Bond volatility spurs Monier to raise Lombard cash exposure

StephaneMonier

As the bond market experiences one of its biggest corrections and experts question the future of the asset class, fund managers are moving to protect their portfolios from further risks.

Lombard Odier chief investment officer for Europe Stéphane Monier has made a step back from sovereign bonds in his asset allocation strategy, ultimately adding a stronger cash exposure to decrease risks.

Since April this year, the £138m Lombard Odier Selection Vantage 1500, which was launched in January 2014 in tandem with Vantage 3000, has been experiencing the biggest drawdown of its history.

As the fund’s exposure was around 32 per cent to sovereign bonds, and due to the strong sell-off in German bonds and US treasuries, “the fund gave back part of the excess return that was earned during the early months of the year,” explains Monier.

Currently, the allocation to sovereign bonds is 16 per cent within Vantage 1500.

While Monier also slightly reduced the exposure on other asset classes at the same time, namely developed equities, emerging equities and credit, the allocation to cash is now 35 per cent of the portfolio, up from zero since December 2014.

He explains: “To reduce the risk, we reduce our allocation to the markets – or level of investment – and keep the proceeds of the asset sales in cash.”

To protect investors on the downside, the fund, which is also managed by senior portfolio managers Rogier van Heyningen and Cyril Caillault, is managed using a drawdown control mechanism, which aims to reduce the target expected shortfall of the portfolio during periods of poor investment performance.

Monier says: “The risk-based approach to investing means that instead of starting with an investor’s target annual returns, the team asks about the maximum capacity for loss.”

He adds: “We promise clients the fund won’t exceed a loss of 5 per cent, so when the value of the fund decreases we reduce the risk of the portfolio.”

This is a dynamic approach and it is managed on a daily basis, Monier says.

“The target risk can be reduced by up to 30 per cent of the total ‘risk budget’ but no more, in order to keep some risk in the portfolio when markets recover,” he adds.

He says this strategy is “an agnostic process” so “we reduce the exposure if we find a risk – it is not a market forecast strategy.”

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“In March, the fund was 4.5 per cent volatility and after the drawdown we reduced that to 2.5 per cent, so we nearly halved the risk of the portfolio,” Monier adds.

Since inception, this conservative risk-based fund has returned 3.22 per cent, representing an annualised 2.24 per cent, slightly below its target performance of cash plus 2.5 per cent.

Since the beginning of the year, however, the performance of the fund is 1.03 per cent.

The main contributors to the positive performance in 2015 are Lombard Odier’s absolute return and high conviction strategies, which are part of the fund’s alpha pocket, says Monier.

He says: “When we look at performance attribution, the alpha pocket is very much a stabiliser of the fund. We have been successful in identifying managers that are able to outperform in an up and down market for both returns strategies that we use and also for the high conviction strategy which is a quite differentiation feature.”

Since the Vantage 1500’s inception, 30 per cent of the risk allocated to the alpha pocket has generated more than 50 per cent of the return of the fund.

He says: “The traditional multi-asset portfolio has less than 10 per cent of risk allocation. [These portfolios] rely solely on the ability of asset allocation, so they don’t try to find uncorrelated sources of return like we do.”

Though not basing the asset allocation on market forecasts, Monier identifies four major themes to follow in the current market outlook.

He says “obviously” the situation in Greece should be well monitored, as well as the strong stock market correction currently hitting China.

He adds: “The third thing to look at is the current talks in Iran as this will have a major impact on the price of oil as well as the geopolitical risks between Iran and Saudi Arabia and their competition for the supremacy in the region.

“However we are not making any bets on the situation as ours is a systematic approach that is reacting to our perception of risks in the market.”

Monier also believes the Federal Reserve will raise interest rates in September 2015 but doesn’t see rates going up in Europe, as the European Central Bank plans to continue the quantitative easing programme until September 2016.