Best Practices in Credit Portfolio Risk Management for Buy-side - - PowerPoint PPT Presentation

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Best Practices in Credit Portfolio Risk Management for Buy-side - - PowerPoint PPT Presentation

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Best Practices in Credit Portfolio Risk Management for Buy-side Managers Moody's Analytics Risk Practitioner Conference October 17 th , 2012 David Latour Caisse de dpt et placement du Qubec Senior Adviser, Quantitative Risk Analysis

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Best Practices in Credit Portfolio Risk Management for Buy-side Managers

Moody's Analytics Risk Practitioner Conference October 17th, 2012

David Latour Caisse de dépôt et placement du Québec Senior Adviser, Quantitative Risk Analysis – Fixed Income

October 2012 1

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2 Caisse de dépôt et placement du Québec

01 02 03

Caisse – Figures and investments activities Risk management at la Caisse Credit risk management tools

04 05

“Usual” credit risk management Key points

This Presentation (the “Presentation”) was prepared by Caisse de dépôt et placement du Québec (“Caisse); it and all information it contains, shall remain the property of Caisse and shall not be reproduced or distributed, in whole or in part, at any time without Caisse prior written consent. The Presentation is not intended to serve as basis for any investment decision.

October 2012

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CAISSE – FIGURES AND INVESTMENT ACTIVITIES

October 2012 Caisse de dépôt et placement du Québec 3

SECTION 01

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฀ Founded in July 1965 ฀ Act of Québec’s National Assembly ฀ Initial mandate: to manage the assets of the Québec Pension Plan (RRQ) ฀ Mandate widened over the years to include the funds deposited by

  • ther Québec public and private sector pension and insurance

plans ฀ As at December 31, 2011: 25 depositors – net assets of $159B

4

SECTION 01

Caisse de dépôt et placement du Québec October 2012

Caisse – Figures and investment activities

History

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Caisse – Figures and investment activities

Mission "The mission of the Caisse is to receive moneys on deposit as provided by law and manage them with a view to achieving

  • ptimal return on capital within

the framework of depositors’ investment policies while at the same time contributing to Québec’s economic development."

5 Caisse de dépôt et placement du Québec

SECTION 01

October 2012

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6 Caisse de dépôt et placement du Québec

SECTION 01

฀ One of the largest institutional fund managers in Canada and North America ฀ One of the world’s 10 largest real estate asset managers ฀ Leading Canadian private equity investor ฀ Shareholder in more than 4,000 companies globally ฀ One of the few North American entities with the highest credit ratings: AAA from DBRS and S&P, and Aaa from Moody's

October 2012

Caisse – Figures and investment activities

Vis-à-vis its peers

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7 Caisse de dépôt et placement du Québec

As a percentage – as at December 31, 2011

SECTION 01 Fixed Income 37 Inflation-Sensitive Investments 16 Equity 46 Hedge Funds 2 Asset Allocation 1 ABTN (2)

October 2012

Caisse – Figures and investment activities

Breakdown by asset class

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8 Caisse de dépôt et placement du Québec

As a percentage – as at December 31, 2011

SECTION 01

October 2012

Canada 60 United States 20 Euro Area 7 United Kingdom 4 Japan 2 Emerging Markets 5 Other 2

Caisse – Figures and investment activities

Geographic breakdown

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RISK MANAGEMENT AT LA CAISSE

October 2012 Caisse de dépôt et placement du Québec 9

SECTION 02

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Transparently ensure a risk-return balance for the Caisse by assuming a second level of control, by employing effective risk management tools and providing support with investment strategy development, while promoting a sound risk culture within the organization

Integrate risk managers Incorporate risk component into

  • ur processes

Develop effective analysis tools Strategies

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SECTION 02

October 2012 Caisse de dépôt et placement du Québec

Risk management at la Caisse

Model

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Knowledge and challenge Guidance and discipline Development of effective analytical tools

  • In-depth knowledge encompassing investments, the

portfolio and interrelated investments

  • Constructive discussions on strategies and
  • pportunities
  • Define policies that reflect the risk management

philosophy

  • Establish clear, shared risk management processes
  • Develop structured and shared investment

processes

  • Develop quantitative and qualitative tools
  • Communicate effectively to ensure buy-in

