fundforward middle east

The People & Ideas Shaping The Future of Asset Management.

FirsT EvEr EdiTion oF FundForward For THE MiddlE EasTFirsT EvEr EdiTion oF FundForward For THE MiddlE EasT

Sébastien Hénin Explores Why

Arab Oil Producers Are Enjoying

A Pricing Bonanza

Hasnain Malik Reveals Exclusive Research On The

Geopolitical Outlook

For Different Regional Markets

Saker Nusseibeh Hopes To Find The

“Alpha Advantage’

Through Passive Vs Active Stock Selection &

Portfolio Management

Sébastien Hénin Explores Why

Arab Oil Producers Are Enjoying

A Pricing Bonanza

Hasnain Malik Reveals Exclusive Research On The

Geopolitical Outlook

For Different Regional Markets

Saker Nusseibeh Hopes To Find The

“Alpha Advantage’

Through Passive Vs Active Stock Selection &

Portfolio Management

Making a plan: The MyFundForum networking platform and app allows delegates to prioritise their week. View the whole agenda and decide which high profile sessions, smaller group discussions and networking opportunities you need to attend and, more importantly, who you need to meet.

Catching up on the news:Being busy people, it is easy to get ‘out of the loop’ on what is happening in the region and reading the news online can only tell you so much. It will be fascinating to talk with delegates and speakers, as well as listening to what is said on the stage and get a feel for what is really happening.

But news comes in all shapes and sizes these days! It’s always interesting to get ‘sucked into’ the event’s twitter feed and see what people are saying, thinking and enjoying at the conference. Use the hashtag #FFME14 and tweet

@FundForum and let people know what you are thinking.

Connecting with the right people: MyFundForum

networking platform and app

allows you to search for the relevant people

you want to meet and set up meetings with them. It’s exciting to watch the industriousness of the FundForum Middle East delegates: shaking hands, exchanging business cards, engaging in lively discussions with peers.

New this year: Manager networking package: asset managers have been signing up to have their own networking table in the exhibition area, and throughout the event we’ll expect to see meetings taking place there and documents being passed around. It is sure to be a real hub.

Meeting & networking: There are two networking receptions this year, taking place on Sunday and Monday - sure to be a centre of activity. For every old friend you bump into, try to connect with someone completely new and make the most of the diversity of the delegation.

Enjoying moments of calm: Every so often everyone needs the chance to kick back, relax and re-energise (by which read ‘drink some coffee’) and it’s always at these moments that you have the most interesting conversations: meet acquaintances and new contacts and get a chance to learn what they are doing.

What I’ll Be Doing At

fundforumMiddle East

FundForum Middle East 2014 What do you think? - #FFME14

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We start by looking at topics for the region.

Hasnain Malik of Exotix, provides an extract from a recent report on Frontier Markets. Malik explains why investor sentiment veers between euphoria and despair when looking at many of these markets. To read more, go to page 5

Imco Brouwer of Gulf Research Centre, looks at the challenges facing the GCC states in terms of labour markets and migration. To read more, go to page 7

Our third piece examining regional outlooks is Sébastien Hénin’s ‘A bonanza for Arab oil producers’. Hénin looks at the reasons behind current high oil prices and tracks the ensuing increase in GCC government budget expenditures. To read more, go to page 8

Finally, Akber Khan, Al Rayan Asset Management, provides an interesting perspective on the

importance of Saudi Arabia. To read more, go to page 9

Our first look at asset allocation comes from Saker Nusseibeh of Hermes Investment Management. Nusseibeh looks at the real value of active asset allocation and stock selection as sources of portfolio returns. To read more, go to page 11

A second paper looking at the theme of ‘Asset Allocation & Cyclicality’ comes from Bernard Caralp of Sedco Capital. Caralp explores the well-known theory of diversification across a portfolio and in dealing with market cyclicality (ignore it at your peril!) To read more, go to page 13

Our final two papers look at two specific investment strategies. Shawn Mato, Aviva Investors, takes a look at multi-strategy portfolios as a means of combining short-term investment ideas with shorter-term risk management. To read more, go

to page 15

Last, but by no means least, Michael Rimmer, Origin Asset Management, argues the case for bottom-up stock filtering as a means of value investing and a better alternative to macro strategies and forecasting. To read more, go to page 17

I hope that you will enjoy reading these features, and take the opportunity to challenge and question the authors on their views. I’ll be looking forward to doing so myself- either with a coffee during a networking break, or during One-To-One time, or even whilst the individual is on the stage! Get your questions ready!

I look forward to seeing you in Dubai.

Ellie Bates - Director, FundForum Middle East 2014

The Magazine For FundForum On The People And Ideas Shaping The Future of Asset Management.

