26 Oct 2015 Laurent Joué, Senior Fund Manager, Lombard Odier Investment Managers
Laurent Joué is a senior portfolio manager on the Systematic Equities and Alternatives team at LOIM. In addition to the LO Funds-Alternative Risk Premia Fund, he has been co-managing a top-down Hedge Fund replication strategy with Marc Pellaud since 2009, as well as two long-only commodities Funds since 2011.
Laurent had been part of the Geneva-based Hedge Fund selection team since 2005, and specialised in CTA, Macro and Systematic strategies before joining the systematic portfolio management team at LOIM.
LuxHedge: Could you kindly introduce Lombard Odier Investment Managers for us?
Laurent Joué: Lombard Odier Group has approximately USD 120 billion under management with 2,100 staff based in 26 offices around the world (as at 30 June 2015). Lombard Odier Investment Managers (LOIM), the asset management business of Lombard Odier, focuses on institutional clients, third-party distributors and financial intermediaries. As of 30 June 2015, we manage around USD 47 billion in Fixed Income, Equities, Convertibles, Multi-Assets and Alternatives. We strive to create greater transparency in the sources of return by separating alpha and beta. We believe that beta exposure should be diversified, cost-efficient and highly scalable, while alpha should be unconstrained and add value for our clients.
LH: Could you describe LO Funds–Alternative Risk Premia in a few sentences?
LJ: The Fund invests in liquid derivative instruments, implementing long/short strategies across major asset classes. It has daily liquidity and operates under a UCITS structure. As an absolute return product, we aim to deliver net returns of cash +5-7% p.a., while maintaining volatility of 6-8%. This leads us to an expected Sharpe ratio of 0.9 over a 24-month period. We aim to provide diversification through low correlation with core asset classes, as well as a potential source of return enhancement in global balanced portfolios.
Our investment philosophy is driven by three core beliefs:
- Individual alternative risk premia strategies need to be implemented in their purest form, without excess optimisation or specific timing concerns. Transparency is of the utmost importance in our process.
- The combination of alternative risk premia needs to give stability regardless of market conditions. While market trends may be challenging to predict, the mutual behaviours of the strategies are more easily predictable.
- Execution should guarantee healthy liquidity as well as cost-efficiency.
LH: You have two sources of return: an income premia and a trend premia. Could you detail it?
LJ: Sure. Income strategies are designed to extract yields from structural spreads within asset classes, and are market-neutral. They deliver a regular yield flow and have long risk profiles. While this source of return works well under normal market conditions and rising markets, it might suffer large losses during market crashes.
Trend strategies are designed to take advantage of the persistence of directional moves across asset classes, and are directional. The trend premia allows us to have a hedge profile by going against the market. It aims to offers protection in case of severe downside events.
The combination of these two sources of return has several advantages. It can reduce the drawdown of the portfolio and can limit the idiosyncratic risk of each individual sub-strategy. It can also improve the global risk/return profile. Last but not least, it has the potential to provide more robust returns that are less dependent on market regimes or cycles.
LH: How is your investment process organised?
LJ: Our process has three distinct steps:
- Selection of individual alternative risk premia. We look at structural, transparent and liquid strategies that we believe can lead to an improvement in the portfolio’s risk/return profile.
- Combination of alternative risk premia strategies. We equalise the risk contribution between and within each source of return (Income and Trend). The higher-risk a strategy, the lower its capital allocation within the portfolio.
- Management of overall portfolio volatility. The portfolio’s overall exposure to the market is managed such that volatility is kept within a target range of 6-8% Portfolio rebalancing is monthly under normal circumstances, and is also triggered if volatility passes a threshold value. The nature of the individual risk premia strategies dictates their volatility targets and rebalancing frequency.
LH: How do you calibrate the risk model?
LJ: We have designed a dedicated risk measure to take into account specific hidden risk of L/S strategies such as extreme losses, asymmetrical payoff, liquidity and correlation risk during periods of market stress. Equal risk is allocated to each source of returns (50% income / 50% Trend).
We base our risk measure on the 90% expected short-fall, a dynamic measure of return amplitudes of the strategies’ sensitivity to extreme losses. Then, we adjust the risk model using:
- Skewness, measuring the asymmetry of the distribution of long/short strategies: This measure is important since some alternative risk premia strategies exhibit significant left-hand tail risk, which is typical for carry strategies.
