in 2011
18 Chinese government agrees to significant
appreciation of its currency
19 Formation of single worldwide accounting
standard
20 Conclusion of Doha round of trade
negotiations
22 Agreement of global accord to replace the
Kyoto Protocol on climate change
23 Globally agreed solution to the “too-big-to-
fail” problem
6
Source: Economist Intelligence Unit “The search for
growth: Opportunities and risks for institutional
investors” (2011)
Chris Condon Financial Services
Chris Condon Financial Services 25 November 2011
7
Chris Condon Financial Services
Chris Condon Financial Services 25 November 2011
8
Basic equity model
Asset class
Scenario
Term in years 5
Inflation 2.0%
Earnings model
Nominal GDP growth 2.0%
Economic growth reflected in earnings 80%
Real EPS growth rate -0.39%
Dividend yield 2.0%
Retained earnings reinvested 0.5%
PE at start 14.6
PE at end 10.0
Annual rate of growth in PE ratio -7.29%
Gross return Effective tax rate Net return
Valuation change -5.81%
Reinvestment of earnings 0.50%
Capital gain -5.31%
Long term capital gains -4.51% 15.0% -3.83%
Short term capital gains -0.80% 15.0% -0.68%
Dividend yield 2.00% -14.1% 2.28%
ROR -3.31% -2.23%
Australian equities
China stops buying Aussie dirt
Chris Condon Financial Services
Chris Condon Financial Services 25 November 2011
Respondents’ views of their impact and likelihood
9 Source: Economist Intelligence Unit
Chris Condon Financial Services
Chris Condon Financial Services 25 November 2011
Creating a non-parametric distribution from
scenarios
10
Weight Scenario 1 Scenario 2 Scenario 3 ... Scenario n
Equ
itie
s
Australia
US
UK
Europe
Japan
Emering markets
Sove
reig
n
Bo
nd
s
Australia
US
UK
Europe
Japan
Emering markets
Corporate bonds (Aust)
Corporate bonds (foreign)
Property (Aust)
Property (foreign)
Private equity
Infrastructure
Hedge funds
Cash
Portfolio return
Probability
Build up a total portfolio
non-parametric distribution
from a collection of asset
classes, regions, sectors and
common risk factors
Chris Condon Financial Services
Chris Condon Financial Services 25 November 2011
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
Pro
babilit
y
Rate of return
Non-parametric distribution
Lognormal return distribution
Abandon mean/variance
11
Medical and IT
breakthroughs
Global
depression
Muddle through
with emerging
markets slowing
China has a
political
meltdown
Stocks rerated in
expectation of strong
growth from 2020
Chris Condon Financial Services
Chris Condon Financial Services 25 November 2011
12