Welcome to FundForum Middle East’s first ever edition of FundForward. Here you’ll find insights to inspire you from some of this year’s speakers, covering important regional geopolitical themes, thoughts on asset allocation as well as investment product innovation. Make the most of the unparalleled access which FundForum Middle East gives you: if something here grabs your attention here, meet the writer in person!

M i d d l e e a s t 2 0 14

FundForum Middle East 2014Join @FundForum on Twitter a

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futureevents

FundForum Middle East 2014

The 6th Annual FundForum USA 27 - 29 October 2014,

Mandarin Oriental in Boston

The 7th Annual FundForum Latin America 1 – 3 December 2014, Hotel Sofitel Santa Clara,

Cartagena in Colombia

The 9th Annual FundForum Asia 13 – 16 April 2015,

JW Marriott in Hong Kong

The 25th Annual FundForum International June 2015,

Venue to be announced

FundForum USA Mandarin Oriental in Boston

FundForum Latin America Hotel Sofitel Santa Clara, Cartagena in Columbia

What do you think? - #FFME14

Our regular feature to show you whats going on in the world of up-comming Fundforum events and functions.

FundForum International Venue to be announced for Europe

FundForum Asia JW Marriott in Hong Kong

inside this issue

contents5 – FROntieR MARKets - Hasnain Malik

7 – MiGRAtiOn & LABOuR MARKets - Imco Brouwer

8 – unDeRstAnDinG OiL PRiCes - Sébastien Hénin

9 – iMPORtAnCe OF KsA - Akber Khan

11 – FinDinG the ALPhA ADvAntAGe - Saker Nusseibeh

13 – RisinG investMent stAR - Bernard Caralp

15 – FResh investMent APPROAChes - Shawn Mato

17 – sYsteMiC investMent - Michael Rimmer

20 – RisinG RAte enviROnMent - Fred Ingham

21 – FLOOR PLAn OF event - The Asian Family and Private

24 – FunDFORuM tv

SPecIAl ThAnkS And credITSFundForward Editorial Team: Amos Rojter and Eleanor Bates

Sponsorship: Ian LawDesign Team : LockOn Productions:

lockonproductions.comArtistic director: Chris Shields, LockOn Productions


Between euphoria and despair. Frontier and smaller Emerging markets are often viewed as the next BRICS type of long-term investment opportunity. While economic growth in the Frontier is likely to be higher (coming off a lower base), it is also likely to be more fragile given weaker political and economic institutions. Although the incidence of economic failed states, where property rights are violated, is rare, we find Frontier investors veer between euphoria over the trajectory of growth and despair. This is exacerbated by the ongoing, rapid growth in the pool of capital allocated to the Frontier and a shortage of liquid, accessible public equities.

Proprietary analytical framework. We seek to qualitatively identify positive investment

opportunities where political and economic risks are improving (based on an analysis of political factors such as cohesion in the ‘deep-state’, stability of the relationship with key international geopolitical sponsors and potential structural macroeconomic catalysts and shocks) and where there is evidence of investor despair (reflected in the de-rating of the market valuation multiple or in discounts to previous index peaks).

Preferred markets.Among the African, Middle Eastern and South Asian markets covered in this report we like Oman and Sri Lanka the most. We are also positive on the risk outlook for Egypt, Bangladesh, Morocco, Saudi (international) and Dubai, although valuation and price performance suggest some of this is priced in. While we have concerns over the deteriorating

risk outlook in Nigeria, valuation and performance arguably already compensates. Among the other larger markets, we are more cautious than many on Abu Dhabi, Kenya, Kuwait, Qatar and Saudi (domestic).

The Middle EastThe US détente with Iran is re-ordering geopolitical relationships across the region and more interventionist foreign policy by the GCC states. In our view, beneficiaries of these changes, in terms of improving political and economic risk, are Dubai, Egypt (see Africa section below) and Oman. On the other hand, we see deteriorating risk profiles in Kuwait, Qatar and Saudi. The GCC as a group has outperformed and re-rated in valuation multiple terms relative to global Frontier and Emerging market peers due to defensible dollar pegs in an environment of QE taper, high oil prices and, in the case of Qatar and

Hasnain Malik, Managing Director, Head of Frontier Markets Strategy, EXOTIX PARTNERS LLP

Hasnain Malik gives a keynote address on the morning of day 2

of the main conference, 23rd septmber.

FROntieR MARKets

Country Contrarian S T r A T E g y


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UAE, index upgrades, but structural vulnerabilities persist (rising fiscal breakeven oil price, under-employment, public sector dependency, duplication in national development strategies) and we call for a more selective approach.

