There’s been quite a lot of interest, but have you seen much take-up?
We’ve certainly seen take-up and adaptation in the sense of institutional investors moving to a very similar approach. For a while we had an annual conference here at CERN bringing together people with an interest in this approach. More importantly, what I am seeing is the industry stepping up to the challenge with solutions that are risk-driven. Perhaps for me the most visible example is Lombard Odier, a globally active asset manager based here in Switzerland. They had adopted a risk-based approach in 2009, which in effect used the CERN model as a way to approach risk. It wasn’t completely by happenstance: Lombard had read about what we had done and invited me to chair their investment committee. Not only did they take the strategic decision to change about five years ago – around the same time CERN also took the decision, but they went further in the sense that they institutionalised a factor-based framework for the entire portfolio.
So you believe a passive approach has an important part to play in institutional investment beyond simply a tactical one?
Absolutely. Passive to me doesn’t just mean market cap weighting, it can also mean factor-based weighting, so absolutely it does. You can look at ‘passive’ factor-based strategies as providing better building blocks than asset class-type strategies. Your growth, size, momentum, value factors etc provide better building blocks because they are more robust. They have risk premia associated them and are more robust in times of crisis. There is an opportunity for these passive but smarter strategies to gain a lot of ground. The area where active has to play a role is in positioning that mix of building blocks relative to the environment and the risk appetite of the sponsor. There is a real fertile ground for active, systematic, portfolio level management strategies. We define active not as seeking to beat an individual asset class index, but in the CERN model as best positioning those factors relative to the environment. This is going to become more and more important, because the environment is so fluid and the risk profile changes.
Can the model make the most of all market conditions?
It all comes down to application. The first answer is yes, this is a model that by definition seeks to extract the highest performance possible in every environment. It’s not dogmatic in anything. If you adopt an approach that is self-limiting or that is biased to the past as opposed to current market conditions, naturally you can underperform. One of my convictions is that if we look at the next 10- 20 years, we are looking at quite a different cycle than the last 20 years, in terms of growth prospects, credit creation and the impact of those growth prospects in terms of deflationary forces and the impact of deleveraging on the global economy. So if you define risk by looking back at that period, which was the complete opposite, you can wonder whether this will position you correctly for the future. Every investor will have to decide how to best position themselves. That comes down to belief and your time horizon. My view is the time is right for forward looking factor rotation models that adapt to the current long term environment.
The fund exceeded last year’s target by some margin. How is performance looking this year?
It is also materially above the return target and continuing to display a very efficient use of the risk budget. I must point out that our mandate is an absolute return mandate. Our specific mandate is to keep risk very low in order to achieve a minimum level of return and we are significantly ahead of our objective. I think this is because the model simply leads you to very strictly question where are you going to get the most return for your buck in terms of the risk? I have found this is an extremely useful test in terms of questioning your portfolio positioning and leading you in the right direction. Not just asking where do you see the highest returns this year, but where do I see the highest returns relative to the risk. It’s a very different question. It’s this which really justifies factor-based portfolio construction.
Where has this approach led you recently?
Accepting that current central bank policies are a direct driver of deflation, have failed to re-inflate the economy and will fail to do so because they are not oriented towards growth, then the consequence is that you should still maintain an exposure to carry, which we have done and has played out very well. We’ve been left looking at more thematic and high conviction investments, either on a geographical basis, where you’re going to be led to those regions which are better at managing the global deleveraging cycle. There are clear differences between the US, Europe and rest of the world at this stage. You could argue that US has been doing a better job because they’ve given themselves the full set of tools to manage the situation, something the eurozone is depriving itself of. From a geographical standpoint this has led us to be overweight US and overweight Japan, which has worked very well in the last year. From a sector standpoint it’s led us to some thematic overweights around those investments that can capture trends that will succeed in a deflationary environment: automation, knowledge management in the broadest sense and quality. The quality factor is really an acid test these days.
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