27 Dec 2013 Cédric Baron, Fund Manager, Lyxor QF – Absolute Return Multi-Asset 8
Since September 2009. Cédric has been the fund manager in the Lyxor Multi-Asset team and has been part of the Lyxor Absolute Return Multi Asset fund management team since its inception.
LUXHEDGE : ARMA 8 is a rather atypical fund in our “Multi-Strategy” sub-universe as it is basically a long-only fund. Could you describe the systematic active process used in managing your ARMA FUND Luxembourg UCITS?
Cédric Baron: First of all, sorting ARMA 8 under your “Multi-Strategy” index seems adequate to us as our process exploits at least three strategies. The first one is the main one called Strategic Asset Allocation based on an optimal risk weighting among the different asset classes. It is then complemented by a tactical process, fed by both trend following and macroeconomic analysis, which enables to adapt the allocation to the market environment by adjusting the pre-selected strategic weightings. And finally an overall volatility control maintains the fund risk within its maximum limit of 8%.
Our process is based on two pillars. First, we invest in a broadly diversified set of liquid assets. Second, we use a dynamic allocation process to capture the returns from these assets. The aim of this allocation is first, to have a highly diversified neutral allocation in order to begin with a balanced starting point and secondly, to modulate this neutral allocation by increasing our exposure to the most promising asset classes regarding the economic cycles. Typically, we tend to focus on bonds in depressed economies while growth period will naturally drive us towards equities; when this growth period combines with inflation, commodities also gain a more important part within our investment scope.
Please bear in mind that our Strategic Allocation is kept diversified and well-balanced. The Tactical Allocation layer will give a bias to the overall strategy regarding several elements, such as price indicators or macroeconomic signals. This tactical process seeks to gain exposure to specific investment opportunities. Last but not least, as our process is very much driven by a well-balanced risk profile, we control the overall volatility on a daily basis. We rigorously manage the risk within our portfolio.
LH: What have been so far the main advantages of this specific program in comparison to other hedge funds operating along a similar proprietary asset allocation model? What is really your added value?
CB: I think our added value relies on our ability to combine different kinds of alternative strategies. The strategic allocation based on risk balancing is a strategy used by some hedge funds and provides true diversification compared to a nominal weight balancing. The tactical allocation modulates this strategic allocation with techniques used by CTA funds (momentum strategy) and Global Macro funds (fundamental macroeconomic analysis). This combination of hedge funds strategies is packaged in a risk controlled framework that gives regularity and robustness to the fund performance and volatility. The allocation flexibility and high reactivity are also key features of the fund and strong advantage compared to many competitors. These characteristics provide ARMA 8 with its absolute return profile despite its long only investments.
LH: With a 9.03% year-to-date return and an annualized volatility of 7.61%, how does ARMA 8 compare to the rest on the industry?
CB: Well, referring to your LuxHedge’s Multi-Strategy Index, we can see that the year-to-date returns for this strategy recorded at the end of November 2013 was 2.55%. Our positive gap of 6.48% ranks us among the best multi-strategy funds for these first 11 months of the year and proves the fund robustness even in a challenging environment for multi-asset funds.
LH: What is the biggest source of risk for your fund? How do you manage volatility risk? Can you explain how you monitor all risk management aspects?
CB: Within ARMA 8, we constraint the fund to a maximum volatility of 8%. At the strategic asset allocation level, the core assets contribute to 90% of this risk, spread as followed: 36% for equities, 36% for sovereign bonds and 18% for commodities. The remaining 10% cover satellite asset classes, namely US high yield bonds and emerging markets bonds. As this risk budget is fixed, the more volatile an asset class, the less important its strategic allocation. Then due to the tactical allocation this risk contribution can change drastically from this starting allocation depending on market circumstances. The overall volatility risk is managed on daily basis by adjusting, if necessary, the overall exposures to risky assets in order to keep the fund annual volatility below 8%. Other risk metrics such as Value at Risk are analyzed to comply with UCITS rules.
LH: Your fund is currently exposed to equities, sovereign bonds, other bonds. Could you comment on the changes made in the asset allocation since the inception of the fund in October 2012?
CB: First of all, our asset allocation is quite flexible and gives us enough room to react to changes. It is set in the following way: equities can range from 0 to 100% exposure, sovereign bonds can even go from 0 to 200%, commodities can range from 0 to 30% and satellites from 0 up to 10%. The overall net exposure cannot exceed 210%.