Dubai should continue to benefit from ‘refugee capital’ and the ultimate softening of Iranian sanctions. Real estate is slowing down but a systemic crash similar to 2008 looks very unlikely. Dubai equities have outperformed almost all peers but there is more to go for in the blue-chip plays on its unrivalled regional hub status. Oman should also benefit if Iran sanctions are lifted, allowing construction of the Iran-Oman-India gas pipeline which should alleviate shortages of gas required for industrialisation and re-establish Oman as a hub for trading between Iran and India. Oman is near its lowest trailing price/book for 5 years.

Kuwait’s political paralysis and associated project spending delays are a theme investors are familiar with. But political risk appears to be deteriorating as opposition elements increasingly express their discontent outside the institutional ‘vent’ of Parliament. Stocks with international exposure have offered a hiding place but their exposure to Iraq deterioration hampers this. Land banks in real estate stocks at least offer stores of value for abundant local liquidity.

Qatar equities are at their most expensive for 5 years, in trailing price/book terms, and the MSCI index is the only one in MENA to have surpassed the peak seen prior to the global financial crisis. Similar to Abu Dhabi, Qatar offers relative portfolio defensiveness in a risk-off global context. However, in a slowly improving global growth outlook Qatar’s higher-risk growth (now driven

more by domestic construction than gas export capacity) and the commercial risks resulting from its interventionist foreign policy (‘loss’ of potential gas customers such as Egypt and Pakistan) make it less appealing, in our view.

We split Saudi into ‘International’, comprising Banks and Chemicals, and “Domestic’, mainly Consumers. A turn in US interest rates and slowly improving global growth favour ‘International’, whereas rising labour costs, more mature penetration, rising political risks and upward valuation re-rating makes us more cautious on “Domestic”. If Cabinet approval for direct foreign ownership sets Saudi on a path to ultimate MSCI EM inclusion, then anticipation of related funds inflow should help all stocks, but note there is no shortage of local liquidity and market trailing price/book is already its highest for 5 years.

Worsening Improving

POLITICAL AND ECONOMIC RISk

Complacency Out-performerHigh Valuation

Despair Under performer

Low Valuation

INV

EST

OR

Ex

PE

CT

AT

ION

S

Oman

Sri Lanka

Morocco

JordanTunisiaLebanon

Nigeria

Bahrain

Zimbabwe

kuwait

Bangladesh

Pakistan

Saudi (i) Egypt

DubaiSaudi (d) Qatarkenya

Abu Dhabi


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All members of the Gulf Cooperation Council

(GCC), albeit having different sizes in terms of population and resources, face similar challenges. These include: the continuous growth of the foreign nationals vs. nationals, both in absolute and relative terms; the failure of substituting foreign nationals by nationals in the labour market; the persisting low level of productivity of both national and foreign workers in most occupations; and the structural discrimination of (often highly educated and skilled) women from the labour market.

These challenges are obviously related to others, such as: the (perceived) challenges to national identities and societal models; the (need for) search for alternative models of development which rely decreasingly on the declining natural resources; the continuous discrepancies between declarations in favour of GCC regional integration and the lack of decision and especially implementation towards this goal; and the incessant search to become

visible globally and achieve more prominent international political roles which increase pressures for reform.

Obviously, there are many explanations for the (persistence / growth) of these challenges. It will not suffice to state that most of the GCC countries became independent forty years ago, that the oil and gas revenues increased massively around the same time, and that many developments escape their control. Here we focus on two issues that contribute in explaining the persistence of the above mentioned challenges and that should be addressed if the GCC countries want to address them effectively.

Firstly, the capacity to develop and implement evidence-based policies. Many ministries, departments, and agencies have been set up over the past decades and produce data, analyses and recommendations. In the realm of population and labour statistics, for example, the capacity of the GCC states has increased dramatically. However, data collection is still largely inconsistent

and uncoordinated and harmonization and pooling data is non-existent. Actually, there is neither a culture nor a practice of sharing data, not only with the stakeholders and the larger public, but also among agencies. Research capacity in the various agencies has improved, but has still a long way to go to incorporate data, evaluate past policies and formulate sound policy recommendations.

Secondly, in the decision-making procedures in the GCC countries a few stakeholders have an enormous weight and most stakeholders are excluded, while policy recommendations prepared by the various agencies are not taken into account.

If both these issues are not addressed vigorously and convincingly, we will continue to hear about, for example, the need for and success of the nationalization of the workforce while in reality the reliance on foreign workers increases and the participation of nationals in the labour market remains stable in absolute terms and diminishes in relative terms.

Challenges for the gCC States: Labour Markets, Migration and Beyond

Imco Brouwer, Executive Director, Gulf Labour Markets & Migration Programme, GULF RESEARCH CENTER

imco Brouwer particiaptes in one of the strategy lab sessions, during the afternoon of day 1 of the main

conference

MiGRAtiOn & LABOuR MARKets


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Volatility of oil prices is also another important

indicator to take into account in any analyses. We are not only well below the long term volatility average but we have even reached an historic bottom. Since mid-2010, we have entered in the longest period of low price volatility since the 90’s.

