The Folly of Forecasting: Active Management in an uncertain
world Richard Ryan 23 September 2014
Slide 2
2 Forecasting the Future Prediction is very difficult,
.especially if its about the future Niels Bohr (1885-1962) Danish
physicist and Nobel Prize Winner
Slide 3
3 Ever wanted to know the weather for next year? Mon 25/1 2016
Tue 26/1 2016 Wed 27/1 2016 Thu 28/1 2016 Fri 29/1 2016 London
4C-1C3C5C10C Birmingham 8C6C-2C6C3C Edinburgh 9C5C2C5C1C would
anyone care to risk losing money if this is wrong? Source: M&G,
TheWeatherWiz.com, long range forecasts as at 14 January 2015
Slide 4
4 Why do we crave forecasts? Human nature we seek clarity, we
need to plan Many players claim they can forecast reliably We are
conditioned to respond to them Seen as a key advantage
Slide 5
5 Where might we look for reliable forecasts? The Bank of
England? Central Banks, for all their inside economic data, are
poor forecasters Source: M&G, Bank of England, Monetary Policy
Committee data. As at 30 September 2014 Bank of England Rolling GDP
Forecast (from 3 years prior) Actual GDP UK GDP (Q4 2007- Q3 2017,
Quarterly, %YoY)
Slide 6
6 Source: M&G, US Bureau of Economic Analysis data, 1989 to
2006 (including data revisions), Bloomberg. As at 30 September 2014
Actual GDP Where might we look for reliable forecasts? The Federal
Reserve? Fed Policy assumed 2% normal GDP Actual average GDP 4% US
GDP (1989-2006, Quarterly, %YoY) Policy makers have the data but
struggle to make sense of it
Slide 7
7 What is our trust in Central Banks based on? Markets believe
in Central Bank omnipotence despite consistent failure to
accurately forecast growth and inflation had their forecasts been
accurate, policy and outcomes would have been different Now we are
trusting them to be the greater fool the last buyer (through QE) of
ever more expensive assets ECB President Mario Draghi: Whatever it
takes
Slide 8
8 Can we rule out a policy error? Countries that have
successfully negotiated a QE programme: This page is intentionally
blank* *Because there arent any
Slide 9
9 Actual 1.8% Source: M&G, Bloomberg, *Concensus Economics
Inc. forecast data 9 December 2013. As at 31 December 2014 % 31
December 2014 Gilt Yield forecasts (range of forecasts, as at
31/12/13) 3.2% (Average) 3.8% (High) 2.6% (Low) Forecasts: Getting
the Economic forecast right is no guarantee Do expectations of UK
growth and monetary policy drive Gilt returns?
Slide 10
10 What can we rely on? New thinking is required to take
advantage of an evolving market Investing on the basis of forecasts
is flawed Remove the barriers between asset classes Remove unwanted
and unrewarded risk The investment environment requires us to adapt
our focus Think about the underlying risks you are exposed to!
Slide 11
11 Multi-Asset Credit: a broader opportunity set Investment
Grade corporate bonds High Yield Bonds Senior Secured Loans
Requires expertise in all of these asset classes and capital
structures Source: M&G, illustrative Asset Backed Securities
(ABS) Mortgage Backed Securities Cash, Floating Rate Notes High
Yield bonds Cash FRNs ABS Investment Grade Credit Senior Loans Risk
versus return of credit assets
Slide 12
12 Source: M&G, illustrative Senior secured bonds Unsecured
borrowings (bonds) Equity (share capital) Company borrowings How
does a company borrow? Loans to public and private companies, with
different features Key features include: Public or private
investments Fixed rate or floating rate returns Secured or
unsecured Senior secured loans
Slide 13
13 Investment opportunities High yield bonds and loans Bonds
and senior loans different features, but how different? High yield
bondsSenior loans Fixed coupon (some floating)Floating coupons
Public disclosure & tradingPrivate disclosure & trading
Secured & unsecuredSecured Weaker investor positionStronger
investor protection Source: M&G, illustrative
Slide 14
14 Investment opportunities - High yield bonds and loans Bonds
& loans issued by less credit-worthy issuers but offering
higher returns High yield Senior loans Source: M&G,
illustrative
Slide 15
15 Investment opportunities - Asset Backed Securities Bonds
with a pool of underlying assets AAA AA BBB BB A Pool of assets are
security for a number of bond issues with different risk/reward
characteristics Pool of assets Lower risk, lower return Higher
risk, higher return Capital losses flow up; riskiest bonds bear
first losses AA A BBB BB AAA Returns on the assets repay the low
risk lenders first AAA Income and capital flow down Source:
M&G, illustrative
Slide 16
16 Source: M&G, BofA Merrill Lynch indices (Ref. ER10,
ER40, HEAD), as at 31 December 2014. *Spread to LIBOR (indicative).