Our allocation has fluctuated significantly since inception. We have kept an overweighting in equities compared to our strategic allocation but this asset class weight has varied from a maximum of 80% at the beginning of March down to a minimum of 22% in early June. The sovereign bond allocation has also changed drastically from a maximum of 134% in November 2012 down to a minimum of 6.5% in August 2013. Our exposure to commodities fluctuated between a maximum of 22% in February and August 2013 and a minimum of 0% in October and November this year.
LH: Which is the ideal market environment for your strategy? How do you benefit from it?
CB: As indicated earlier, our strategy allows us to quickly reallocate our assets in response to perceived economic changes. We don’t want to depend on a specific environment. Even though we are a long-only fund, we are very determined to generate a stable absolute return in any market conditions. The aim of our fund is to capture the upward trends while protecting our capital when markets deteriorate.
LH: Would you have a few words about your past performance? Your fund delivered 13.94% since its inception in October 2012 and three successive positive returns from September to November 2013. Which strategies are contributing to these results?
CB: This year, our performance was mainly driven by the flexibility and reactivity of the fund allocation. This enabled us to benefit largely from the strong rally in Japanese equities from November 2012 to May 2013 as well as the US equities one. At the same time our very low exposure to emerging markets prevented the fund from suffering from the poor performance in this area. In May, when all traditional asset classes dropped together, our reactivity pushed the overall fund allocation in risky assets down to very low levels. This was the best way for a long only fund to preserve part of the return posted during the first half of the year. Our overall risk control played a key role during this trouble period. But we didn’t stick to this low exposure as we increased it rather quickly at the end of June to take profit from the strong rebound in equity market, especially in Europe during last summer. Since then we benefited from the upsurges in US and Japanese equities. At the same time our management of the sovereign bond exposure was a success in this highly challenging environment. We benefited from the decrease in interest rates over the first half of the year, and then we reduced it to a very low level in order to avoid the negative effect of rising long term interest rates on our bond bucket. Finally we increased it by the end of August making this asset class contribution flat year to date despite the strong rise in long term interest rates. As you know, market conditions were particularly tough this year in commodity. This lead us to reduce our asset allocation in this asset class. At the moment, we have no exposure in commodities. Our focus remains entirely on sovereign bonds and equities.
LH: Can you give us please, an overview of the quantitative/ qualitative research that goes into your investment decisions?
CB: The ARMA investment process relies both on quantitative and qualitative researches. The strategic asset allocation based on the risk contributions is a purely quantitative model developed by our research team in Lyxor, and more specifically by Thierry Roncalli, head of quantitative research at Lyxor and one of the pioneers in this field. Within the tactical asset allocation we use two types of analysis: (1) The trend following one which is quantitative as it uses mathematical tools to analyze trends on each market within our investment universe; (2) The macroeconomic one which is based on our fundamental views on each market we invest in. To perform our qualitative screening of the different asset classes we have notably the support of our cross asset research team at Lyxor.
LH: Could you please share with us your near term and medium term outlook of the global markets?
CB: We are positive on equities for the coming months. We think the last FOMC statement paved the way for positive returns in equity over the end of this year and the beginning of next year, thanks to their dovish stance and despite the start of tapering. In 2014 markets may be quite volatile due to uncertainties around the central bank and government decisions and their impacts on the economy. But the trend should be positive once again especially if Yellen policy proves to be accommodative and if economic figures (especially on the employment and corporate investment side) keep on improving in the US. We expect long term interest rates to keep on increasing but at a slower pace than this year. Combined with a higher carry level, the sovereign bond market could post only a slightly negative to flat performance. With regards to commodities, we could still face a downward trend for structural reasons. Our allocation is currently overweighed in equities compared to bonds and commodities and if our forecasts prove to be right it should remain like this for a while.
LH: Can you give us a position of your investor base?
CB: ARMA8’s assets are now reaching €120M and could reach €140M in the coming weeks. We enjoy a nice “atomicity” in terms of investor base with the largest investor at €7M. They include private banker teams, family offices, institutional investors focused on absolute return strategies, asset managers and fund of funds managers.
LH: Why did you choose Luxembourg for the domiciliation of this product as it appears that the majority of your investment funds are based in Dublin?
CB: You’re right, the domiciliation of our alternative funds is in Dublin, but most of our long only products like our ETFs are in Luxembourg. As a long only fund ARMA 8 is in Luxembourg, a place recognize and used by a large number of international funds attracted by this type of investments.