On the supply side the oil market went through significant changes. The geopolitical situation in the MENA region had some severe consequences in terms of output for countries such as Libya, Iran and Syria which have lost almost 2 million barrels per day of production during the last two years. At the same time the oil production in the USA has increased by 2.5 million barrels per day since the beginning of the shale revolution and the

country will soon be back on the international stage as an exporter of refined products. Meanwhile the demand is growing consistently at a yearly average of 1 million barrels per day driven mainly by emerging economies. The market is well balanced and the visibility is quite good despite intensifying geopolitical issues in key production areas.

In this favorable context, GCC governments benefit from lifted revenues and a great visibility on it to increase significantly their budget expenses. The context has been particularly serious for public budgets. Following the Arab spring powers in place have to deal with a more demanding population and an ongoing demographic pressure. Indeed, the region has the highest growth population rate in the

world at 2% per year.

Budget expenditures have increased at a double digit pace since 2011 within the GCC. With an average break-even level at USD80 per barrel, governments can however feel at ease when implementing their decisions. The first round of public expenses was targeting salary increases and social benefits in a region where most nationals are employed by the public sector. The next round of public spending which has just started will target infrastructure in sectors such as education, healthcare, power and transport. In an environment in which governments have limited leeway to postpone their capital expenditures decisions, the current oil price environment represents a key support.

a bonanza for Arab oil producers

Sébastien Hénin, Head Asset Management, THE NATIONAL INVESTOR

Oil prices are trading close to their highest levels. The average price for oil (Brent quality)

during the first half of 2014 reached USD108.8 per barrel, a level very close to yearly

average prices recorded since 2011. During this period oil prices have been consistently

trading above the average price of 2008, the year that oil prices reached a historic high.

sébastien Hénin will be contributing to a panel discussion on opportunities in MEna during the Global asset

allocation summit, 21st september.

undeRstAndinG OiL PRiCes


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MSCI’s reclassification of UAE and Qatar from Frontier to Emerging Markets was akin to these countries winning a prize on the global stage. After much excitement, extensive press coverage and billions of dollars of foreign inflows, the long-awaited upgrades are behind us. So what happens next?

Some impacts are already visible while others will take years to emerge. Quick wins included the virtuous cycle from a jump in liquidity, squeezing bid-offer spreads and attracting further volume. The narrative in global financial media will change. Dubai will no longer just be a popular destination for tourists and real estate investors; Abu Dhabi’s domestic spending plans will enjoy greater external attention; while Qatar will see articles

about more than just its own investments abroad. Increased capital inflows will expand equity markets adding another option to finance government plans and associated private sector expansion.

A recalibration of shareholders will follow. Many international investors have long invested in the GCC and higher correlation to global markets is evident in the stocks they favour. As foreign ownership rises, UAE and Qatari equities will also see indiscriminate selling during times of global ‘de-risking’. However some of these new investors have considerably longer horizons than existing shareholders and companies will see greater demands to improve transparency and come up the investor communication curve.

The importance of Saudi Arabia

While attention has been on UAE and Qatar, the real prize in the GCC would be to add the Kingdom of Saudi Arabia (KSA) to the fold.

In early 2013, H.E. Mohammad Al-Sheikh was named Chairman of the Capital Markets Authority (CMA). After a few adjustments, such as moving the work-week to the regionally conventional Sunday-Thursday, in July 2014 Al-Sheikh’s CMA announced that the Saudi equity market will open to foreign investors in 2015.

Regulatory change is never rushed in Saudi Arabia and this is likely to be a measured and gradual liberalisation.

Akber khan, Head Of Asset Management, AL RAYAN ASSET MANAGAMENT EXOTIX PARTNERS LLP

After years of anticipation, the UAE and Qatar have finally been reclassified from

Frontier to Emerging Markets by MSCI. While local exchanges and regulators have

done the heavy lifting so far, the onus will now be on listed companies to prove

themselves to a more international audience. However the region’s giant, Saudi Arabia,

remains in the shadows. If, or rather when, the Kingdom opens up to foreign investors,

the gCC will be firmly on the global investment map.

THE IMPORTANCE OF KSA


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The Kingdom’s size and potential are compelling. The $750 billion economy should continue to grow in the mid-single digits and accounts for almost half of the GCC’s GDP. KSA’s 28 million people represent more than 60% of the region and Saudis make up 75% of their country’s population in stark contrast to Qatar and the UAE where just one-in-nine are citizens.

While Qatar boasts the greatest proportion of millionaire households of any country (at 16%) and Abu Dhabi’s $100,000+ GDP/capita makes it one of the highest globally, Saudi’s more modest $26,000 reflects a demographic closer to an average emerging economy. The Kingdom is home to the ultra-wealthy but also a very large middle class, low income and unemployed. This brings to bear familiar themes for global investors such as urbanisation and industrialisation which are limited in the region.