SECTION 02

11 October 2012 Caisse de dépôt et placement du Québec

Risk management at la Caisse

Focus of our strategy

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  • Measure risks using systematic tools, e.g. VaR, stress tests,

concentrations and indicators

  • Analyze risks using quantitative and qualitative methods
  • Identify

acceptable level

  • f risk
  • Develop and

implement a mitigation plan

  • Anticipate major risks
  • Prioritize risks
  • Monitor potential risks
  • 1. Identify
  • 2. Assess
  • 3. Mitigate

Dialogue: Market update, rebalancing committee and risk-return report

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SECTION 02

October 2012 Caisse de dépôt et placement du Québec

Risk management at la Caisse

ERM process

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Asset Allocation Fixed Income Equity Markets Private Equity Real Estate Market risk analysis, stress testing and concentrations Credit, counterparty and liquidity risk management Data management Risk management intelligence and policies Geopolitical risk analysis Operational risk management

Activities associated with risk measurement and quantitative analysis Activities associated with qualitative analysis Business Unit Risk Managers

(BURMs)

13 October 2012 Caisse de dépôt et placement du Québec

SECTION 02

Risk management at la Caisse

Organisational structure

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CREDIT RISK MANAGEMENT TOOLS

October 2012 Caisse de dépôt et placement du Québec 14

SECTION 03

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15 October 2012 Caisse de dépôt et placement du Québec

SECTION 03

Credit risk management tools

Corporate bonds portfolio outlook ฀ Roughly 25% of 40 B$ Bonds portfolio invested in non-sovereign credit sensitive instruments ฀ Benchmark is DEX Universe All Corporate Bond Index

  • Index is composed of all Canadian dollar denominated bonds

with effective maturity of at least one year and a broad enough distribution, rated BBB or higher and issued by Canadian corporations or SPVs ฀ On top of publicly traded corporate bonds, portfolio can also include private debt investments, leveraged loans, high yield securities and credit derivatives ฀ Small exposure to issuers in USA and Europe ฀ Portfolio constructed to match benchmark’s duration

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16 October 2012 Caisse de dépôt et placement du Québec

SECTION 03

Credit risk management tools

Investment approach ฀ Bottom-up approach ฀ Issuers and sectors assigned to portfolio managers/analysts to build expertise ฀ Fundamental analysis drives investment decision ฀ Relative-value approach to assess cheap/rich bonds ฀ Low turnover Risk managers can add value through quantitative approach

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17 October 2012 Caisse de dépôt et placement du Québec

SECTION 03

฀ Moody’s CreditEdge Platform that delivers forward-looking daily public firm EDF™ (Expected Default Frequency) credit measures to support credit risk assessment and investment decisions ฀ Moody’s RiskFrontier Platform that enables you to perform rigorous analysis of credit risk and economic capital. It also identifies risk concentrations by industry, geography or asset type, computes expected and unexpected loss, and calculates distributions of portfolio values, losses and capital

Credit risk management tools

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18 October 2012 Caisse de dépôt et placement du Québec

SECTION 03

Credit risk management tools

Major Risk

CreditEdge

  • Calculate probability of defaults

for issuers

  • Derive point-in-time credit

ratings to supplement ratings provided by external agencies

RiskFrontier

  • Estimate portfolio’s tail risk

(Credit Value at Risk)

  • Identify main contributors to tail

risk

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Impact of risk on the Caisse

Illustrative probability distribution

"Major" risk "Usual" risk

Potential event characterized by:

  • Major impact
  • Generally low frequency
  • Typically not central to investment

strategies

  • Dialogue intended to mitigate risk

Potential risk characterized by:

  • Significant but less critical impact
  • Higher frequency
  • Deliberately accepted to generate

returns

  • Dialogue intended to optimize risk-

return ratio

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SECTION 02

October 2012 Caisse de dépôt et placement du Québec

Credit risk management tools

Response to risk is modulated

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“USUAL” CREDIT RISK MANAGEMENT