- Conditional correlation: While our strategies have very limited correlation with traditional asset classes, this correlation can increase significantly during risk-off periods.
- Liquidity: We take into account each instrument’s market capacity in order to keep the portfolio cost-efficient.
LH: The Fund was launched just over a year ago, on 6 August 2014. Could you comment on its performance thus far?
LJ: Since inception in August 2014 to the end of September 2015, the Fund is up 7.14% on a net basis (USD Class I) with volatility of 8% i.e. a Sharpe ratio of 0.8. These results are in line with the Fund’s objectives – cash +5-7% net p.a.) and a target Sharpe ratio of 0.8 to 0.9. The past year’s performance has been realised with a low correlation with traditional asset classes, measured at 0 versus the MSCI World Index and 0.4 versus the Citi WGBI All Maturities Index.
The strategy is continuing to evolve, adding new alternative risk premia with the aim of improving the risk/return profile and diversification between income and trend sources of return. The Long/Short commodity backwardation strategy was successfully introduced into the portfolio in July, as was the Long/Short equity factors strategy in August.
Over this period, the diversification between the strategies has worked well. Each strategy has brought some value depending on the market environment, while displaying low cross-correlations. The best contributors since the launch have been the carry 10-year bonds, cross-asset trend, carry credit and L/S commodity backwardation. The carry FX G10 and equity/volatility arbitrage strategies have hurt performance.
LH: You mentioned many different strategies. Could you detail them?
LJ: We currently have seven sub-strategies within LO Funds-Alternative Risk Premia. First, the “income” part of the portfolio:
1. Carry 10 years bond strategy: We seek to exploit risk premia in yield curves across global government bonds markets. We take long positions in 10-year bonds in the three markets with the steepest curves, and short positions in the three markets with the flattest curves. We are currently long Gilts, US T-notes and Canadian 10-year, and short Euro Bunds, Australian 10-year and Japanese 10 year bonds.
2. Carry FX G10 strategy: We aim to extract yield return from interest rate spreads between G10 currencies. We use the forward IR ratio (Yield/Volatility) to gain long exposure to the four currencies with the highest forward IR ratios and short exposure to the currencies with the lowest forward IR ratios.
3. Carry credit strategy: We aim to benefit from the carry difference between the investment grade and high yield corporate universes by being long risky assets and short safer assets.
Next, the “trend” part of the portfolio:
4. Cross-Asset trend strategy: We use a trend-following model to take long/short positions in a diversified set of asset classes such as equities, bonds, credit, currencies and volatility. We use liquid derivative instruments.
Finally, we have three ‘hybrid strategies which we believe are able to extract both income and trend premia.
5. Commodity backwardation strategy: We seek to extract yield from the natural carry of commodity forward prices while benefiting from the momentum effect induced by imbalances in supply and demand. The strategy takes long exposure to commodities in backwardation and short exposure to commodities which are in contango.
6. Equity volatility curve arbitrage strategy: We aim to take advantage of the spread between implied and realised volatility, while extracting the carry from the volatility in forward prices.
7. Long/Short equity factor strategy: We are long global equities that are exposed to factors such as momentum, quality value, and low risk, and short the index adjusted for beta.
LH: How do your fund distinguish yourself from the other Trend-Following CTAs?
LJ: The main advantage that we believe we have is that we are able to deliver the same beneficial features, while avoiding the usual drawbacks. We offer similar risk/return profiles, as well as diversification benefits and protection levels.
In addition to trend opportunities, the combination of income to trend allows to exploit yield spread opportunities within asset classes. At equal risk, assets can have a different risk-reward due to their carry. Risk adjusted to carry has the effect to maximise yield of the long book while reducing negative carry of the short book. To us, it is essential in today’s low yield world.
Trend and income have historically had low correlations to one another, so we expect them to be complimentary in different market conditions. In our view, our strength comes from combining Trend and Income in the right proportions based on their overall risk contribution, targeting a smooth return over time and ensuring that, at the macro level, the portfolio remains robust throughout varying economic cycles.
LH: Where does interest in this Fund come from?
LJ: Interest comes from two main groups of investors. The first is Multi-Asset portfolio managers seeking to diversify their portfolios with investments that are uncorrelated with equities and bonds. The second is hedge fund investors looking to reduce or replace single or multi-manager exposure where they find that our Alternative Risk Premia Fund displays the same risk-return profile as some of their current investments but with better transparency and liquidity and at a lower costs.