The Saudi stock market boasts superior breadth and depth versus regional peers.

164 listed companies (92 in the UAE, 43 in Qatar) with average daily volumes ($2.2 billion+) more than double the UAE and Qatar combined.

The Kingdom offers superior diversification and is not dominated by banks and real estate companies. There are numerous petrochemical producers benefitting from some of the cheapest feedstock in the world as well as dozens of consumer and industrials which are key beneficiaries of enhanced government spending.

MSCI Saudi Arabia’s $490 billion market capitalisation compares to MSCI South Africa at $430 billion (≈7.5% weight in MSCI EM) and $370 billion for MSCI Mexico (≈5.0%). Foreign ownership limits would lower Saudi’s weight, but the GCC’s overall weight in global indices would become significant.

So while UAE and Qatari equity markets bask in their upgrade to MSCI EM, the true coming of age for the region will be if, or when, Saudi joins them.




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Academics and institutional investors then took two

extraordinary leaps of faith. The first was to dismiss stock picking (except when they were willing to pay hedge fund managers two-and-20 fees).The second was to assume they were skilled at asset allocation – and are therefore able to add value by this means!

In turn, this spawned a whole industry geared towards creating value out of asset allocation, with no more proof that alpha exists in asset allocation than in stock selection!

After 2008, more and more ‘outcome-oriented’ strategies have been created, promising

remarkable returns through magical asset allocation modality and built either through new factor-based investing, overlays or sophisticated models using such new tools as ‘volatility’.

New strategies to invest in, such as direct loans, have also emerged.

Saker Nusseibeh, Cheif, Executive Officer, HERMES INVESTMENT MANAGEMENT & Chairman, THE 300 CLUB

The accepted wisdom in the institutional investment world is that strategic asset

allocation (SAA) dictates portfolio returns, and the accepted corollary is that specific stock

picking value-add is random. This was partly built on gary Brinson’s work, in which he

observed that SAA determined more than 93.6% of the variability of portfolio returns1. In

2000, roger Ibbotson and Paul Kaplan concluded that it explained all returns2.

f i n d i n g t h e

ALPHA a d v a n t a g e

■ 1 Weightings rebalanced at the end of each calendar year. Underlying exposures managed against standard industry benchmarks, such as the MSCI All Countries World Index for global equities. ■ 2 Based on quarterly returns.

Multi-asset portfolio1

Return 7.28% 4.48% 13.60%

30 June 1998 30 June 2013

30 June 1998 30 Sep 2008 Run up to Lehman

1 Oct 2008 to 30 Jun 2013 After Lehman

Standard deviation 7.56% 7.27% 7.96%

GBP(annualised)

uK CPi

Return 2.23% 1.78% 3.24%


state street Global services WM 50 universe2

Return 5.83% 4.77% 8.16%



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Still, there is no proof that any of this actually works in the long term because asset allocation only adds value when directed by skill (alpha). I would argue that a careful study of the facts reveals that alpha is rare in both stock selection and asset allocation.Moreover, the rush towards sophisticated new models is, in my view, entirely without merit, in that it complicates what is essentially a simple proposition.

To prove this point, we at Hermes created a multi-asset paper portfolio and compared its long-term returns against those of the large pension funds in the UK, constituting the State Street Global Services WM50 Universe. From 1998-2013, it outperformed them by an annualised 1.35% in GBP terms with a lower standard deviation of 3.27%. It made a real return of more than 5% annualised! During the financial crisis, it outperformed peers by 5.44% and with less volatility, with real returns of over 4% annualised!

What did the multi-asset portfolio that beat the competition and produce such remarkable real return ‘outcome’ contain? 1980s-style asset allocation:

■ Global equities: 40%

■ Global bonds: 35%

■ Corporate credit: 15%

■ Private equity: 10%

The main difference between our model and all the sophisticated models touted

by fund managers today is that it held a static strategy over 15 years, only rebalancing once a year. It ignored market movements and crises and just held steady. This particular strategy invested in indices and was therefore remarkably cheap, yet it beats all the expensive computer-model-driven, back-tested offerings of outcome and access strategies.Why? For the same reason that people now use index funds to access beta, and even smart beta. Unless you know you have skill in stock selection, buy beta. Similarly, unless you know you have skill in asset allocation, adopt a long-term static approach.

Rare skill boosts SAAAs I indicated at the start, investment skill does exist. The 2010 findings of Ibbotson and colleagues show that active management contributes significantly to portfolio returns3.

As with stock picking, it is possible to exhibit skill in asset allocation. However, I would argue that skill is as rare in asset allocation as it is in stock selection – if not more so – because the required depth of knowledge and holistic view cannot be acquired through models or a short career span. Where it can be found, it can add value, as demonstrated by my colleague, Alan Brown, Schroders’ former CIO4, who argues that a skilled asset allocator can add value through dynamic asset allocation.