**Based on daily dealing. Ratings Current spreads*
SenioritySecuredLiquidity**Complexity Cash AAA- n/a Low Government
Bonds AAA- n/a Low Investment Grade Corporates () AAA-BBB30-110
Varies Low Senior Mortgages A175-225 XXXHigh Asset Back Securities
AAA-B25-450 Varies High Senior Loans BB-CCC350-425 XHigh Euro High
Yield (Ex-Financials) BB-CCC390 Varies Medium Credit offers a range
of characteristics What other risks should you be compensated
for?
Slide 17
17 Barriers lead to mis-pricing of risks In separating assets
into Silos investors hold correlated assets Investment Grade Credit
Senior Loans The same issuer will often have debt issued in
multiple silos: e.g. Auto Issuers, Retailers, Banks Sector
Investors allocate top down into Silos High Yield Credit Asset
Backed Securities Source: M&G, illustrative
Slide 18
18 Removing the silos increases opportunities Source: M&G,
Bloomberg, Credit Suisse as at 31 December 2014 Investment Grade
Credit Senior Loans Asset Backed Securities High Yield Credit BMW
Mercedes Ford Peugeot Honda Renault Toyota VW Senior Loans Asset
Backed Securities Schaeffler TI Group Renault Peugeot VW BMW
Mercedes Ford Fiat GM Renault Peugeot Schaeffler Jaguar Investment
Grade Credit High Yield Credit It makes more sense to assess
investments in a common sector framework, without asset class
barriers or investment Silos
Slide 19
19 Corporate bond market spreads Source: M&G, Asset swap
spreads. BofA Merrill Lynch Corporate Non-gilt Index (Ref. UN00),
Euro High Yield Index (Ref. HE00), Euro Broad ex Sovereign Index
(EX00): composite credit rating derived from average of
S&P/Moodys/Fitch, Credit Suisse Leveraged Loan Index S&P
rated issues, 4 year discount margin, as at 31 December 2014 Stock
selection presents plenty of opportunities
BBB-BBB+BBBBB+BB-BBB+A-AA+BB- Opportunities exist across public and
private debt issues Asset swap spreads of Investment Grade and High
Yield credit (bps, Rated A+ to B-)
Slide 20
20 Multi-Asset Credit strategies demonstrate new thinking
Delivering higher performance with lower volatility Source:
M&G, BofA Merrill Lynch, Credit Suisse as at 31 December 2014.
*Standard deviation of excess returns since inception 26 April 2007
Excess returns to Libor, local currency, normalised (Dec 2015,
April 2007 =100) Volatility* Multi-Asset Credit4.37 Credit6.76 Lev.
loans9.74 High yield13.99
Slide 21
21 Multi-Asset Credit for Pension schemes Source: M&G as at
31 December 2014 Accessing the credit risk premium while minimising
interest rate exposure A flexible and unconstrained approach free
from the ties of a benchmark Access to a broad range of credit
assets, both public and private Can complement a Liability Driven
Investment solution An extremely diversified approach to reduce
downside exposure & volatility
Slide 22
22 FOR INVESTMENT PROFESSIONALS ONLY For the addressee only.
The distribution of this document does not constitute an offer or
solicitation. Past performance is not a guide to future
performance. The value of investments can fall as well as rise.
There is no guarantee that these investment strategies will work
under all market conditions or are suitable for all investors and
you should ensure you understand the risk profile of the products
or services you plan to purchase This document is issued by M&G
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