October 2012 Caisse de dépôt et placement du Québec 20

SECTION 04

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21 October 2012 Caisse de dépôt et placement du Québec

SECTION 04

“Usual” credit risk management

Fundamental approach to credit risk ฀ Risk assessment is based on both in-house fundamental risk analysis and rating agencies’ analysis ฀ Risk analysis is mostly based on :

  • Financial strength analysis
  • Industry overview
  • Quality of management
  • Company operationnal strengths/weaknesses analysis

฀ Decision to buy or sell securities is based on risk assessment and

  • n comparative analysis of spreads for securities of similar risk
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22 October 2012 Caisse de dépôt et placement du Québec

SECTION 04

“Usual” credit risk management

Quantitative approach to credit risk ฀ Market-based data can also be used to perform risk analysis ฀ Many sources of market data available for debt:

  • Bond market
  • CDS market
  • Equity market

฀ Market data has generally the advantage of providing point-in-time risk information Combined approach provides better risk assessment

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23 October 2012 Caisse de dépôt et placement du Québec

SECTION 04

“Usual” credit risk management

Fair value spreads approach ฀ Approach used is based on Moody’s Fair Value Spreads (FVS) ฀ Fair Value Spreads calculated are compared to actual market spreads for securities included in the portfolio managers investment universe

  • Approx. 60% of securities in benchmark have FVS available

฀ For each sector, top overvalued/undervalued securities are included in a report ฀ Portfolio managers review opportunities presented in report Quantitative approach adds another source of potential

  • pportunities
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24 October 2012 Caisse de dépôt et placement du Québec

SECTION 04

“Usual” credit risk management

Risk in portfolio context ฀ Current investment approach focuses on security selection and puts less emphasis on portfolio construction ฀ Portfolio level reporting revolves around:

  • Concentration reports (credit ratings, geography, industry)
  • Duration
  • Sensitivity to credit spreads

Focus should be on risk contribution and not standalone risk

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25 October 2012 Caisse de dépôt et placement du Québec

SECTION 04

“Usual” credit risk management

Risk in portfolio context ฀ Approach used is based on Moody’s RiskFrontier ฀ Portfolio value distributions for both portfolio and relative portfolio are generated ฀ Focus on standard deviation of distributions (not VaR) ฀ Contributions of each securities/industries/rating groups are presented to portfolio managers ฀ Historical and expected returns are compared to risk contributions to establish risk-reward dialogue

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26 October 2012 Caisse de dépôt et placement du Québec

SECTION 03

“Usual” credit risk management

Value proposition

Major Risk Usual Risk

CreditEdge

  • Calculate

probability of defaults for issuers

  • Derive point-in-

time credit ratings to supplement ratings provided by external agencies

RiskFrontier

  • Estimate

portfolio’s tail risk (Credit Value at Risk)

  • Identify main

contributors to tail risk

CreditEdge

  • Calculate risk-

adjusted theorical spreads to identify cheap/rich securities

RiskFrontier

  • Use portfolio

risk contribution as part of risk- reward analysis framework

  • Focus on

standard deviation, not VaR

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27 October 2012 Caisse de dépôt et placement du Québec

SECTION 03

“Usual” credit risk management

Value proposition Better integration of credit risk management tools in investment process requires: ฀ Transparency

  • Training sessions on methodology
  • Easily available and clear documentation

฀ Data quality

  • Team dedicated to ensure data availability and accuracy

฀ Timely reporting

  • Processes that allow punctual and flexible reporting
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KEY POINTS

October 2012 Caisse de dépôt et placement du Québec 28

SECTION 05

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29 October 2012 Caisse de dépôt et placement du Québec

SECTION 05

Key Points

฀ Organisational structure should facilitate dialogue with portfolio managers ฀ Portfolio managers focus on usual risk ฀ Quantitative approach is a valuable addition to fundamental approach used by portfolio managers

  • Market based risk information
  • Portfolio risk contribution vs standalone risk

฀ Transparency, data quality and timely reporting are necessary to

  • btain buy-in
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THANK YOU

October 2012