ConclusionThe conclusion is therefore simple. If you think you can find skill or alpha as a stock picker, construct portfolios with high active shares. If you are unsure of your skill, become a beta jockey, and buy either beta or smart beta exposure.

Likewise, if you think your 30-year investment career and holistic understanding of geopolitics, behavioural finance and the financial system makes you one of the very rare people who exhibit alpha in asset allocation, then apply it either in a standard format, a model, or dynamically. If you are unsure, then decide on a long-term static SAA, switch your screens off and go to the beach for the next 15 years. Chances are you will achieve an amazing ‘outcome’ of positive real returns and beat more than 85% of other investors!

stAtisiC ReFeRenCes

■ “Determinants of Portfolio Performance,” by Gary Brinson et al. Published July/August 1985 in the Financial Analysts Journal.

■ “Does Asset Allocation Policy Explain 40,90, or 100 Percent of Performance?” by Roger Ibbotson and Paul Kaplan. Published January/February 2000 in the Financial Analysts Journal.

■ “The Equal Importance of Asset Allocation and Active Management,” by Roger Ibbotson et al. Published March/April 2010 in the Financial Analysts Journal.

■ “Dynamic Asset allocation and Fund Governance,” by Alan Brown. Published April 2013 by the 300 Club.Saker Nusseibeh founded the 300 Club and is a current participant.




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Rather than putting together a basket of individual

companies and relying on market timing to get in and out at the right time, research shows that an investor is better off investing broadly across many markets, adhering to an asset mix that suits his/her circumstances: a blend of stocks, bonds and other asset types – and geographic location of these – that works best for his /her personal circumstances (age, liquidity requirements, risk profile, etc.) Furthermore, it is worth noting that few actively managed portfolios are able to outperform the market consistently.Diversification reduces risk without compromising

performance. This reduces the impact of individual holding and enables investors to scientifically employ the risk factors that offer higher expected returns. Keeping one’s eggs in more than one basket is the age-old means of reducing risk. Investing across various asset classes – stocks, bonds, real estate, cash, and subsets of each across different investment styles– allows one to benefit (and avoid or minimize losses) at any stage of the market cycle. And, here is the word: Cycle! It is essential to keep in mind that just about everything in our world proves to be cyclical. The basic reason for this cyclicality

is the involvement of human instincts being in our decision making process. Mechanics can go straight forever but processes which involve people provide variable and cyclical results mainly due to their emotionality and inconsistency. When people feel good about the way things are going, their behavior is strongly impacted. They spend more and save less. They borrow to increase their enjoyment, even though doing so makes their financial position more precarious. They act as if things will do well for ever and investments that are outperforming will continue to do so.

Bernard Caralp, CIO- Head Asset Management, SEDCO CAPITAL

RisinG inVestMent stAR

Whether in academia or the real world, asset allocation had

been proven to be the primary and unquestioned driver of portfolio

performance ahead stock picking or market timing.

&Cyclicalityasset allocation


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But as Heraclitus once said “Change is the only constant”. All these things are quickly reversible supporting the fact not only that extremes of cycles are largely due to people’s emotions and weaknesses but also that cycles are self-correcting and their reversal is not necessarily dependent on exogenous events.

Cycles reverse (rather than going on forever) because trends create the reasons for their own reversal. In fact, success carries within itself the seeds of failure, and failure the seeds of success.

Ignoring cycles and extrapolating trends is one of the most dangerous things an investor can do. But cycles will never stop occurring. Economies will wax and wane as consumers spend more or less, responding emotionally to economic factors or exogenous events, whether geopolitical or naturally occurring. Companies will anticipate a rosy future during an up cycle and thus over-expand facilities and inventories; these will become burdensome

when the economy turns down. Investors will overvalue companies when they are doing well and undervalue them w hen things get difficult.

And yet, every decade or so, people decide cyclicality is over. This belief exemplifies a way of thinking based on the dangerous premise that “this time it’s different”. These four words should trigger fear and suggest asset allocation “cyclical” rebalancing for any investor/manager who understands the past and knows that it repeats itself.

To support such reallocations, the credit cycle deserves a special mention as a factor driving the fluctuations of the economic cycle. It takes only a small fluctuation in the economy to produce a large fluctuation in the availability of credit with great impact on asset prices and back on the economy itself.

At the extreme, it is easy to notice that the worst loans are made at the best of times and vice versa. Does this remind you of something?

Bernard Caralp speaks during a panel on the second day of the main conference,

23rd september.




Traditional investment strategies employed by

long-term investors, biased to equities and bonds, have often struggled to provide the investment performance schemes want in recent years. As the US Federal Reserve (Fed) contemplates the timing of the next rate rise and the euro zone skirts a period of deflation, the prospects for improved performance from traditional approaches look limited.

Time for a fresh approachWe believe an outcome-focused strategy could meet the needs of many long-term investors to generate sufficient returns to remove any funding deficit while reducing the volatility of funding levels.

More complex investment strategies must be employed to combine suitable types

of investment to provide the performance investors typically expect. What is needed is a strategy that provides value during a negative environment while not costing too much during a normal environment.

In our view portfolios need to become much more diverse than in the past to achieve their desired risk and return aims. In particular reducing portfolio volatility levels can be done

Shawn Mato, Fund Manager, Global Convertible Bonds AVIVA INVESTORS

FResh inVestMent APPROAChes

Multi-strategy portfolios combining diverse long-term investment ideas with shorter-term

risk management could deliver many investors’ risk and return objectives, says Shawn

Mato, a convertibles fund manager at Aviva Investors.

simplicity out of

complexity

shawn Mato ‘s colleague, daniel James,

gives a solo talk during the morning of the first day of

the main conference, 22nd september.


15

more effectively by combining investments in traditional asset classes such as equities, bonds and property with financial instruments. This allows a wide range of investment views to be taken in portfolios, possibly including views on interest rates, inflation and volatility.

Multi-strategy investingMore than anything, we believe that in taking a long-term approach to meeting client needs, it is crucial to focus on portfolio construction and build portfolios that combine long-term investment ideas with shorter-term risk management.

We launched the Aviva Investors Multi-Strategy Target Return Fund in July 2014. The fund targets average annual returns of 5 per cent above the European Central Bank rate over a rolling three-year period with less than half the volatility levels of equities.

We believe constructing a flexible, robust portfolio

is as important as coming up with good investment ideas. And, by drawing ideas from our capabilities around the business, which may include equities, fixed income, convertibles, currencies and interest rates we can create truly diverse portfolios.

Risk considerations are at the heart of portfolio construction when selecting strategies. By blending each strategy in the appropriate proportions we can generate lower portfolio risk than the sum of the risks of each strategy irrespective of market conditions. We manage each strategy to remain within set tolerance levels so portfolio risk is consistently diversified.

“In our view portfolios need to become much more diverse than in the past to achieve their desired risk and return aims.”




16

Origin Asset Management is proud to be different. It’s

slogan is ‘evidence, not opinion’, meaning its five-strong team of investment professionals does not rely on macro and market forecasting, nor on external stock analysis to guide their unconstrained, high conviction global, emerging market and small cap strategies.

‘We are different. We do not do macro and we do not forecast. Making forecasts at the economic or company level tends to over-inflate your sense of confidence; it is a

real behavioural issue,’ asserts Michael Rimmer, partner at Origin Asset Management.

He also sees little value in buying in research from the investment community. Too much research input from multiple sources can lead to “management by committee” which dilutes conviction and return potential. Instead, Origin relies on hard evidence that individual stocks have good growth prospects.

Stock filtering is a bottom-up process that relies on four

key factors: management performance; reasonable valuation; share price trends; and earnings revisions.

‘A company has to be well-managed. The management need to know what they are doing. Value investors look for companies in distress, but they then have to predict how and when a turnaround will happen,’ says Rimmer.

Linked to this is growth. Most investors tend to concentrate on growing earnings per share. Predictably, the Origin team

Michael Rimmer, Partner, ORIGIN ASSET MANAGEMENT

Forecasting is a mug’s game. real evidence a company is

growing is best for stock pickers, says Michael rimmer,

partner at Origin Asset Management.

sYsteMiC inVestMent

Evidence BEATS opinion


17

takes a different tack. They also look for asset growth, a strong signal that companies are making money and reinvesting to

create further value. The approach currently provides a bias towards technology, healthcare and selected industrials across Origin’s five investment strategies.

Yet such consistent growth stocks also tend to be highly prized, a trait reflected by often high valuations. As Rimmer points out, he wants to avoid buying yesterday’s winners without being the last into any stock. Stocks must be undervalued - but not for all the wrong reasons.

‘We look at the earnings and operating environment and whether they are getting better. It provides a nearer term indication a company is doing well,’ he says. Whilst Origin does not rely on external forecasters, it does set each potential stock in context.

Rimmer says the market is generally efficient. If the first three criteria are met and the market agrees - as measured by relative technical strength - then a stock may make it into a portfolio. ‘We do not go to company meetings either. But we still retain a personal touch through our long experience and relentless focus on the things we care about. Our approach reduces the number of false positives and weeds out the noise,’ says Rimmer.

‘It is a systemic approach, not pure quant. The machine is never in charge. Empirical evidence shows the four characteristics deliver over time, but we try to be modest. In our process, we never pretend we know more than we actually do,’ he adds.

Origin portfolios do not hug the benchmark, and each has a high tracking error. The team also has a wider margin at broad country or regional level to select the stocks they think best fit their criteria. Position size and liquidity are important, yet stock specific risk is reduced by maintaining a diversified portfolio at all times.

‘The process is decidedly ‘risk-on’,’ says Rimmer. Its mid-cap bias will lead to lagging performance when markets seek shelter in big, high dividend stocks. But it generally turns round quickly when more normal conditions return, as in 2013, which was a strong one for the firm, further enhancing its long term track record.

Even in a downturn, we can outperform. Our focus on high return, low leverage and non-cyclical stocks equals quality - and the market always comes back to rewarding strong corporate fundamentals,’ says Rimmer.

“A company has to be well-managed.

The management need to know what they

are doing.”

Michael rimmer speaks during a panel looking at Emerging

Markets on the Global asset allocation

summit day, 21st september.




The potential for hedge funds to help mitigate downside and even

benefit from rising rates can make them an attractive complement to traditional allocations for all types of investors, particularly in the current environment.

For many, hedge fund investments are helping to fill the void left by declining fixed income allocations. Since 2002, hedge funds have

posted strong performance during periods of rising rates, due in part to their ability to short, hold cash, allocate among different asset classes and move across different sub-strategies.

A rising rate environment creates attractive opportunities for specific types of managers, including fundamental equity long/short, credit arbitrage and event-driven managers.

On May 2, 2013, the 10-year Treasury yield reached its year-to-

date low of 1.63%, before going on rise to 3.04% by year end. This

led to a meaningful outflow from investment grade fixed income

and conventional income generating strategies in mid to late 2013.

Although bonds have surprised on the upside in 2014, with the

10-year Treasury retracing to 2.45% at the time of writing, longer-

term investors have heeded the warning signs and continue to seek

alternatives to low bond yields and interest rate risk.


Fred Ingham, Head of International Hedge Fund Investments, Neuberger Berman Alternative Investment Management

Hedge Funds offer alternative to bonds in a

rising rate environment

What do you think? - #FFME14

Fertile ground for Long/Short picks

Higher interest rates generally mean that hedge funds receive higher rebates on their short positions. This environment also indirectly exposes the disparity among companies with varying financing structures, margins and business models, leading to higher dispersion among stocks. Consequently, fundamental hedge fund managers find these to be fertile stock-picking conditions, with the ability to generate returns on both the long and short sides of the portfolio by identifying the best and worst stocks.

Benefiting from Credit arbitrage opportunities

These managers also find interesting relative value opportunities during a rising rate environment. For example, a fund could invest in floating rate bank loans and hedge their credit exposure with duration-sensitive fixed rate corporate bonds. This position has a net negative duration and benefits directly as rates rise. Additionally, rising interest rates are associated with rising costs for corporates with floating rate debt financing. Identifying the companies that will struggle to refinance this expensive cost of capital, as a short investment, or those that can refinance this debt as a long investment, also

leads to fundamental credit selection decisions.

Risk premiums will rise for merger stories

Merger arbitrage strategies, where investors seek to profit from trading in merger targets, have returns comprised of the risk-free rate and a spread (or risk premium) above this rate. The risk premium, among other things, compensates an investor for risks associated with regulatory approvals, the ability to secure deal financing, shareholder approvals and any uncertainties related to delays in the timing of a deal closing. As interest rates rise, this risk premium typically increases as well, perhaps most obviously because the cost of financing and the ability to secure financing increases. Additionally, the risk-free rate itself is rising, which means the combination of the risk-free rate and the risk premium is higher on an absolute basis in periods of rising rates.

CTA and Global Macro strategies are less well set

Trend following strategies (also known as “CTA” strategies) have historically typically maintained a long position in government bonds, and so offered protection in a risk-off market. However, more recently, low interest rates have made it difficult to trade with a long bond

bias. If interest rates continue to rise, CTAs may begin to short government bonds, increasing their correlation to risky assets. This could make them less effective as portfolio diversifiers over the medium term. Similarly, we expect that some global macro funds could experience related issues in the current environment and have historically demonstrated less diversification potential in rising rate environments as well, although they have fared better than CTA strategies.

Timing is difficult

Hedge funds have the potential to protect capital and often benefit from rising rates, which can make them an attractive complement to traditional allocations for a variety of investors. Although the exact timing and future extent of rising interest rates are uncertain and dependent on a number of factors, investors may consider an allocation to hedge funds versus more traditional asset classes sooner rather than later, particularly given the run up in risk assets over periods.

By diversifying across hedge fund strategies and building a conservatively positioned portfolio with a robust short book and modest gross and net exposures, many investors are targeting absolute returns and a low beta to the broader markets during these challenging times.




20

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